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Chapter 6 Sourcing McGraw-Hill/Irwin Operations Strategy Copyright © 2008 The McGraw-Hill Companies, Inc. All rights reserved. 6-1 Sourcing Strategy Questions How many suppliers should the company engage in total and for a given part or commodity? What role should each supply play? Should overseas sourcing be used, and if so, how much? How should supplier relationships be structured and managed? 6-2 Sourcing Strategy: What Can Be Sourced Design of part of all of a product or service Manufacturing or delivery of a complete product or service Manufacturing or delivery of some or all of the components or modules of a product or service Extraction and processing of raw materials Processing equipment for both manufacturing and services Logistics and supply chain services IT and other services 6-3 Choosing the Right Number of Suppliers: Value to Reducing the Supply Base Lower cost and effort to manage relationships overall Greater potential to coordinate designs Increased capability to synchronize schedules Increased capability to evaluate suppliers on multiple criteria, not just cost Capabilities of procuring modules rater than parts Ease of tracking performance Ease of exchanging information 6-4 Choosing the Right Number of Suppliers: Disadvantages to Multi-tier Supply Chains Lack of visibility over inventory leading to: More stockouts as information is late to arrive from lower levels of the supply chain More inventory throughout the supply chain as each tier buffers against uncertainty Increased cost of quality Greater demand volatility Diminished new product or service performance: Increased cycles times Less effective optimization of integral designs 6-5 Choosing the Right Number of Suppliers: Per Item Outsourced Depends On - Uniqueness of sourced item or equipment Viability and reliability of suppliers Stability of the technology associated with the item being sourced Significance of the buying company’s business to the total business of the supplier Branding implications of sourcing decision Competitiveness of market 6-6 Choosing the Right Number of Suppliers: Pros and Cons of Having Multiple-Suppliers Adappted from Murther and Hayes 6-7 Structuring Supplier Relationships: Roles of Suppliers Design Procurement Manufacture Service delivery Distribution 6-8 Structuring Supplier Relationships: Types of Supplier Relationships 6-9 Structuring Supplier Relationships: Choosing the Right Type of Relationship 6-10 Structuring Supplier Relationships: Choosing the Right Type of Relationship 6-11 Structuring Supplier Relationships: Contextual Profiles for Different Relationships 6-12 Structuring Supplier Relationships: Management Profiles for Different Relationships 6-13 Structuring Supplier Relationships: Outsourcing Design Procure an existing design for a complete product or service, component or module, process, piece of equipment Engage a design supplier to make minor revisions to an existing design Hire the design supplier to perform a specific design activity Hire the design supplier to design against a set of specifications 6-14 Structuring Supplier Relationships: Incentives and Contracts To improve flexibility e.g., minimum guarantees for certain volumes e.g., vendor managed inventories To optimize inventory and stockout trade-offs e.g., supplier allows returns e.g., revenue sharing 6-15 Structuring Supplier Relationships: Revenue Sharing Example Video purchase price to the retailer: $45 Average rental income: $4.00 Marginal cost per video: $2.00 Average number of rentals per video: 35 Average revenue per video lifetime = 35 x $4.00 = $140 Purchase price under revenue sharing: $5 Revenue sharing: 50% 6-16 Structuring Supplier Relationships: Revenue Sharing Example Without revenue sharing Co = $45 Cu = $140 – 45 = $95 Cu/(Co+Cu) = 95/140 = 67.9% With revenue sharing: Co = (35 x $2) - $5 = $65 Cu = $5 Cu/(Co+Cu) = $65/($65+5) = 92.9% Optimal solution: Cu = cost of underage = revenue less marginal cost = $140 - $2.00 = $138.00 Co = cost of overage = $2.00 Cu/(Co+Cu) = 138/140 = 98.6% 6-17 Structuring Supplier Relationships: Economics of Revenue Sharing Costs Curve of lost sales or penalties plus inventory Modified curve for returns Optimum point with Modified curve x x Order of retailer With no returns x Optimum point for manufacturer Selling to customer Inventory level 6-18 Sourcing from Overseas Source offshore to: Access local markets Obtain needed technologies or skills Operate with lower factor costs Source locally in a developed country when the company’s products or services Come in a wide variety Entail high transportation costs Are innovative or in the early stages of their life cycles 6-19 Managing Suppliers: Developing Needed Information Sharing Co-locate highly interdependent stages of the process Use vendor managed inventories to concentrate information management at the vendor Use incentives such as buybacks and revenue sharing Use electronic communication and coordination of schedules Streamline authoring for ordering 6-20 Critical Success Factors in Supplier Management: Procurement Organization Maturity Model 6-21 Critical Success Factors in Supplier Management: Managing Risks 6-22 Developing a Sourcing Strategy Determine the critical components, products or services to be outsourced Identify which products or services should be sourced overseas Determine number of suppliers Determine organizational relationships Determine levels of engagement and risk management methods Establish contracts and incentives Establish the appropriate procurement management structure 6-23