Module 5

Sourcing
• Purchasing, also called procurement, is the process by which companies acquire raw materials,
components, products, services, or other resources from suppliers to execute their operations.
• Sourcing is the entire set of business processes required to purchase goods and services.
• For any supply chain function, the most significant decision is whether to outsource the function or
perform it in-house. Outsourcing results in the supply chain function being performed by a third
party. The outsourcing of supply chain activities by a firm based on the following three questions:
1. Will the third party increase the supply chain surplus relative to performing the activity
in-house?
2. How much of the increase in surplus does the firm get to keep?
3. To what extent do risks grow upon outsourcing?
Key Sourcing Related Process
• Supplier scoring and assessment is the process used to rate supplier performance. A good supplier
scoring and assessment process must identify and track performance along all dimensions and
evaluate the impact on the total cost of using a supplier.
• Supplier selection uses the output from supplier scoring and assessment to identify the appropriate
supplier(s). A supply contract is then negotiated with the supplier. A good contract should account
for all factors that affect supply chain performance and should be designed to increase supply chain
profits in a way that benefits both the supplier and the buyer.
• Design collaboration allows the supplier and the manufacturer to work together when designing
components for the final product. Design collaboration also ensures that any design changes are
communicated effectively to all parties involved with designing and manufacturing the product.
• Once the product has been designed, procurement is the process whereby the supplier sends
product in response to orders placed by the buyer. The goal of procurement is to enable orders to be
placed and delivered on schedule at the lowest possible overall cost.
• Finally, the role of sourcing planning and analysis is to analyze spending across various suppliers
and component categories to identify opportunities for decreasing the total cost.
In-House or Outsource
How Do Third Parties Increase the Supply Chain Surplus?
• Capacity aggregation.
• Inventory aggregation.
• Transportation aggregation by transportation intermediaries.
• Transportation aggregation by storage intermediaries.
• Warehousing aggregation.
• Procurement aggregation.
• Information aggregation.
• Receivables aggregation.
• Relationship aggregation.
• Lower costs and higher quality
Third Parties Increase the Supply Chain
Surplus
• Capacity aggregation: A third party can increase the supply chain surplus by aggregating demand
across multiple firms and gaining production economies of scale that no single firm can on its own.
This is the most common reason for outsourcing production in a supply chain.
• Inventory aggregation: A third party can increase the supply chain surplus by aggregating
inventories across a large number of customers. Aggregation allows them to significantly lower
overall uncertainty and improve economies of scale in purchasing and transportation.
• Transportation aggregation by transportation intermediaries: A third party may increase the
surplus by aggregating the transportation function to a higher level than any shipper can on its
own. The transportation intermediary aggregates shipments across multiple shippers, thus lowering
the cost of each shipment below what could be achieved by the shipper alone.
• Transportation aggregation by storage intermediaries: A third party that stores inventory can
also increase the supply chain surplus by aggregating inbound and outbound transportation. This
form of aggregation is most effective if the intermediary stocks products from many suppliers and
serves many customers, each ordering in small quantities
• Warehousing aggregation: A third party may increase the supply chain surplus by aggregating
warehousing needs over several customers. Savings through warehousing aggregation arise if a
supplier's warehousing needs are small or if its needs fluctuate over time.
• Procurement aggregation: A third party increases the supply chain surplus if it aggregates
procurement for many small players and facilitates economies of scale in production and inbound
transportation. Procurement aggregation is most effective across many small buyers.
• Information Aggregation: A third party may increase the surplus by aggregating information to a
higher level than can be achieved by a firm performing the function in-house. All retailers
aggregate information on products from many manufacturers in a single location. This information
aggregation reduces search costs for customers and allows better matching of truckers and
shipments.
• Receivables aggregation: A third party may increase the supply chain surplus if it can aggregate
the receivables risk to a higher level than the firm or it has a lower collection cost than the firm.
Receivables aggregation is likely to increase the supply chain surplus if retail outlets are small and
numerous and each outlet stocks products from many manufacturers that are all served by the same
distributor.
• Relationship aggregation: An intermediary can increase the supply chain surplus by decreasing
the number of relationships required between multiple buyers and sellers. Without an intermediary,
connecting a thousand sellers to a million buyers requires a billion relationships. Relationship
aggregation is most effective when many buyers sporadically purchase small amounts at a time but
each order often has products from multiple suppliers.
• Lower costs and higher quality: A third party can increase the supply chain surplus if it provides
lower cost or higher quality relative to the firm. If these benefits come from specialization and
learning, they are likely to be sustainable over the longer term.
Risks of Using a Third Party
• The process is broken
• Underestimation of the cost of coordination.
• Reduced customer/supplier contact
• Loss of internal capability and growth in third-party power
• Leakage of sensitive data and information.
• Ineffective contracts
• Loss of supply chain visibility
• Negative reputational impact
• The process is broken: The biggest problems arise when a firm outsources supply chain functions
simply because it has lost control of the process. The first step should be to get the process under
control, then do a cost–benefit analysis, and only then decide on outsourcing.
• Underestimation of the cost of coordination: A common mistake when outsourcing is to
underestimate the effort required to coordinate activities across multiple entities performing supply
chain tasks.
• Reduced customer/supplier contact: A firm may lose customer/supplier contact by introducing
an intermediary. The loss of customer contact is particularly significant for firms that sell directly
to consumers but decide to use a third party to either collect incoming orders or deliver outgoing
product.
• Loss of internal capability and growth in third-party power: A firm may choose to keep a
supply chain function in-house if outsourcing will significantly increase the third party’s power.
• Leakage of sensitive data and information: Using a third party requires a firm to share demand
information and, in some cases, intellectual property.
• Ineffective contracts: Contracts with performance metrics that distort the third party’s incentives
often significantly reduce any gains from outsourcing.
• Loss of supply chain visibility: Introducing third parties reduces the visibility of supply chain
operations, making it harder for the firm to respond quickly to local customer and market demands.
This loss of visibility can be particularly harmful for long supply chains.
• Negative reputational impact
Supplier Scoring and Assessment
• Supplier scoring and assessment is the process used to rate supplier performance. Suppliers should
be compared based on their impact on the supply chain surplus and total cost. Unfortunately,
sourcing decisions are often driven based solely on the price charged by a supplier. Many other
supplier characteristics, such as lead time, reliability, quality, and design capability also affect the
total cost of doing business with a supplier.
• A good supplier scoring and assessment process must identify and track performance along all
dimensions and evaluate the impact on the total cost of using a supplier. Supplier selection uses the
output from supplier scoring and assessment to identify the appropriate supplier(s). A supply
contract is then negotiated with the supplier. A good contract should account for all factors that
affect supply chain performance and should be designed to increase supply chain profits in a way
that benefits both the supplier and the buyer.
• Replenishment lead time
• On-time performance
• Supply flexibility
• Delivery frequency/ minimum lot size
• Supply quality
• Inbound transportation cost
• Pricing terms
• Information coordination capability
• Design collaboration capability
• Exchange rates, taxes, and duties
• Supplier viability
1. Select the key dimensions of performance mutually acceptable to both customer and supplier.
2. Monitor and collect performance data.
3. Assign weights to each of the dimensions of performance based on their relative importance to
the company’s objectives. The weights for all dimensions must sum to 1.
4. Evaluate each of the performance measures on a rating between zero (fails to meet any intended
purpose or performance) and 100 (exceptional in meeting intended purpose or performance).
5. Multiply the dimension ratings by their respective importance weights and then sum to get an
overall weighted score.
6. Classify vendors based on their overall scores, for example:

Unacceptable (less than 50)—supplier dropped from further business

Conditional (between 50 and 70)—supplier needs development work to improve performance
but may be dropped if performance continues to lag
Certified (between 70 and 90)—supplier meets intended purpose or performance
Preferred (greater than 90)—supplier will be considered for involvement in new product
development and opportunities for more business
7. Audit and perform ongoing certification review.
• The Margo Manufacturing Company (MMC) is performing an annual evaluation of one
of its suppliers, the Mimi Company. Anto, purchasing manager of the MMC, has collected
the following information:

• A score based on a scale of 0 (unsatisfactory) to 100 (excellent) has been assigned for each of the
performance category considered critical in assessing the supplier. Different weights are assigned
to each of the performance criteria based on its relative importance. How would you evaluate the
Mimi Company’s performance as a supplier?
Contracts, Risk Sharing and Supply Chain
Performance
• A supply contract specifies parameters governing the buyer-supplier relationship. In addition to
making the terms of the buyer-supplier relationship explicit, contracts have significant impact on
the behavior and performance of all stages in a supply chain. Contracts should be designed to
facilitate desirable supply chain outcomes by growing the supply chain
surplus and minimizing actions that hurt performance.
• A manager should ask the following three questions when designing a supply chain contract:
1. How will the contract affect the firm‘s profits and total supply chain profits?
2. Will the incentives in the contract introduce any information distortion?
3. How will the contract influence supplier performance along key performance measures?
• Ideally, a contract should be structured to increase the firm‘s profits and supply chain profits,
discourage information distortion, and offer incentives to the supplier to improve performance
along key dimensions. Many shortcomings in supply chain performance occur because the buyer
and supplier are different entities, each trying to optimize its own profits.
Contracts for Product Availability and Supply
Chain Profits
To improve overall profits, the supplier must design a contract that encourages the buyer to purchase
more and increase the level of product availability. This requires the supplier to share in some of the
buyer‘s demand uncertainty. Three contracts that increase overall profits by making the supplier share
some of the buyer‘s demand uncertainty are as
follows:
• Buyback or returns contracts: A buyback or returns clause in a contract allows a retailer to return
unsold inventory up to a specified amount, at an agreed-upon price.
• Revenue-sharing contracts: In revenue-sharing contracts, the manufacturer charges the retailer a
low wholesale price, and shares a fraction of the retailer‘s revenue. Even if no returns are allowed,
the lower wholesale price decreases the cost to the retailer in case of an overstock. The retailer thus
increases the level of product availability resulting in higher profits for both the manufacturer and
the retailer.
• Quantity flexibility contracts: Under quantity flexibility contracts, the manufacturer allows the
retailer to change the quantity ordered (within limits) after observing demand.
Revenue Management in a Supply Chain
• Revenue management is the use of pricing to increase the supply chain surplus and profit generated from a
limited availability of supply chain assets. Supply chain assets exist in two forms—capacity and inventory.
• Capacity assets in the supply chain exist for production, transportation, and storage.
• Inventory assets exist throughout the supply chain and are carried to improve product availability. In the
presence of multiple customer types, revenue management aims to grow profits by selling the right asset to
the right customer at the right price.
• Besides varying capacity and inventory, revenue management suggests varying price to grow
profits by better matching supply and demand.
• Revenue management adjusts the pricing and available supply of assets and has a significant impact on supply
chain profitability when one or more of the following four conditions exist:
1. The value of the product varies in different market segments.
2. The product is highly perishable or product wastage occurs.
3. Demand has seasonal and other peaks.
4. The product is sold both in bulk and on the spot market.
Pricing and Revenue Management
To use revenue management successfully when serving multiple customer segments, a firm must use
the following tactics effectively:
• Price based on the value assigned by each segment
• Use different prices for each segment
• Forecast at the segment level

The two revenue management tactics used for perishable assets are
• Vary price dynamically over time to maximize expected revenue
• Overbook sales of the asset to account for cancellations
Sustainability and Supply Chain
The factors driving an increased focus on sustainability can be divided into three distinct categories:
1) Reducing risk and improving the financial performance of the supply chain
2) Attracting customers who value sustainability
3) Making the world more sustainable
Even though there has been a lot of talk about all three categories, most concrete action has been
observed in reducing risk for the supply chain and improving financial performance. Much less
success has been driven by customer demand or the desire to make the world more sustainable. It is
interesting to note that significant opportunity exists even if supply chains focus only on reducing
risk and improving financial performance.
Key Metrics for Sustainability
• A look at various corporate social responsibility (CSR) reports shows some commonality but also a
lot of divergence in terms of the metrics they chose to report. All companies report some social and
environmental metrics. A large variation exists, however, in terms of the precise metrics reported.
• For example, (a) transportation companies tend to report on greenhouse emissions, fuel
consumption, and transportation efficiency whereas (b) pharmaceutical firms have a greater focus
on waste management and water consumption.
• From an environmental perspective, all firms should measure and report on these four categories:
• Energy consumption
• Water consumption
• Greenhouse gas emissions
• Waste generation
Logistics Outsourcing
Every subsequent outsourcing decision is rooted in a clear understanding of what an organization is
trying to accomplish because the motivations drive the selection of activities, expectations and
outcomes.
For example, for a firm to evaluate whether to own a private fleets of trucks or outsource by hiring
carriers, not only the current rates and costs are important but long-term cost trends and strategic
vision need also be considered
Tactical reasons for short-term Outsourcing:
• Reduce and control operating costs
• Freeing capital for investment
• Cash infusion
• Unavailability of resources internally
• Function difficult to manage or out of control
Logistics Outsourcing
Strategic reasons for long-term Outsourcing:
• Improve business focus
• Provides access to world class capabilities
• Provides acceleration to reengineering efforts
• Shared risks
• Frees resource for other purposes
Transformational reasons for outsourcing:
• Brings new and faster solutions to customers
• Helps respond to shortening product life cycles
• Redefines relationships with suppliers and business partners
• Helps in surpassing the competitors
• Helps to enter new markets with reduced risks
Issues in Outsourcing Decision
While making outsourcing decisions two important factors that to be considered are:
• Economic factors
• Strategic factors
Economic Factors:
Economic factors mainly refer to transaction costs. Transaction costs are those expenses that are
associated with performing specific activity. Its analysis suggests that logistics activities can be
performed internally if the transaction costs are lower than expenses associated with outsourcing.
This will be possible when:
• Only a few potential suppliers are available for outsourcing
• Transaction specific assets such as dedicated trucks, buildings or work force are required.
Major cost elements to be considered, while evaluating logistics activities will be performed
internally or outsourced, are based upon two factors:
• Internal performance
• Outsourcing performance
Major cost elements associated with internal performance include fixed capital costs such as
warehousing costs, volume based variable costs, equipment costs, managerial costs, direct labor such
as payment to drivers, and overhead costs such as those incurred in warehouse lighting.
Major cost elements associated with outsourcing performance include transportation costs, e.g.
carrier rates and warehouse charges, e.g. cost per square feet.
STRATEGIC FACTORS:
Strategic factors involve evaluating which supplier is the most capable of performing the service at
best practice level. An enterprise requires to evaluate the potential outsource services in terms of that
contribution to a firm’s core and noncore activities.
Typically, a firm will not dilute its core competencies by having external firms perform highly
sensitive activities. Once the enterprise has isolated those activities that are its core activities, the
balance of required activities or the non-core requirements become candidates for outsourcing.
Companies are realizing that the outsourcing decisions should not be limited to asset investment. It
must take into account capabilities provided or achieved through the asset investment. If the results
achieved by performing internally do not lead to best practices, then such activities should be
outsourced.
Strategic Partnerships
• Third Party Logistics, 3PL: An independent logistics service provider who performs any or all
the functions of logistics to get the clients’ products to the market. These services can be provided
on a stand alone or integrated basis. A stand alone operator, extends only one type of service in
which they have an expertise.
• These services may be any one among (i) warehousing, (ii) transportation, (iii) inventory
management, (iv) packaging, etc. However, the one who provides entire logistics services and
offers logistic solutions to customer problems is called an ‘integrator’.
• Fourth Party Logistics, 4PL: It is defined as follows, 4PL assembles and manages the resources,
capabilities and technology of its own organization with those of complementary service providers
to deliver a comprehensive supply chain solution.
The genesis of 4PL lies in forming collaborative relationships among various logistics service
providers based on an IT backbone. Hence, the network arrangement can be termed as 4PL, provided
it fulfills the following requirements:
• It covers the entire supply chain of the customer
• It is a collaboration between two or more logistics service providers on a resource sharing basis to
extend logistics solution to a common customer
• The integrator’s alliances are led by IT based and not asset based service providers
• The arrangement is flexible
Unlike traditional methods that focus on reduction in operational cost and asset transfer, 4PL works
in the following four ways:
(i) Increase revenue (ii) Reduces cost (iii) Reduces working capital and (iv) Reduces fixed capital
Reverse Logistics
• Today, logistical support means going beyond ‘forward logistics’ to include product recall, product
disposal, and product recycling. The logistics design objectives includes reverse material flow
system to support the life cycle of the product.
• In fact, reverse logistical competency is the result of world wide attention to environmental
concerns.
• Reverse logistics may be defined as a process of moving goods from their place of use, back to
their place of manufacture for reprocessing, refilling, repairs or waste disposal.
• It is a planned process of goods movement in reverse direction, done in an effective and cost
efficient manner, through an organized network.
Reverse Logistics
Reverse logistics can be a stand-alone or integrated system in the company’s supply chain.
The reasons for this are:
• Stiff competition
• Growing consumerism
• Government regulations on product recycling and waste disposal
• Growing public concern for environment pollution
The reverse logistics network can be used for various purposes such as:
• Refilling – LPG cylinders
• Repairs & Refurbishing – Any product under warranty period
• Product Recall – Defective design
• Remanufacturing – Worn out parts in replaced Cell phones & upgraded to the level of new one
• Recycling and Waste Disposal – Car recycling supply chain
Reverse Logistics – A competitive Tool
To remain competitive and differentiated, more and more firms across the world are showing speed and
reliability in service offerings such as:
• Replacing defective goods
• Repairing used products
• Refurbishing returned products
• Calling back substandard or harmful goods, and
• Disposing product waste.
These services add to the competitiveness of the company operating in a regulatory environment and
create customer value by providing a clean environment through reverse logistics services without any
extra cost to the customer.
Today, corporations across the world are leveraging reverse logistics for growth, by enhancing the level of
customer satisfaction beyond the traditional boundaries of product and service supply.