outsourcing strategies in supply chain.ppt

Outsourcing strategies in supply chain management

1. Supply Chain Management
Lecture 24

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. Services Provided by 3PLs
Service CategoryBasic 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 logisticsHandle 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?

9. 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

10. 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

11. 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

12. 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
Design
collaboration
Supplier
selection
and
contract
negotiation
Procurement
Sourcing
planning
and
analysis

13. Sourcing Process
Supplier
scoring
and
assessment
Design
collaboration
Supplier
selection
and
contract
negotiation
Procurement
Sourcing
planning
and
analysis

14. 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

15. 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

16. 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

17. 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

18. Sourcing Process
Supplier
scoring
and
assessment
Design
collaboration
Supplier
selection
and
contract
negotiation
Procurement
Sourcing
planning
and
analysis

19. 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

20. 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 Amplifier
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 Amplifier$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 Amplifier$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

21. Supply Chain Top 25, 2009

22. 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)

23. Sourcing Process
Supplier
scoring
and
assessment
Design
collaboration
Supplier
selection
and
contract
negotiation
Procurement
Sourcing
planning
and
analysis

24. 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

25. 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

26. Contracts and Supply Chain
Performance
Retailer Supplier
p =
c =
s =
CSL =
O* =
Expected profits =
Total profit = 3,803 + 4,000 = $7,803
Manufacturer 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) = $3,8031,000*4 = $4,000

27. 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

28. 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

29. 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

30. Impact of Buyback Contracts on
Profitability
Expected Expected Expected
WholesaleBuyback Optimal Expected Profit Profit Profit
Price cPrice bOrder SizeReturnsRetailerSupplier 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

31. 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

32. 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

33. 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

34. 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

35. Impact of Revenue Sharing Contracts
on Profitability
Revenue Expected Expected Expected
WholesaleSharingOptimal Expected Profit Profit Profit
Price cFraction fOrder SizeReturnsRetailerSupplier 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

36. 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

37. Sourcing Process
Supplier
scoring
and
assessment
Design
collaboration
Supplier
selection
and
contract
negotiation
Procurement
Sourcing
planning
and
analysis

38. 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

39. Product Categorization by Value
and Criticality
Low
Low
High
HighValue/Cost
C
r
i
t
i
c
a
l
i
t
y
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

40. 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?