Supply Chain Management

Lecture 24

Semester Outline

• Thursday April 15 Chap 14• Tuesday April 20 Chap 15• Thursday April 22 Simulation Game briefing• Tuesday April 27 Review, buffer• Thursday April 29 Simulation Game

Outline

• Today– Finish with Chapter 14

• Sections 1, 2, 3, 4, 6, 7, 8, 9– Section 6 buyback and revenue sharing contracts only

• Homework 5 due tomorrow• Next week

– Chapter 15• Sections 1, 2

– Simulation game briefing

Summary

• In-House or Outsource (make or buy)? – The decision to outsource is based on the growth in supply

chain surplus provided by the third party and the increase in risk by using a third party

Summary

• Buy if– Supplier has cost advantage, better quality

• Supplier may have better technology and may aggregate orders

– Insufficient capacity • Demand grows faster than anticipated

– Lack of expertise • Supplier may hold the patent to a process or product

• Make if– Control cost and quality

• Easier to control cost and quality – Protect proprietary technology

• Protect competitive advantage– Use existing idle capacity

• Short term solution

Single Versus Multiple Suppliers• Reasons for favoring a single supplier

– To establish a good relationship– Less quality variability– Lower cost (quantity discount)– Transportation economies

• Reasons for favoring multiple suppliers– Need capacity– Spread the risk of supply interruption– Create competition– Policy

Outsourcing Logistics

• A third-party logistics (3PL) provider performs one or more of the logistics activities relating to the flow of product, information, and funds that could be performed by the firm itself– First party logistics provider (1PL)

• Shipper, a firm that needs to have goods transported from A to B

– Second party logistics provider (2PL)• Carrier, firm which actually owns the means of

transportation

– Third party logistics provider (3PL) (sometimes LSP)• Typically specialize in integrated operation, warehousing

and transportation services that can be scaled and customized to customer’s needs

Services Provided by 3PLs

Service Category Basic Service Some specific value added services

Transportation Inbound, outbound by ship, truck, rail, air

Track/trace, mode conversion

Warehousing Storage, facilities management

Cross-dock, in-transit merge, inventory control

Information technology

Provide and maintain advanced information systems

Transportation management systems, warehousing management

Reverse logistics Handle reverse flows Recycling, customer returns, repair/refurbish

Other 3PL services Customs brokering, hazardous material, order taking, consulting, port services, etc.

How has globalization impacted sourcing decisions?

Outsourcing Logistics

• A fourth-party logistics (4PL) provider manages other 3PLs. Whereas a 3PL targets a function, a 4PL targets management of an entire process– Fourth party logistics provider (4PL)

• “A 4PL is an integrator that assembles the resources, capabilities, and technology of its own organization and other organizations to design, build and run comprehensive supply chain solutions” Source: Accenture

• 4PL use 2PLs and/or 3PLs to supply service to customers, owning mostly computer systems/technology

Best Practice 4PL

• Li & Fung– The firm aggregates demand across hundreds of

customers, capacity across thousands of suppliers, and uses detailed information to match supply and demand in the most cost effective manner

– By sourcing appropriately Li & Fung gets around regional trade umbrellas such as the EU and NAFTA

How do 4PLs Add Value?

• How do 4PLs add value to a firm managing its own logistics providers?

The fundamental advantage that 4PLs may provide comes from greater visibility and

coordination over a firm’s supply chain and improved handoffs between logistics

providers

Sourcing Process

• Supplier scoring and assessment– Process used to rate suppliers

• Supplier selection– Choose the appropriate supplier(s)

• Design collaboration– Work together with supplier when designing components for the

final product

• Procurement– Process of placing orders and receiving orders from supplier(s)

• Sourcing planning and analysis– Analyze spending across various suppliers, identify opportunities

for decreasing cost

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Supplier scoring and assessment• Common fundamental mistake when choosing a

supplier– Only focus on quoted price

Supplier performance should be compared on the basis of the supplier’s impact on total cost

Factors besides purchase price that influence total cost• Replenishment lead times

– Does it pay to select a more expensive supplier with a shorter lead time?

– If lead time grows, safety inventory grows proportionally to the square root of the replenishment lead time

• On-time performance– Is a more reliable supplier worth the extra pennies?– If variability of lead time grows, the required safety inventory at

the firm grows

Factors besides purchase price that influence total cost• Supply flexibility

– The less flexible a supplier is, the more lead-time variability it will display as order quantities change

• Delivery frequency/lot size– Delivery frequency affects the transportation cost, lot size affects

the cycle inventory holding cost

• Supply quality– Quality affects unit price and lead time as follow-up orders may

need to be fulfilled to replace defective products

• Inbound transportation cost– Sourcing a product overseas may have lower product cost, but

generally incurs a higher inbound transportation cost

Factors besides purchase price that influence total cost• Pricing terms

– For example, quantity discounts (and the impact it has on cycle inventory)

• Information coordination capability– Good coordination results in better planning and ultimately lower

production, safety inventory, and transportation cost

• Exchange rates, taxes, and duties– Important for global supply chains as it affects the unit price

• Supplier viability– The likelihood that the supplier will be around to fulfill the

promises it makes (uncertainty increases safety inventory)

• Design collaboration capability– Can help reduce all cost, improve quality, and decrease time-to-

market

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Design Collaboration

• 50-70% of spending at a manufacturer is through procurement– Compared to only about 20% several decades ago

• 80% of the cost of a purchased part is fixed in the design phase

• Design collaboration with suppliers can result in reduced cost, improved quality, and decreased time to market

Component Estimated cost

Display Module - 9.7" Diagonal, 262K Color TFT, IPS Technology, 1024 x 768 Pixels

Touchscreen Assembly - 9.7" Diagonal, Capacitive, ITO Glass on Glass, Painted

All enclosure metals, plastics, PCB substrates, connectors, etc.

Battery - Li-Ion Polymer, 3.75V, 6600mAh

Microprocessor A4 Microprocessor Core Integrated w ith Graphics Processing Unit w / PoP DRAM

2Gbit Mobile SDRAM - Package on Package (stacked on A4)

WLAN n + BT + FM Module (Featuring Broadcom)

Touchscreeen Microcontroller

Touchscreen Driver

Multitouch Controller - Capacitive

Audio Codec - Ultra Low Pow er, Stereo, w / Headphone Amplif ier

Pow er Management Integrated Circuit

Pow er Management Integrated Circuit

Other Electronic Components

NAND Flash

Box Contents

Total Materials

Manufacturing

Retail Price $499.00

How Much Does it Cost to Make an iPad?

Source: iSuppli

Component Estimated cost

Display Module - 9.7" Diagonal, 262K Color TFT, IPS Technology, 1024 x 768 Pixels$65.00

Touchscreen Assembly - 9.7" Diagonal, Capacitive, ITO Glass on Glass, Painted$30.00

All enclosure metals, plastics, PCB substrates, connectors, etc.$32.50

Battery - Li-Ion Polymer, 3.75V, 6600mAh $21.00

Microprocessor A4 Microprocessor Core Integrated w ith Graphics Processing Unit w / PoP DRAM$19.50

2Gbit Mobile SDRAM - Package on Package (stacked on A4) $7.30

WLAN n + BT + FM Module (Featuring Broadcom) $8.05

Touchscreeen Microcontroller $2.30

Touchscreen Driver $1.80

Multitouch Controller - Capacitive $1.40

Audio Codec - Ultra Low Pow er, Stereo, w / Headphone Amplif ier$1.20

Pow er Management Integrated Circuit $2.10

Pow er Management Integrated Circuit $1.25

Other Electronic Components $20.20

NAND Flash $29.50

Box Contents $7.50

Total Materials $250.60

Manufacturing

Retail Price $499.00

Component Estimated cost

Display Module - 9.7" Diagonal, 262K Color TFT, IPS Technology, 1024 x 768 Pixels$65.00

Touchscreen Assembly - 9.7" Diagonal, Capacitive, ITO Glass on Glass, Painted$30.00

All enclosure metals, plastics, PCB substrates, connectors, etc.$32.50

Battery - Li-Ion Polymer, 3.75V, 6600mAh $21.00

Microprocessor A4 Microprocessor Core Integrated w ith Graphics Processing Unit w / PoP DRAM$19.50

2Gbit Mobile SDRAM - Package on Package (stacked on A4) $7.30

WLAN n + BT + FM Module (Featuring Broadcom) $8.05

Touchscreeen Microcontroller $2.30

Touchscreen Driver $1.80

Multitouch Controller - Capacitive $1.40

Audio Codec - Ultra Low Pow er, Stereo, w / Headphone Amplif ier$1.20

Pow er Management Integrated Circuit $2.10

Pow er Management Integrated Circuit $1.25

Other Electronic Components $20.20

NAND Flash $29.50

Box Contents $7.50

Total Materials $250.60

Manufacturing $9.00

Retail Price $499.00

Supply Chain Top 25, 2009

Design Collaboration

• Design for logistics– Attempts to reduce transportation, handling, and inventory cost– Coors redesigned glass bottle reduced transportation cost

• Design for manufacturability– Attempts to design products for ease of manufacture (part

commonality, designing symmetrical parts, designing parts to provide access for catalog parts)

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Contracts and Supply Chain Performance• Many shortcomings in supply chain performance occur

because the buyer and supplier each try to optimize their own profits– Total supply chain profits might therefore be lower than if the

supply chain coordinated actions to have a common objective of maximizing total supply chain profits

– Double marginalization results in suboptimal order quantity– The supplier must share in some of the buyer’s demand

uncertainty

• A contract should be structured to increase the firm’s profits and supply chain profits

Contracts and Supply Chain Performance• Example

– Consider a music store that sells compact discs. The supplier buys/manufactures compact discs at $1 per unit and sells them to the music store at $5 per unit. The retailer sells each disc to the end customer at $10. At this price demand is normally distributed, with a mean of 1,000 and a standard deviation of 300. The retailer has a margin of $5 per disc and can potentially lose $5 for each unsold disc

Manufacturer Distributor Retailer Customer

$10$5$1

Contracts and Supply Chain Performance

Retailer Supplier

p =

c =

s =

CSL =

O* =

Expected profits =

Total profit = 3,803 + 4,000 = $7,803Manufacturer Distributor Retailer Customer

$10$5$1

$10 $5

$5 $1

$0

(p-c)/(p-s) = 0.5

F-1(CSL,,) =1,000

(see 12.3) = $3,803 1,000*4 = $4,000

Contracts and Supply Chain Performance

Supply Chain

p =

c =

s =

CSL =

O* =

Expected profits = versus $7,803

Manufacturer Distributor Retailer Customer

$10$1

$10

$1

$0

(p-c)/(p-s) = 0.9

F-1(CSL,,) =1,384

(see 12.3) = $8,474

Supplier Selection and Contracts• Contracts to increase product availability and supply

chain profits– Buyback Contracts– Revenue-Sharing Contracts– Quantity Flexibility Contracts

• Contracts to increase agent effort• Contracts to induce performance improvement

– Shared savings contract

Buyback Contracts

• Allows a retailer to return unsold inventory up to a specified amount at an agreed upon price

• Increases the optimal order quantity for the retailer, resulting in higher product availability and higher profits for both the retailer and the supplier

Impact of Buyback Contracts on Profitability

Expected Expected Expected Wholesale Buyback Optimal Expected Profit Profit Profit

Price c Price b Order Size Returns Retailer Supplier SC$5 $0 1,000 120 $3,803 $4,000 $7,803$5 $2 1,096 174 $4,090 $4,035 $8,125$5 $3 1,170 223 $4,286 $4,009 $8,295$6 $0 924 86 $2,841 $4,620 $7,461$6 $2 1,000 120 $3,043 $4,761 $7,804$6 $4 1,129 195 $3,346 $4,865 $8,211$7 $0 843 57 $1,957 $5,056 $7,013$7 $4 1,000 120 $2,282 $5,521 $7,803$7 $6 1,202 247 $2,619 $5,732 $8,351

Buyback Contracts

• Downsides that buyback contract results in – Surplus inventory for the supplier that must be disposed of,

which increases supply chain costs– Misleading for the supply chain as it reacts to (inflated) retail

orders, not actual customer demand

• Most effective for products with low variable cost, such as music, software, books, magazines, and newspapers so that the supplier can keep the surplus

Revenue Sharing Contracts

• The buyer pays a minimal amount for each unit purchased from the supplier but shares a fraction of the revenue for each unit sold

Blockbuster (1998)

• Blockbuster purchases a copy from a studio for $60 and rents for $3– Blockbuster must rent the tape at least 20 times before earning

profit– In 1998, 20% of surveyed customers reported that they could not

rent the movie they wanted because the Blockbuster did not have that movie

• In 1998, Blockbuster started revenue sharing with the major movie studios– Blockbuster pays the wholesale price of $9 per copy. – Blockbuster shares (1-θ) =30-45% portion of the revenue with

the movie studio• The impact of revenue sharing on Blockbuster was

dramatic– Rentals increased by 75% in test markets due to higher video

availability

Netflix

• Blockbuster owns its DVDs• Netflix has established revenue sharing contracts with

most studios– DVDs are purchased at cost– Netflix pays on average $1.40 to the studios each time their title

is rent– At end of contract Netflix acquires some percentages of the units

for retention or sale, the remaining DVDs are destroyed or returned to the original studio

Impact of Revenue Sharing Contracts on Profitability

Revenue Expected Expected Expected Wholesale Sharing Optimal Expected Profit Profit Profit

Price c Fraction f Order Size Returns Retailer Supplier SC$1 0.30 1,320 342 $5,526 $2,934 $8,460$1 0.45 1,273 302 $4,064 $4,367 $8,431$1 0.60 1,202 247 $2,619 $5,732 $8,351$2 0.30 1,170 223 $4,286 $4,009 $8,295$2 0.45 1,105 179 $2,881 $5,269 $8,150$2 0.60 1,000 120 $1,521 $6,282 $7,803

Contracts Advantages vs. Disadvantages• Advantages

– Uncertainty reduction for retailer

– Relationship leveraging

• Disadvantages– Supplier being blocked

from selling to other retailers

– Retailer being blocked from buying from other suppliers

Sourcing Process

Supplier scoring

and assessment

Designcollaboration

Supplier selection

and contract

negotiation

Procurement

Sourcing planning

and analysis

Procurement

• Procurement transactions begin with the buyer placing the order and end with the buyer receiving and paying for the order– Goal is to enable orders to be placed and delivered on schedule at

the lowest possible overall cost

• Two main categories of purchased goods:– Direct materials: components used to make finished goods

• Memory, hard drives, and CD drives are direct materials for a PC

– Indirect materials: goods used to support the operations of a firm• PCs are indirect materials for a car manufacturer

Product Categorization by Value and Criticality

Low

Low

High

HighValue/Cost

Cri

tica

lity

Critical items(i.e. components with

long lead times)

Ensure availability

Strategic items(i.e. subsystems, electronics

for an auto manufacturer)

Ensure long term relationship

General items(mostly indirect materials)

Ensure low cost

Bulk purchase items(small parts, packaging)

Ensure low cost

Outsourcing at Darden

Darden Restaurants, owner of popular brands such as Olive Garden and Red Lobster, serves more than 300 million meals

annually in over 1,700 restaurants across the US and Canada. To achieve competitive advantage via its supply chain, Darden must

achieve excellence at each step. With purchases from 35 countries, and seafood products with a shelf life as short as 4

days, this is a complex and challenging task. Those 300 million meals annually mean 40 million pounds of shrimp and huge quantities of tilapia, swordfish, and other fresh purchases.

What are outsourcing opportunities in a restaurant?