SUPPLY CHAIN MANAGEMENT

BMEE310L — Module 6
Sourcing, Transporting and Pricing of Products
Final Exam Study Guide
PART 1: SOURCING DECISIONS IN SUPPLY CHAIN

1.1 What is Sourcing?

Sourcing is the set of business processes required to purchase goods and services. The two key
concepts are:
• Outsourcing: Having a third party perform a function that was previously done in-house.
• Offshoring: Moving operations to a different country to reduce costs.

1.2 The Sourcing Process (5 Steps)

📌 Remember the flow: Score → Select → Collaborate → Procure → Analyze

Step Description
1. Supplier Scoring & Compare suppliers based on total cost impact, not just purchase
Assessment price.
2. Supplier Selection & Identify appropriate suppliers. Contract should increase supply chain
Contract profit for both parties.
3. Design Collaboration ~80% of product cost is determined during design. Suppliers must be
involved early.
4. Procurement Supplier sends product in response to orders. Goal: deliver on
schedule at lowest overall cost.
5. Sourcing Planning & Analyze spending across suppliers; identify cost-reduction
Analysis opportunities.

1.3 Benefits of Effective Sourcing

• Better economies of scale through aggregated purchasing
• More efficient procurement transactions
• Design collaboration → products easier to manufacture and distribute
• Good procurement → better coordination with suppliers
• Appropriate contracts → risk sharing between supplier and buyer
• Auctions → lower purchase prices through increased competition

1.4 In-House vs. Outsourcing Decision

A third party can increase supply chain surplus through:
• Capacity aggregation
• Inventory aggregation
• Transportation aggregation (by transport or storage intermediaries)
• Warehousing, Procurement, Information, Receivables aggregation
• Relationship aggregation
 • Lower costs and higher quality

Key Factors: When Does a Third Party Add Value?

Factor Low Asset Specificity High Asset Specificity
Low Firm Scale High growth in surplus Low to medium growth
High Firm Scale Low growth in surplus No growth (unless 3rd party
has lower capital cost)
Low Demand Uncertainty Low to medium growth Low growth
High Demand Uncertainty High growth (aggregation Low to medium growth
helps)

1.5 Risks of Using a Third Party

• The process is broken
• Underestimation of coordination costs
• Reduced customer/supplier contact
• Loss of internal capability; third party gains power
• Leakage of sensitive data
• Ineffective contracts
• Loss of supply chain visibility
• Negative reputational impact

1.6 3PL vs. 4PL

Type Definition Example Services
3PL (Third-Party Performs one or more logistics activities Transportation, Warehousing, IT,
Logistics) (product/info/funds flow) that the firm Reverse logistics
could do itself.
4PL (Fourth-Party Designs, builds and runs the ENTIRE End-to-end supply chain
Logistics) supply chain process. management

1.7 Cost of Goods Sold (COGS)

• COGS represents well over 50% of sales for most major manufacturers.
• Purchased parts account for a much higher fraction than in the past.
• Companies have reduced vertical integration and increased outsourcing.
📌 This is why sourcing decisions are so critical — they directly impact profitability.
PART 2: TRANSPORTATION IN THE SUPPLY CHAIN

2.1 Role of Transportation

• Moves product from one location to another — products are rarely produced and consumed in
the same place.
• Significant cost component in the supply chain.
• Shipper: requires movement of product. Carrier: moves/transports the product.

2.2 Transportation Modes — Overview

Mode Freight Value ($B, Freight Tons (B) GDP Value Added
2002) ($B, 2009)
Air (incl. truck+air) $563 6 $61.9
Truck $9,075 11,712 $113.1
Rail $392 1,979 $30.8
Water $673 1,668 $14.3
Pipeline $896 3,529 $12.0
Multimodal $1,121 229 —

2.3 Mode Details: Benefits, Limitations, Challenges

AIR
• Key carriers: American, Southwest, United, Delta
• Cost structure: Fixed infrastructure + fixed flight costs (labor/fuel) + variable costs per load
• BENEFIT: Fastest mode; best for high-value, time-sensitive, lightweight shipments (<500 lbs).
In 2002, air-shipped goods valued at $75,000/ton — highest of all modes.
• LIMITATION: Very high cost; only viable for urgent/high-value cargo.
• CHALLENGES: Hub/route planning, maintenance scheduling, dynamic pricing for profitability.

PACKAGE CARRIERS (FedEx, UPS, USPS)

• Handle small packages up to 150 lbs; use air, truck, and rail.
• BENEFIT: Speed, reliability, package tracking, value-added services. Boosted by e-commerce
growth.
• LIMITATION: More expensive than LTL for large shipments.
• CHALLENGES: Consolidation for efficiency, delivery routing optimization, transfer point
tracking.

TRUCK (Most dominant mode)

• In 2002: moved 69.5% of freight by value and 60.1% by weight.
 • TL (Truckload): 10,000+ lbs, low fixed costs, easy entry. Minimizes empty "deadhead" travel.
• LTL (Less-than-Truckload): <half a TL; consolidated via hub-and-spoke.
• BENEFIT: Door-to-door service (faster than rail), flexible (no dedicated infrastructure).
• LIMITATION: More expensive per mile than rail for long hauls. Service imbalance in some
markets.
• CHALLENGES: Route optimization, LTL delays from transfers, driver fatigue regulations.

RAIL
• In 2002: 3% by value, 10% by weight, 30%+ of ton-miles. High fixed costs (tracks, cars,
locomotives); labor+fuel = 60%+ of expenses.
• BENEFIT: High capacity for heavy/dense goods over long distances (e.g., coal). Lower cost per
ton-mile. Fuel-efficient.
• LIMITATION: Slow; unsuitable for urgent deliveries. Less flexibility.
• CHALLENGES: Scheduling delays (building trains), track congestion at terminals.

WATER
• Key carriers: Maersk, Evergreen, APL, Hanjin. Limited to waterways.
• In 2002: 78% of U.S. international freight by weight.
• BENEFIT: Cheapest for large bulk commodities. Dominant for global trade. Containerization
improving efficiency.
• LIMITATION: Slowest mode; significant port/terminal delays. Limited short-haul suitability.
• CHALLENGES: Port congestion, customs/security delays.

PIPELINE
• Primarily crude petroleum, refined products, natural gas. In 2002: ~16% of U.S. ton-miles.
• BENEFIT: Cost-effective for stable, high-volume flows. Operates efficiently at 80–90% capacity.
• LIMITATION: High initial fixed costs; only viable for high-demand routes. Not flexible.
• Pricing: Fixed fee (peak usage) + variable cost (quantity). Trucks cover demand fluctuations.

INTERMODAL
• Combines multiple modes (e.g., truck/rail, truck/water/rail).
• BENEFIT: Rail/truck combinations are cheaper than TL and faster than rail alone. One-stop
service. Essential for global trade.
• LIMITATION: Transfers can cause significant delays. Relies heavily on coordinated
infrastructure.
• CHALLENGES: Information exchange between modes; container demand requires robust
infrastructure.

2.4 Transportation Infrastructure and Policies

• Governments take full or major responsibility for building and managing infrastructure.
• Without a monopoly, deregulation and market forces create effective industry structure.
• Pricing should reflect the marginal cost impact on society (see Figure 14-1 concept).
📌 Key insight: When price = average cost (Point A), usage is Q0. When price = marginal cost (Point B),
usage drops to Q1 but efficiency improves.
PART 3: TRANSPORTATION NETWORK DESIGN

3.1 Key Questions When Designing a Network

• Should transportation be direct or through an intermediate site?
• Should the intermediate site stock product (DC with storage) or only cross-dock?
• Should each route serve one destination or multiple (milk run)?

3.2 Network Design Options

Network Type Pros Cons
Direct Shipping No intermediate warehouse. High inventories (large lot size
Simple to coordinate. required)
Direct Shipping with Lower transport cost for small Increased coordination complexity
Milk Runs lots. Lower inventories.
All via Central DC Lower inbound cost through Increased inventory cost. Extra
(Storage) consolidation. handling at DC.
All via Central DC Low inventory requirement. Lower Increased coordination complexity
(Cross-dock) transport cost through
consolidation.
Via DC Using Milk Runs Lower outbound transport cost for Further increase in coordination
small lots. complexity
Tailored Network Transport choice best matches Highest coordination complexity
individual product/store needs.

3.3 Milk Run Definition

A milk run is a route on which a truck either:
• Delivers product from a SINGLE supplier to MULTIPLE retailers, OR
• Picks up from MULTIPLE suppliers going to a SINGLE buyer location.

3.4 Network Selection — Numerical Example

📌 This type of calculation may appear in your exam. Memorize the formulas!

Given: 8 stores, 4 supply sources, Truck capacity = 40,000 units, Cost = $1,000/load + $100/delivery, Holding
cost = $0.20/unit/year

Scenario Annual Trucking Cost Inventory Total Cost

Sales/Store Cost
Direct Shipping 960,000 $844,800 $128,000 $972,800
Milk Runs (2 stores/truck) 960,000 $921,600 $64,000 $985,600
 Scenario Annual Trucking Cost Inventory Total Cost
Sales/Store Cost
Direct Shipping 120,000 $105,600 $128,000 $233,600
Milk Runs (4 stores/truck) 120,000 $134,400 $32,000 $166,400

📌 Key insight: With HIGH annual sales, direct shipping wins. With LOW annual sales, milk runs win due to
lower inventory from smaller batches.

3.5 Trade-offs in Transportation Design

Trade-off 1: Transportation Mode vs. Inventory Cost
Mode Cycle Inv. Safety Inv. In-Transit Transport Time Transport Cost
Cost
Rail 5 (highest) 5 5 2 5
TL 4 4 4 3 3
LTL 3 3 3 4 4
Package 1 (lowest) 1 1 6 1
Air 2 2 2 5 2
Water 6 6 6 1 (fastest) 6
Ranking: 1 = best (lowest inventory/cost, highest speed). Numbers show relative ranking.

Trade-off 2: Inventory Aggregation

Factor Aggregate (Centralize) Disaggregate (Decentralize)
Transport cost Low (bulk shipments) High (many small shipments)
Demand uncertainty High (pooling helps) Low
Holding cost High (more inventory) Low
Customer order size Large Small

📌 Aggregate when: transport cost is LOW or demand uncertainty is HIGH. Disaggregate when: holding cost
is LOW or customer orders are SMALL.

Trade-off 3: Transportation Cost vs. Responsiveness

Consolidating shipments (waiting longer to send) reduces transport cost but hurts responsiveness.
• 2-day response (ship daily): Higher transport cost, faster delivery
• 3-day response (ship every 3 days): Lower transport cost, slower delivery
• 4-day response (ship every 4 days): Lowest transport cost, slowest delivery
📌 From the steel shipment example: 2-day=$4,164, 3-day=$3,464, 4-day=$3,264. Each extra day saves
~$350-$700 in transport cost.
3.6 Tailored Transportation
Using DIFFERENT transportation networks/modes based on customer and product characteristics.

By Customer Density and Distance

Density Short Distance Medium Distance Long Distance
High density Private fleet with milk Cross-dock with milk Cross-dock with milk
runs runs runs
Medium Third-party milk runs LTL carrier LTL or package carrier
density
Low density 3rd-party milk runs or LTL or package carrier Package carrier
LTL

By Product Value and Demand

Product High Value Low Value
Type
High demand Disaggregate cycle inventory. Disaggregate all inventories. Use cheap
Aggregate safety inventory. Use cheap mode for replenishment.
mode for cycle replenishment; fast
mode for safety inventory.
Low demand Aggregate all inventories. Use fast Aggregate only safety inventory. Use
mode if needed for customer orders. cheap mode for cycle inventory
replenishment.
PART 4: PRICING AND REVENUE MANAGEMENT

4.1 Overview
Pricing and revenue management in the supply chain involves optimizing how prices are set to
maximize revenue given constrained capacity and variable demand.

• Revenue management is most relevant when fixed costs are high and variable costs are low
(e.g., airlines, rail, water).
• Dynamic pricing adjusts prices based on demand and time to maximize revenue per unit of
capacity.
• Airlines use yield management as a classic example — charging more as capacity fills up.

4.2 Role of IT in Transportation

• IT software assists in identifying optimal routes (minimize costs subject to delivery constraints).
• Optimal fleet utilization and load planning.
• GPS applications for real-time tracking and routing.

4.3 Risk Management in Transportation

Three Main Risks
• Risk of shipment delay
• Risk of disruptions (weather, political, infrastructure failure)
• Risk of hazardous materials

Risk Mitigation Strategies

• Decrease the probability of disruptions through preventive measures
• Alternative routings (backup routes if primary route fails)
• For hazardous materials: modified containers, low-risk transport modes, modify
physical/chemical properties

4.4 Making Transportation Decisions in Practice

• Align transportation strategy with overall competitive strategy
• Consider both in-house and outsourced transportation options
• Use technology to improve transportation performance
• Design flexibility into the transportation network
QUICK REFERENCE: KEY NUMBERS & FACTS
Fact Value/Detail
% of product cost determined during design ~80% (Design Collaboration slide)
COGS as % of sales for manufacturers Well over 50%
Trucks: % of US freight by value (2002) 69.5%
Trucks: % of US freight by weight (2002) 60.1%
Air cargo value per ton (2002) $75,000/ton (highest of all modes)
Water: % of US international freight by weight 78%
Rail: % of US ton-miles (2002) >30%
Pipeline: % of US ton-miles (2002) ~16%
Pipeline optimal capacity utilization 80-90%
TL shipment size threshold 10,000+ pounds
Package carriers: max package weight Up to 150 pounds
3PL definition Performs one or more logistics activities for firm
4PL definition Designs, builds and runs the ENTIRE supply
chain

EXAM TIP SUMMARY

• Know the 5-step sourcing process (Score → Select → Collaborate → Procure → Analyze)
• Know all 7 modes with their key pros/cons (Air, Package, Truck TL/LTL, Rail, Water, Pipeline,
Intermodal)
• Understand the 6 network types and their trade-offs (Table 14-2)
• Be able to calculate transport + inventory costs for direct vs. milk run networks
• Know the aggregation vs. disaggregation trade-off table (Table 14-7)
• Understand tailored transportation by density/distance and by product value/demand
• Know 3 types of transportation risk and mitigation strategies
📌 Good luck on your finals! You've got this.