Supply Chain - A Source of Competitive Advantage

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    Operations StrategyBuilding and Evaluating Firms Operating Systems

    Week2Partha Priya Datta

    Supply Network Strategy

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    Strategic SourcingWhat is it?

    = Deciding on appropriate supply relationships for each activity.

    Three step approach:

    1. Identify the activity and its requirements;

    2. Make-or-buy decision: which activities are internal or not?

    3. SRM: define, contract and manage the supplier relationship

    Distinguish:

    Strategic buyers: lead cross-functional sourcing teams thatdevelop sourcing strategy

    Tactical buyers: execute transactional purchase orderprocesses

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    Strategic Sourcing

    Why it is important Purchasing, sourcing, procurement is the biggest single cost for most firms

    Accounts for 60% of the average companys total cost

    Great potential for bottom-line improvement.

    E.g., 20% profit margin and purchasing is 85% of COGS.

    Price = $100, COGS = $80, Purchasing = .85*$80 = $68

    Say purchasing improves 10%

    Then margin becomes $20+$6.8, which is a 34% increase And even greater leverage on net income!

    Sourcing must be strategic:

    1. Cost containment is fundamental

    Control prices and prevent wasteful spending

    2. If well practiced, it can also drive innovation, quality, flexibility or

    responsiveness

    Need talent and mindset beyond transactional purchasing

    Need to integrate with overall operations strategy

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    Strategic Sourcing

    A strategic framework

    2. Is outsourcing necessary?

    Are internal financial and operational capabilities insufficient?

    1. Is outsourcing feasible? Is a stable supply base with necessary capabilities available?

    Is outsourcing politically viable?

    3. Is outsourcing in line with strategic priorities and risks? Is this activity non-core?

    Is the risk of outsourcing it tolerable?

    4. Is outsourcing desirable given our value proposition? Can external suppliers do it better? (TCO & NPV)

    5. Do we have the ability to manage suppliers and ongoing risk? Can we contract on detailed requirements?

    Can we coordinate incentives and operational flows?

    No

    No

    No

    Yes

    Easy Difficult Impossible

    Yes

    Yes

    Yes

    No

    Market Buy Long Term Relationships Vertical Integration

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    Two Main Reasons for Outsourcing

    Dependency on capacity Firm has the knowledge and the skills required to

    produce the component

    For various reasons decides to outsource Dependency on knowledge

    Firm does not have the people, skills, and

    knowledge required to produce the component

    Outsources in order to have access to these

    capabilities.

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    Outsourcing Decisions at Toyota

    About 30% of components in-sourced

    Engines: Company has knowledge and capacity

    100% of engines are produced internally

    Transmissions

    Company has the knowledge

    Designs all the components

    Depends on its suppliers capacities

    70 % of the components outsourced

    Vehicle electronic systems

    Designed and produced by Toyotas suppliers.

    Company has dependency on both capacity and knowledge

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    Outsourcing Decisions at Toyota

    Toyota seems to vary its outsourcing practicedepending on the strategic role of the

    components and subsystems

    The more strategically important the component,the smaller the dependency on knowledge or

    capacity.

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    Sourcing Strategy Questions

    How many suppliers should the company engage intotal and for a given part or commodity?

    What role should each supply play?

    Should overseas sourcing be used, and if so, howmuch?

    How should supplier relationships be structured and

    managed?

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    Choosing the Right Number of Suppliers: Value

    to Reducing the Supply Base

    Lower cost and effort to manage relationshipsoverall

    Greater potential to coordinate designs

    Increased capability to synchronize schedules Increased capability to evaluate suppliers on

    multiple criteria, not just cost

    Capabilities of procuring modules rater than parts Ease of tracking performance

    Ease of exchanging information

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    Choosing the Right Number of Suppliers:

    Disadvantages to Multi-tier Supply Chains

    Lack of visibility over inventory leading to:

    More stockouts as information is late to arrive fromlower levels of the supply chain

    More inventory throughout the supply chain as eachtier buffers against uncertainty

    Increased cost of quality

    Greater demand volatility

    Diminished new product or service performance: Increased cycles times

    Less effective optimization of integral designs

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    Choosing the Right Number of Suppliers: Per

    Item Outsourced Depends On -

    Uniqueness of sourced item or equipment

    Viability and reliability of suppliers

    Stability of the technology associated with theitem being sourced

    Significance of the buying companys business

    to the total business of the supplier

    Branding implications of sourcing decision

    Competitiveness of market

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    Fishers Functional vs. Innovative Products

    Functional Products Innovative Products

    Product clockspeed Slow Fast

    Demand Characteristics Predictable Unpredictable

    Profit Margin Low High

    Product Variety Low High

    Average forecast error at

    the time production is

    committed

    Low High

    Average stockout rate Low High

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    Supply Chain Strategy

    Functional Products

    Diapers, soup, milk, tiers Appropriate supply chain strategy for functional products

    is push

    Focus: efficiency, cost reduction, and supply chain planning.

    Innovative products

    Fashion items, cosmetics, or high tech products

    Appropriate supply chain strategy is pull

    Focus: high profit margins, fast clockspeed, and

    unpredictable demand, responsiveness, maximizing

    service level, order fulfillment

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    Procurement Strategy for the Two Types

    Functional Products

    Focus should be on minimizing total landed cost

    unit cost

    transportation cost

    inventory holding cost

    handling cost

    duties and taxation

    cost of financing

    Sourcing from low-cost countries, e.g., mainland China and Taiwan is

    appropriate

    Innovative Products

    Focus should be on reducing lead times and on supply flexibility.

    Sourcing close to the market area

    Short lead time may be achieved using air shipments

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    Different Contracts & Service Level

    Demand for novels follow normal distribution with average of 5000 and

    s.d. of 3000.

    Bookstore buys at a wholesale price from publisher at $10 and sells for

    $20, discards all unsold items, service level = 50%, order 5000

    Assume manufacturing cost of $2, the supply chain optimal service level =$18/$20= 90%

    Buy-back contracts: supplier buys back unsold books at $6, thus reducing

    overage cost to $4 for bookstore and increasing service level to 71%

    Revenue sharing contracts: Buyers share 45% of revenue with suppliers

    while the supplier sells books at reduced wholesale price of $3, thusunderage cost reduces to $8 and overage cost becomes $3, increasing

    service level to 73%

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    Contracting:

    Learning points Strategic contracting specifies commitments and contingency options in

    terms of quantity flexibility, quality, and responsiveness in addition toprice

    Strategic contracting goes beyond coordination and aims to Balance risk and align incentives (reduce or eliminate double marginalization)

    Allocate capacity to buyer

    Can lead to win-win if advantages (e.g. higher orders) outweigh downsides(e.g. overage risk) for each party.

    It also is a tool in strategic sourcing

    Structured contracts include:

    Buy Back VMI

    Profit & Revenue sharing

    Quantity-Flexibility & option contracts

    Performance-based contracts (e.g., performance-based logistics)