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8/22/2019 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)