OUTLINE Questions, Comments? Quiz Target Comments Go over homework New homework Start Evaluating suppliers

Chapter 14 – Sourcing Decisions Assessing suppliers Selecting suppliers - Single or multiple Contracts Negotiation (BATNA, ZOPA, Reservation values) Design Collaboration Procurement Process

Definitions Cost of Goods Sold – total expenditures to obtain or manufacture the product. This does not include Sales and administrative costs. Safety Inventory – Inventory held to protect against variations in demand and lead time Cycle Inventory – Inventory held to account for lot sizing Landed Cost – Purchase Price plus transportation in Bullwhip effect – accentuation of variations in demand as we go up the chain Replenishment lead time – time from ordering to receipt

Definitions - continued Quantity Discounts – Price depends on the amount purchased Double Marginalization – Retailer sets price higher than is optimal for the chain in order to have enough margin (Sales are a function of price) Newspaper problem – Deciding how many of a perishable item to order, based on loss of profits (under stocking) and cost of unsold goods (over stocking) Excel Norm functions to calculate normal probabilities: NORMINV(percentage, mean, standard deviation) = Value NORMDIST(Value, mean, standard deviation, TRUE) = percentage

Newspaper problem Newspaper person’s cost = $0.25, no salvage value Profit on a paper = $0.50 Estimated average sales = 60 Estimated standard deviation of sales = 5 Percentage (Service level) = 0.50/(0.50+0.25) = .667 NORMINV(0.667, 60, 5) = 63 or Q= average + z(std. dev) If the overage cost is lower than the shortage cost we order more than the average Underage cost = lost profit = Selling price – Cost Overage cost = Excess unsalvageable inventory = Cost – salvage value Service level = Underage cost/ (Underage + overage cost)

The newspaper problem Expected Profit at Q = 62: $28.64 Expected Profit at Q = 63: $28.62 The formula for expected profit comes from the probability of demand being less or more than the order quantity

The newspaper problem

The newspaper problem

Assessing suppliers What would you want to now about a potential supplier?

Assessing suppliers Price (landed) and terms Lead time, mean and variance affect safety inventory Supply flexibility – changes in quantities (lot sizes) (safety inventory) Delivery frequency – affects cycle inventory Quality Information infrastructure Design collaboration Exchange rates, taxes, duties Viability – are they going to be around

Evaluation Company Profile Management Capability Personnel capabilities Cost Structure (see example on next three slides) Total quality management Process and technology Environmental capability Financial capability (see slides from Park’s Engineering Economics Text) Production scheduling and control systems Information Systems capability Supplier sourcing strategies Potential for a long term relationship

CHAPTER 2 of Park - CATEGORIES OF RATIOS DEBT MANAGEMENT - HOW DO YOU GET YOUR CAPITAL LIQUIDITY - CAN YOU PAY YOUR DEBTS ASSET MANAGEMENT- INVENTORY AND RECEIVABLES MARKET VALUE - HOW REALISTIC IS THE VALUE OF THE STOCK PROFITABILITY - HOW WELL ARE YOUR INVESTMENTS GENERATING PROFITS

CHAPTER 2 of Park - DEBT MANAGEMENT DEBT RATIO = TOTAL DEBT / TOTAL ASSETS HAVE YOU BORROWED TOO LARGE A PART OF YOUR ASSETS? TIMES INTEREST EARNED RATIO = EARNINGS BEFORE INTEREST AND INCOME TAXES / INTEREST EXPENSE CAN YOU EARN ENOUGH TO PAY THE INTEREST?

CHAPTER 2 of Park - LIQUIDITY CURRENT RATIO = CURRENT ASSETS / CURRENT LIABILITIES DO YOU OWE MORE THAN YOU HAVE? QUICK RATIO = (CURRENT ASSETS - INVENTORIES) / CURRENT LIABILITIES HOW FAST CAN YOU PAY YOUR DEBTS?

CHAPTER 2 of Park - ASSET MANAGEMENT INVENTORY TURNOVER = SALES / AVERAGE INVENTORY BALANCE ARE YOU MOVING YOUR INVENTORY FAST ENOUGH? ACCOUNT RECEIVABLE TURNOVER (DAYS SALES OUTSTANDING) = RECEIVABLES / DAILY SALES ARE YOU COLLECTING FROM YOUR CUSTOMERS? TOTAL ASSET TURNOVER = SALES / TOTAL ASSETS ARE YOUR ASSETS GENERATING SALES?

CHAPTER 2 of Park - MARKET VALUE PRICE EARNING RATIO = STOCK PRICE / ANNUAL EARNINGS PER SHARE LIKE INTEREST (JUST A LOT LOWER) BOOK VALUE PER SHARE (TOTAL STOCK HOLDER EQUITY - PREFFERED STOCK) / SHARES OUTSTANDING USUALLY MUCH LOWER THAN THE STOCK PRICE

CHAPTER 2 of Park - PROFITABILITY PROFIT MARGIN ON SALES = NET INCOME / SALES HOW EFFECTIVE ARE YOUR SALES IN GENERATING INCOME? RETURN ON TOTAL ASSETS = (NET INCOME + TAXED INTEREST EXPENSE) / AVERAGE TOTAL ASSETS ARE YOUR INVESTMENTS GENERATING ENOUGH INCOME?

Contracts Objectives Protect both parties Reduce double marginalization Reduce information distortion Increase agent effort Induce improvement in performance Types Buyback or return Revenue sharing Quantity flexible

Design Collaboration Customers’ Requirements Suppliers’ specifications Design for manufacturability (DFM)

Procurement Process Placing orders Receiving orders Paying for orders Consider types of transaction when designing the process Separate direct from indirect purchases