Copyright 2011 John Wiley & Sons, Inc.

Chapter 6

Sourcing

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Lecture Outline

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• What is Sourcing?

• The Sourcing Function

• Sourcing and SCM

Copyright 2011 John Wiley & Sons, Inc.

What is Sourcing?

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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.

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Related Terms

• Purchasing

– process of buying goods and services

– supplier selection, buying, negotiating contracts

• Strategic Sourcing

– seeks competitive advantage with sourcing opportunities

– builds supplier relationships

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Evolution of the Sourcing Function

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Consumer vs. Commercial Sourcing

• Consumer

– many suppliers

– buyer is final customer

– small portion of supplier’s total business

– little ability to negotiate

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Consumer vs. Commercial Sourcing Continued

• Commercial– 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 concerns6-9Copyright 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

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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

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Sourcing Process

• Supplier Selection

– Existing vs. New Suppliers

– Request for Quotation (RFQ), Request for Proposal (RFP), Request for Bid (RFB)

• Negotiate Contracts

• Manage Process of Acquisition

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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”

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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

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Cost vs. Price Continued

• Price– 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

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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

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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 purchase6-17Copyright 2011 John Wiley & Sons, Inc.

Bidding or Negotiation?

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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)

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Functional Products

– satisfy basic functions or needs

– stable and predictable demand

– long life cycles

– supply chains are easy to manage

– low profit margins

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Innovative Products

– purchased for innovation or status

– highly unpredictable demand

– short life cycles

– supply chains are more difficult to manage

– higher profit margins

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Supply Uncertainty

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Supply chain supply uncertainty can be classified as:

• Stable (low supply uncertainty)

• Evolving Process (high supply uncertainty)

Stable Supply Process

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– low supply uncertainty

– mature manufacturing processes

– underlying technology is stable

Evolving Supply Process

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– high supply uncertainty

– manufacturing process in early stage

– underlying technology is quickly evolving

Types of Supply Chains

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• Efficiency-focused– 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

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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

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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

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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

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Global vs. Domestic Sourcing

• 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

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Outsourcing

Companies may outsource to:– 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

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Dimensions of Outsourcing

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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

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Advantages of E-Auctions

– simplified comparison of supply sources

– decreased error rate

– market transparency

– increased buying reach

– reduction in ordering cycle time

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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

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Types of E-Auctions

• Open 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

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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

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Three Stages of E-Auction Process

1. Preparation– set product requirements

– identify and prequalify suppliers

– specify auction rules

– test and train participants on technology

2. The Auction Event– communication between suppliers and seller

3. Follow-up

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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

Measuring Sourcing Performance

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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 SoldAverage Inventory Value

Inventory Turnover Example

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$8,000,000$2,000,000

• 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

Measuring Sourcing Performance Continued

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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

Weeks of Supply Example

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2,000,000$8,000,000/52

Review

1. Sourcing is the business function responsible for all activities and processes required to purchase goods and services from suppliers.

2. 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.

3. 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.

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Review Continued

4. 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.

5. Competitive bidding and negotiation are two different methods used to reach agreement and develop contracts with suppliers.

6. 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.

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Review Continued

7. Outsourcing engagements can be classified based on scope and criticality of outsourced tasks.

8. E-auctions are the use of Internet technology to conduct auctions as a means of selecting suppliers and determining aspects of the purchase contract.

9. Inventory turnover and weeks of supply are two metrics that can be used to measure performance of the sourcing function.

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