Chapter 6 Sourcing

Lecture Outline What is Sourcing? The Sourcing Function Sourcing and SCM Copyright 2011 John Wiley & Sons, Inc.

What is Sourcing? Sourcing is the business function responsible for all activities and processes required to purchase goods and services from suppliers select suppliers negotiate contracts manage process of acquisition Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Related Terms Purchasing Strategic Sourcing process of buying goods and services supplier selection, buying, negotiating contracts Strategic Sourcing seeks competitive advantage with sourcing opportunities builds supplier relationships Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Evolution of the Sourcing Function Copyright 2011 John Wiley & Sons, Inc.

Consumer vs. Commercial Sourcing many suppliers buyer is final customer small portion of supplier’s total business little ability to negotiate Copyright 2011 John Wiley & Sons, Inc.

Consumer vs. Commercial Sourcing Continued larger volumes purchased very specialized purchasing needs number of suppliers may be limited large sums of money often imbalance of power buying contracts legal, ethical, environmental, security concerns Copyright 2011 John Wiley & Sons, Inc.

Impact on the Organization Operational Impact right materials, right quantities, right place, right time optimal inventory balance Financial Impact sourcing spends 50% - 90% of revenue in most manufacturing organizations large sums of money  can have huge savings impact Copyright 2011 John Wiley & Sons, Inc.

Impact on the Organization Continued Strategic Impact support organization’s strategic direction Risk Mitigation minimize supply disruptions and protect reputation ensure suppliers meet performance standards Information Impact collect information on prices, suppliers, goods, new products and technologies Copyright 2011 John Wiley & Sons, Inc.

Sourcing Process Supplier Selection Negotiate Contracts Existing vs. New Suppliers Request for Quotation (RFQ), Request for Proposal (RFP), Request for Bid (RFB) Negotiate Contracts Manage Process of Acquisition Copyright 2011 John Wiley & Sons, Inc.

Sourcing Process Continued It is important for supplier management to be directed through the sourcing function combine requests from different users for same materials to lower costs seek input from other functions of organization understand material requirements to meet performance standards “Maverick buying” Copyright 2011 John Wiley & Sons, Inc.

Total Cost = Fixed Costs + Variable Costs Cost vs. Price Cost sum of all costs incurred to produce the product Total Cost = Fixed Costs + Variable Costs Fixed Costs do not vary with # units produced taxes, insurance, overhead Variable Costs vary directly with # units produced materials, labor Copyright 2011 John Wiley & Sons, Inc.

Cost vs. Price Continued the amount at which the item is sold in the marketplace Fair Price lowest price that can be paid while ensuring a continuous supply of quality goods Total Cost of Ownership (TCO) purchase price plus all other costs associated with acquiring the item Copyright 2011 John Wiley & Sons, Inc.

Cost vs. Price Example Variable Cost Materials $5,000 Labor $2,000 + Fixed Cost Facility Overhead $3,500 Total Cost (not TCO) $10,500 Profit $1,000 Selling Price $11,500 Copyright 2011 John Wiley & Sons, Inc.

Bidding or Negotiation? Sourcing function determines how to award contracts Competitive Bidding awards business to the most qualified bidder most efficient for purchasing standard items Negotiation communication process between two parties that attempts to reach a mutual agreement best when working with suppliers on factors beyond the purchase Copyright 2011 John Wiley & Sons, Inc.

Bidding or Negotiation? Copyright 2011 John Wiley & Sons, Inc.

Demand Uncertainty Supply chain demand uncertainty varies depending on the type of product sourced Two Categories of Products: Functional (low demand uncertainty) Innovative (high demand uncertainty) Copyright 2011 John Wiley & Sons, Inc.

Functional Products satisfy basic functions or needs stable and predictable demand long life cycles supply chains are easy to manage low profit margins Copyright 2011 John Wiley & Sons, Inc.

Innovative Products purchased for innovation or status highly unpredictable demand short life cycles supply chains are more difficult to manage higher profit margins Copyright 2011 John Wiley & Sons, Inc.

Supply Uncertainty Supply chain supply uncertainty can be classified as: Stable (low supply uncertainty) Evolving Process (high supply uncertainty) Copyright 2011 John Wiley & Sons, Inc.

Stable Supply Process low supply uncertainty mature manufacturing processes underlying technology is stable Copyright 2011 John Wiley & Sons, Inc.

Evolving Supply Process high supply uncertainty manufacturing process in early stage underlying technology is quickly evolving Copyright 2011 John Wiley & Sons, Inc.

Types of Supply Chains Efficiency-focused Responsive Risk-hedging low demand and supply uncertainty Responsive innovative products with stable supply base, mass customization Risk-hedging high supply uncertainty, high safety stocks, resource pooling Agile high demand and supply uncertainty Copyright 2011 John Wiley & Sons, Inc.

Copyright 2011 John Wiley & Sons, Inc.

Multiple vs. Single Sourcing Multiple Sources of Supply traditionally considered best increases competition ensures supplier security arms-length relationship with buyer can result in variations between sources Copyright 2011 John Wiley & Sons, Inc.

Multiple vs. Single Sourcing Continued Single Source of Supply becoming the norm focus on building close, long-term relationship cooperative negotiation lower freight costs easier scheduling Copyright 2011 John Wiley & Sons, Inc.

Global vs. Domestic Sourcing Global Sourcing also called “off-shoring” takes advantage of cheaper labor prominent with products with easily defined standards higher fuel costs result in high transportation costs virtual teaming can result in culture clashes and misunderstandings Copyright 2011 John Wiley & Sons, Inc.

Global vs. Domestic Sourcing reduces transportation costs can monitor quality more closely closer buyer-supplier relationships the emphasis on sustainability and “green” has resulted in a push toward local sourcing Copyright 2011 John Wiley & Sons, Inc.

Outsourcing Companies may outsource to: Two Key Dimensions: Scope access technical skills lower costs free themselves of doing non-core activities Two Key Dimensions: Scope degree of responsibility assigned to the supplier Criticality importance of the outsourced activities Copyright 2011 John Wiley & Sons, Inc.

Dimensions of Outsourcing Copyright 2011 John Wiley & Sons, Inc.

Electronic Auctions Buyers can use Electronic Auctions (E-Auctions) to select suppliers and determine aspects of the purchase contract Look at: Advantages and Disadvantages Types of E-Auctions Criteria for Use Three Stages of the E-Auction Process Copyright 2011 John Wiley & Sons, Inc.

Advantages of E-Auctions simplified comparison of supply sources decreased error rate market transparency increased buying reach reduction in ordering cycle time Copyright 2011 John Wiley & Sons, Inc.

Disadvantages of E-Auctions unrealistic low bidders seek to renegotiate after contract is awarded (may eliminate better suppliers) auction may include nonparticipants seeking to gather market intelligence may interrupt an existing good supplier relationship Copyright 2011 John Wiley & Sons, Inc.

Types of E-Auctions Open Auction Sealed Bid Auction Reverse Auction suppliers can select items to place offers on suppliers can see competitive offers suppliers can keep submitting offers until close Sealed Bid Auction sellers submit one blind bid Reverse Auction one buyer and many sellers most common type sellers place decreasing bids Copyright 2011 John Wiley & Sons, Inc.

E-Auction Criteria E-Auctions should have: specifications for goods or services well defined sufficient number of qualified suppliers clear understanding of market standards clear rules for running the E-Auction Copyright 2011 John Wiley & Sons, Inc.

Three Stages of E-Auction Process Preparation set product requirements identify and prequalify suppliers specify auction rules test and train participants on technology The Auction Event communication between suppliers and seller Follow-up Copyright 2011 John Wiley & Sons, Inc.

Measuring Sourcing Performance Inventory Turnover and Weeks-of-Supply are two common performance measures of the sourcing function Inventory Turnover measures how quickly inventory moves Inventory Turnover = Cost of Goods Sold Average Inventory Value Copyright 2011 John Wiley & Sons, Inc.

Inventory Turnover Example Jenco Inc. produces dolls. Annual cost of goods sold is $8,000,000 and average inventory is $2,000,000. What is the annual inventory turnover? Inventory Turnover = = = 4 inventory turns/year Cost of Goods Sold Average Inventory Value $8,000,000 $2,000,000 Copyright 2011 John Wiley & Sons, Inc.

Measuring Sourcing Performance Continued Weeks-of-Supply provides the length of time demand can be met with on-hand inventory Weeks of Supply = Average On-Hand Inventory Average Weekly Usage Copyright 2011 John Wiley & Sons, Inc.

Weeks of Supply Example Jenco Inc. has an annual cost of goods sold of $8,000,000 and average inventory is $2,000,000. How many weeks of supply are on-hand? Weeks of Supply = = = 13 weeks of supply Average On-Hand Inventory Average Weekly Usage 2,000,000 $8,000,000/52 Copyright 2011 John Wiley & Sons, Inc.

Review Sourcing is the business function responsible for all activities and processes required to purchase goods and services from suppliers. Terms such as “purchasing,” “strategic sourcing,” and “supply management” are used interchangeably but are not the same. Purchasing defines the process of buying goods and services, whereas strategic sourcing, or supply management, involve looking at sourcing from a strategic and future oriented perspective. The sourcing function provides a number of critical roles for the organization. These are operational impact, financial impact, strategic impact, risk mitigation impact, and information impact. Copyright 2011 John Wiley & Sons, Inc.

Review Continued The sourcing process involves every aspect of acquiring goods and services, ranging from identifying potential suppliers to negotiating and awarding contracts, and ensuring contract standards are met. Competitive bidding and negotiation are two different methods used to reach agreement and develop contracts with suppliers. Products can be classified as either primarily functional or primarily innovative. Depending on their classification, they will be sourced differently and require different types of supply chains. Copyright 2011 John Wiley & Sons, Inc.

Review Continued Outsourcing engagements can be classified based on scope and criticality of outsourced tasks. E-auctions are the use of Internet technology to conduct auctions as a means of selecting suppliers and determining aspects of the purchase contract. Inventory turnover and weeks of supply are two metrics that can be used to measure performance of the sourcing function. Copyright 2011 John Wiley & Sons, Inc.

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