MGMT 346 Chapter 16 Global Sourcing and Procurement

Three Types of Costs making up Total Cost of Ownership

*1) Acquisition Costs* - are the initial costs associated with the purchase of materials, products and service - are not long-term costs of ownership - represent an immediate cash outflow - *include* (1) pre purchase costs associated with preparing documents to distribute to potential suppliers, (2) identifying suppliers and evaluating suppliers, (3) other costs associated with actually procuring the item, (4) actual purchase price (taxes, tariffs, and transportation costs) *2) Ownership Costs* - are incurred after the initial purchase and are associated with the ongoing use of the product or material - *example of quantifiable costs* (1) energy usage, (2) scheduled maintenance, (3) repair, (4) financing (leasing situation) - *example of qualitative costs* (1) aesthetic factors (the item is pleasing to the eye), (2) ergonomic factors (productivity improvement or reducing fatigue) - *often* exceed the initial purchase price and have an impact on cash flow, profitability and employee morale/productivity *3) Post-Ownership Costs* - *include* (1) salvage value, (2) disposal costs, (3) long-term environmental impact (when the firm has sustainability goals), (4) warranty and product liabilities, and (5) negative marketing impact of low customer satisfaction

Total Cost of Ownership (Three Areas of Costs)

*1) Acquisition Costs* - purchase planning costs - quality costs - taxes - purchasing price - financing costs *2) Ownership Costs* - energy costs - maintenance and repair - financing - supply chain/supply network costs *3) Post-Ownership Costs* - disposal - environmental costs - warranty costs - product liability costs - customer dissatisfaction costs

Framework for Structuring Supplier Relationships

*1) Coordination Characteristics* *DO NOT outsource:* - coordination and interfaces are not well defined - information and coordination is specific to each job - technology is immature and there is a need for "expert" knowledge obtained. by experience *DO outsource:* - standardized interfaces, required information is highly codified and standardized (prices, quantities, delivery schedules) *2) Investment in Strategic Assets Characteristics* *DO NOT outsource:* - significant investments in highly specialized assets are needed - investments cannot be easily recovered if the relationship terminates - long0term investments in specialized R&D, and lengthy learning curves *DO outsource:* - assets are commonly available from a large number of potential customers or suppliers *3) Intellectual Property Characteristics* *DO NOT outsource:* - weak intellectual property protection - easy-toimitate technology when access is given *DO outsource:* - strong intellectual property protection difficult-to-imitate technology

Four Types of Supply Chain Strategies

*1) Efficient Supply Chain* - are supply chains that utilize strategies aimed at creating the highest levels of cost efficiency - *for efficiencies to be achieved*, (1) no-value added activities should be eliminated, (2) scale economies should be pursued, (3) optimization techniques should be deployed to get the best capacity utilization in production and distribution, (4) information linkages should be established to ensure most efficient, accurate, and cost-effective transmission of information *2) Risk-Hedging Supply Chain* - are supply chains that utilize strategies aimed at pooling and sharing resources in a supply chain so risks in supply disruption can be shared - *single entity in supply chain* can be vulnerable to supply disruptions, but there is more than one supply source the risk of disruption is reduced - *common in retailing* where retail stores or dealerships share inventory - *information technology is important for the success of these strategies bc real-time info on inventory and demand allows for most cost-effective management and transshipment of goods between partners *3) Responsive Supply Chain* - are supply chains that utilize strategies aimed at being responsive and flexible to the changing and diverse needs of the customers - *to be responsive*, companies use build-to-order and mass customization processes to meet requirements *4) Agile Supply Chains* - are supply chains that utilize strategies aimed at being responsive and flexible to customer needs, while the risks of supply shortages or disruptions are hedged by pooling inventory and other capacity resources - *have strategies in that combine the strengths of "hedged" and "responsive" supply chains - *agile bc* they have the ability to be responsive to the changing, diverse and unpredictable demands of customers on front-end, while minimizing the back-end risks of supply disruptions

Two Common Measures to Evaluate Supply Chain Efficiency

*1) Inventory Turnover* - measure of supply chain efficiency *formula*: Inventory Turnover = (COGS / Average Aggregate Inventory Value) *2) Weeks of Supply* - preferred measure of supply chain efficiency that is mathematically the inverse of inventory turnover times 52 weeks - measure of how many weeks' worth of inventory is in the system at a particular point in time *formula* Weeks of Supply = (Average Aggregate Inventory Value / COGS) x 52 weeks TERMS: 1) *cost of goods sold* - is the annual cost of a company to produce the goods or services provided to customers - sometimes referred to as "cost of revenue" 2) *average aggregate inventory value*: - is the average total value of all items held in inventory for the firm *valued at cost* - *include* (1) raw material, (2) work-in-process, (3) finished goods, (4) distribution inventory considered owned by the company NOTE: - *good inventory turnover values* vary by industry and type of product being handled - values of 6 to 7 are typical for manufacturing firms - when company's financial reports cite "inventory turnover" and "weeks of supply" assume that the measures are being calculated *firmwide* - calculations can be done for individual entities within an organization - *inventory is considered an investment bc* the intent is for it to be used in the future

Whether an activity is to be outsourced can be evaluated using the following characteristics

*1) Required Coordination* - refers to how difficult it is to ensure that the activity will integrate well with the overall process - *uncertain activities* that require much back and forth exchange of info should not be outsourced - *well understood and highly standardized activities* can easily move to business partners who specialize in the activity *2) Strategic Control* - refers to the degree of loss that would be incurred if the relationship with the partner were severed - *types of loss to consider include* (1) specialized facilities, (2) knowledge of major customer relationships, (3) and investment in research and development *3) Intellectual Property* - is the consideration of potential loss of intellectual property through the partnerships

Six-Step Process for Green Sourcing

*1. Assess the Opportunity* - "evaluate and prioritize costs" - for a given category of expense, all relevant costs need to be taken into account - *five common areas of costs include:* (1) electricity and other energy costs, (2) disposal and recycling, (3) packaging, (4) commodity substitution (alternative materials to replace materials such as steel or plastic), (5) water (other related resources) - costs are identified and incorporated into an analysis of total costs ("spend" cost analysis) *2. Engage Internal Supply Chain Sourcing Agents* - "encourage cross-functional ownership of the process" - *internal sourcing agents*: are those within the firm that purchase items and have direct knowledge of (1) business requirements, (2) product specifications and (3) other internal perspective of supply chain - *must be "on-board"* and be partners in the improvement process to help set realistic green goals *3. Assess the Supply Base* - "engage vendors in the process" - *in traditional sourcing* firm needs to understand vendor capabilities, constraints and product offers - *in green sourcing*, the process needs to be augmented with formal requirements that relate to green opportunities (including commodity substitutions and new manufacturing process - *requirements need to be incorporated in* vendor bid documents or request for proposal (RFPs) *4. Develop the Sourcing Strategy* - "develop quantitative criteria" - *main goal* is to develop quantitative and qualitative criteria that will be used to evaluate the sourcing process - *criteria are needed to* properly analyze associated costs and benefits - *criteria* must be clearly articulated in bid documents and request for proposal (RFPs) *5. Implement Sourcing Strategy* - "select vendors and products based on criteria" - *based on the criteria from step 4*, select the vendors and products for each business requirement - *evaluation process* should consider initial cost and the total cost of ownership for the items in the bid *6. Institutionalize the Sourcing Strategy* - "implement metrics and audits to monitor performance" - *once the vendor is selected and contracts finalized*, the *procurement process begins* - *sourcing and procurement department* needs to define a set of metrics against which the supplier will be measured for the contracts duration - *metrics should be based on* (1) performance, (2) delivery, (3) compliance with pricing guidelines, (4) similar factors - *vital that metrics related to the company's sustainability goals* are considered

Reasons to Outsource and the Resulting Benefits (Exhibit 16.4)

*Financially Driven Reasons* - improve return on assets by reducing inventory and selling unnecessary assets - generate cash by selling low-return entities - gain access to new markets, particularly in developing countries - reduce costs through a lower cost structure - turn fixed costs into variable costs *Improvement-Driven Reasons* - improve quality and productivity - shorten cycle time - obtain expertise, skills, and technologies that are not otherwise available - improve risk management - improve credibility and image by associating with superior providers *Organizationally Driven Reasons* - improve effectiveness by focusing on what the firm does best - increase flexibility to meet changing demand for products and services - increase product and service value by improving response to customer needs

Difference Between Core and Strategic Activities

*core activities* are key to the business, but do not confer a competitive advantage - *ex* bank's information technology operations *strategic activities* are a key source of competitive advantage *since competitive environment can change rapidly*, companies need to monitor the situation constantly and adjust

Logistics

*management functions that support the complete cycle of material flow:* (1) from the purchase and internal control of production materials (2) to the planning and control of work-in-process (3) to the purchasing, shipping, and distribution of the finished product - *emphasis on lean inventory means* there is less room for error in deliveries - *logistics companies* have complex computer tracking technology that reduces the risk in transportation and allows the logistics company to add more value to the firm than it could if function were performed in-house *FedEx* has one of the most advanced systems available for tracking items being sent through its service - system is available to all customers over the internet - tells the exact status of each item currently being carried by the company

NOTE

- *a key aspect of green sourcing (compared to a traditional process)* is the expanded view of the sourcing decision - *sourcing decisions* are "strategic" decisions - *expanded view requires* (1) the incorporation of new criteria for evaluating alternatives, (2) a wider range of internal integration (such as designer, engineers, and marketers) - *visualizing and capturing green sourcing* savings involves greater complexity and longer payback periods compared to traditional processes

NOTE

- *commonly available products* can be purchased using a relatively simple process - *low-volume and inexpensive items* purchased during. the regular routine of work, firm may order from an online catalog - *online catalogs are customized for a customer*, special user identifications can be set up. to authorize. customer's employees to purchase certain groups of items, with limits on how much they can spend

NOTE

- *companies usually outsource standard activities* when they are not part of the "core competency" of the firm - *keep control of (or acquire) activities that are true competitive differentiators or have potential to yield a competitive advantage* and outsource the rest

NOTE

- *costs that do not vary based on the decision* are not considered - *costs that vary depending on the decision* should be included in the analysis *TCO analysis considers* 1) Finance (net present value) 2) Accounting (product pricing and costing) 3) Operations management (reliability, quality, need, and inventory planning) 4) Marketing (demand) 5) Information Technology (system integration) *use a cross-functional team approach*, representing the key functional areas

Green Sourcing

- *environmentally responsible ahs become a business imperative*, with firms looking to their supply chains to deliver "green" results - *significant areas of focus relate to how a firm works with suppliers* where the opportunity to save money and benefit the environment might not be a strict trade-off - *green sourcing IS NOT just about finding new environmentally friendly technologies or increasing the use of recyclables materials, *BUT can also help drive cost reductions* (product content substitution, waste reduction, lower usage) - *comprehensive green sourcing effort should assess* how a company uses items that are purchased internally, in its own operations, or in its products and services - *green sourcing efforts goals* is to significantly reduce and possibly eliminate the need for steel, electricity, and fossil fuels - *green sourcing can help establish entirely new lines of business* to serve environmentally conscious customers - *green sourcing takes advantage of* ENVIRONMENTAL FACTORS

NOTE

- *innovative products with unpredictable demand and an evolving supply process* face major challenges bc of shorter product life cycles.

NOTE

- *overemphasis on acquisition cost or purchase price*, results in a failure to address other significant ownership and post-ownership costs

NOTE

- *since each category requires a distinctly different kind of supply chain, *the cause of supply chain problems is a mismatch between the type of product and type of supply chain*

NOTE

- *to appreciate the cost of purchasing an item from a particular vendor*, an approach that captures the costs of the activities associated with purchasing and using the item should be considered - *depending on complexity of the purchasing process*, activities such as (1) prebid conferences, (2) visits by potential suppliers (3) visits to potential suppliers can significantly impact the total cost of the time

NOTE

- *to avoid low margins, companies introduce "innovations" in fashion or technology* to give customers an additional reason to buy their products - *innovation* can enable companies to achieve higher profit margins but the very newness of the products make demand for them unpredictable

Total Cost of Ownership Includes

- Disposal Costs and Procurement Costs - *does not include* overhead or searching costs

Sourcing/Purchasing Design Matrix

- EXHIBIT 16.1 on page 449 - purchasing processes that span from a simple "spot" or one-time purchase to a long-term strategic alliance are depicted in diagram - *diagram positions* a purchasing process according to the specificity of the time, contract duration, and intensity of transaction costs

Sourcing

- a process suitable for procuring products that are strategically important to the firm - *implies a more complex process* suitable for products that. are strategically important - *sourcing activities* can vary greatly and depend on the "item being purchased"

Evolving Supply Process

- a process where the underlying technology changes *rapidly* - is where the manufacturing process and the underlying technology are still under development and are rapidly changing - *results in a supply base* that is limited in both size and experience - *in an evolving supply process,* the manufacturing process requires a lot of fine-tuning and is often subject to breakdowns and uncertain yields

Stable Supply Process

- a process where the underlying technology is *stable* - is where the manufacturing process and the underlying technology. are mature and the supply base is well established - *in a stable supply process*, manufacturing complexity tends to be low or manageable - *stable manufacturing process* are highly automated and long-term supply contracts are prevalent

Request for Proposal (RFP)

- a solicitation that asks for a detailed. proposal from a vendor interested in supplying an item - used for purchasing items that are complex or expensive and where there may be a number of potential vendors INCLUDES - 1) *detailed information packet describing what is to be purchased* is prepared and distributed to potential vendors - 2) vendor responds with a detailed proposal of how the company intends to meet the terms of the RFP - 3) request for bid or reverse auctions (similar to information packet needed) *major difference in how a bid price is negotiated* - *In the RFP*, the bid is included in the proposal - *In a Request for Bid or Reverse Auction*, vendors actually bid on the items in real time (use internet)

NOTE

- as. a result of globalization and inexpensive communications technology, the basis for competition is changing, *a firm is no longer constrained by the capabilities it owns*, what MATTERS is its ability to make the most of available capabilities (whether owned by firm or not)

Total Cost of Ownership (TCO)

- is an estimate of the cost of an item that includes all the costs related to its procurement and use of the item, including disposing of the item after its useful life (no longer useful) - used when considering all costs of an item - *TCO is applied* to a company's internal costs or more broadly to consider costs throughout the supply chain - *TCO* is a philosophy for understanding all relevant costs of doing business with a particular supplier. for a goods or service - *TCO is NOT relevant for a business that* wants to (1) reduce its cost of doing business and also (2) a firm that aims to design products or service that provide the lowest total cost of ownership to customers - *costs can be estimated as* *(1) cash inflows* (sale of used equipment) *(2) cash outflows* (purchase prices, demolition of an obsolete facility, etc.)

Outsourcing

- is so sophisticated that even core functions. such as. engineering, research and development, and manufacturing, information technology, and marketing can be moved outside

Outsourcing

- moving some of a firm's internal activities and decisions responsibility to outside providers - *terms of agreement* are established in a contract - *outsourcing goes beyond the more common purchasing and consulting contracts because* the activities are transferred and the resources that make the activities occur (include people, facilities, equipment, technology, and other assets are transferred. - *responsibilities for making decisions* over certain elements of the activities are transferred as well - *allows a firm to focus on* activities that represent its core competencies, thus a company can create a "competitive advantage" while reducing cost - *entire function or some elements of an activity (rest kept-in house) may be outsourced - *drawback of outsourcing is layoffs*, which makes outsourcing perceived by many unions as an effort to circumvent union contracts - *allows companies to* (1) unload noncore activities, (2) shed balance sheet assets, and (3) boost their return on capital by using third party service providers

Innovative Products

- products such as fashionable clothes and personal computers that typically have a life cycle of just a few months - *imitators* quickly erode the competitive advantage that innovative products enjoy, forcing companies to introduce a steady stream of newer innovations - *short product life cycle and great variety of products* increase "unpredictability" - innovative products have a *higher inventory level* than functional products

Continuous Replenishment

- program pioneered by Campbell Soup - a program for automatically supplying groups of items to a customer on a regular basis - *typifies* what many manufacturers are doing to smooth the flow of materials through their supply chain HOW IT WORKS: 1) Campbell establish electronic data interchange (EDI) links with retailers and offers an "everyday low price" that eliminates discounts 2) Every morning retailers electronically inform the company of their demand for Campbell products and of the level of inventories in their distribution centers 3) Campbell uses information to forecast future demand and determine which products require replenishment based on upper and lower inventory limits 4) Trucks leave Campbell shipping plant that afternoon and arrive at the retailers distribution centers with required replenishment the same day - *has allowed Campbell to cut the retailers' inventory* from four weeks of supply to two weeks

What are some reasons that a firm might outsource logistics?

- reducing the number of employees - lower costs - freight tracking using technology

Specificity

- refers to how commonly available the material (item) is and whether substitutes can be used or are available - *example*: 1) blank USB flash drives are commonly available. from many different vendors and would have low specificity 2) custom-made Apple AirPods case, is a high-specificity item

Forward Buying

- refers to when a customer, responding to a promotion, buys far in advance of when an item will be used - *occurs when* retailers respond to the price cut by stocking up (can be a year supply) - *nobody wins* in a forward buying deal - *retailers* have to pay to carry the year's supply, shipment bulge adds cost throughout the supplier's system, and the vendors that supply the manufacturing plants are affected bc they must quickly react to large surge in raw material requirements

Advantages of Continuous Replenishment for Retailers

- retailers figure that the *cost to carry the inventory of a given product for a year equals at least 25%* of what they paid for the product - *two week inventory reduction* represents a cost savings equal to nearly 1% of sales - *average retailers profit equal about 2% of sales, so this savings can increase profits by 50%

What are the drawbacks to forward buying?

- shipment bulge - large carrying costs - higher supply chain costs

Functional Products

- staples that people buy in a wide range of retail outlets (such as grocery stores and gas stations) - *since such products satisfy basic needs (which do not change overtime)*, they have stable, predictable demand and long life cycles - *functional products stability invites competition*, leading to low profit margins - *tend to have more mature and stable supply process*, but this is not always the case *criteria for identifying functional products* 1) product life cycle of more than 2 years (long product life cycle) 2) contribution margins of 5% to 20% 3) only 10 to 20 product variations 4) average forecast error at time of production of only 10% 5) lead time for make-to-order products. of form 6 months to 1 year

Strategic sourcing

- the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the needs of a business - *sourcing* was just another term for purchasing, a corporate function that financially was important but strategically was not the center of attention

Bullwhip Effect

- variability in demand is magnified as we move from the customer to the producer in the supply chain - *describes the phenomenon of variability magnification* as one moves down the supply chain from customer to produce - *bullwhip effect indicates* a lack of "synchronization" among supply chain members - *even a slight change in consumer sales* ripples backward in the form of a magnified oscillations upstream (resembling the result of a flick of a bullwhip) - *supply patterns do not match the demand patterns* so inventory accumulates at various stages, and storages and delays occur at others

Vendor-Managed Inventory

- when a customer allows the supplier to manage the inventory policy of an item or group of items - when the supplier takes full responsibility to manage items for the customer - *supplier* is given the freedom to replenish the item as they see fit - *common constraints regarding vendor-managed inventory* (1) maximum that the customer is willing to carry (maximum inventory level) (2) required service levels (3) billing transaction processes - *selecting the proper vendor-managed inventory process* depends on (1) minimizing the balance between the supplier's delivered costs of the item over a period of time (2) the customers costs of managing the inventory

Nodes of a Supply Chain

1) Manufacturer 2) Distributor 3) Wholesaler 4) Retailer - *retailer's orders to the wholesaler* display greater VARIABILITY than the end-consumer sales - *wholesaler's orders to the manufacturer* show even more oscillations - *manufacturer's orders to its suppliers* are most volatile

Supply Chain Uncertainty Framework

EXHIBIT 16.3 on page 451 - *shows the difference between functional and innovative products* - *shows the difference between stable and evolving supply processes* - *shows some examples of products that have different demand and supply uncertainties - *more challenging to operate a supply chain that is in the right column* of exhibit 16.3 than left - *more challenging to operate a supply chain that is in the lower row of exhibit 16.3 than upper row - is designed to help managers understand the nature of demand for their products and then devise the supply chain that can best satisfy that demand - *important aspects of a products demand* (1) product life cycle (2) demand predictability (3) product variety (4) market standards for lead times and service - *products can be categorized as either* (1) primarily functional (2) primarily innovative

Relative to evolving manufacturing (supply) process, stable processes have ___________ quality problems.

Few

Relative to evolving manufacturing (supply) process, stable processes have __________ process yields

High

Relative to evolving manufacturing (supply) process, stable processes have _______ supply sources

Many

A product with high demand uncertainty and low supply uncertainty would utilize which type of supply chain?

Responsive