Sourcing Decisions

Chapter Objectives

Be able to: Discuss the various strategic issues surrounding

sourcing decisions and identify some of the key factors favoring one approach over the other.

Perform a simple total cost analysis. Explain what a sourcing strategy is, and show how

portfolio analysis can be used to identify the appropriate sourcing strategy for a particular good or service.

Show how multicriteria decision models can be used to evaluate suppliers, and interpret the results.

Discuss some of the longer-term trends in supply management and why they are important.

Introduction

• The sourcing decision

• Sourcing strategies

• Supplier evaluation

• Trends in supply management

• Sourcing decisions – High level, often strategic decisions regarding which products or services will be provided internally and which will be provided by external supply-chain partners

• Purchasing – discussed in Chapter 11The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance

Sourcing decisions and purchasing activities serve to link a company with its supply chain partners

Focus

• Insourcing – The use of resources within the firm to provide products or services

• Outsourcing – The use of supply chain partners to provide products or services

Sourcing decisions are high-level, often strategic decisions that address:What will use resources within the firm

What will be provided by supply chain partners

The Sourcing Decision

Make-or-Buy Decision

Advantages and Disadvantages of Insourcing

Advantages• High degree of control• Ability to oversee the

entire program• Economies of scale

and/or scope

Disadvantages• Required strategic

flexibility• Required high

investment• Loss of access to

superior products and services offered by potential suppliers

Advantages and Disadvantages of Outsourcing

Advantages• High strategic flexibility• Low investment risk• Improved cash flow• Access to state-of-the-art

products and services

Disadvantages• Possibility of choosing a

bad supplier• Loss of control over the

process and core technologies

• Communication and coordination challenges

• “Hollowing out” of the corporation

Factors Affecting the Decision to Insource or Outsource

Environmental uncertainty low high

Competition in the supplier market low high

Ability to monitor supplier performance low high

Relationship of product/service to high low buying firm’s core competencies

FactorFavors

InsourcingFavors

Outsourcing

Total Cost Analysis

A process by which a firm seeks to identify and quantify all of the major costs associated with various sourcing options

• Direct costs – Costs that are tied directly to the level of operations or supply chain activities

• Indirect costs – Costs that are not tied directly to the level of operations or supply chain activity

Insourcing and Outsourcing Costs

•Direct material•Direct labor•Freight costs•Variable overhead

•Price (from invoice)•Freight costs

•Supervision•Administrative support•Supplies•Maintenance costs•Equipment depreciation•Utilities•Building lease•Fixed overhead

•Purchasing•Receiving•Quality control

Insourcing Outsourcing

Directcosts

Indirectcosts

Portfolio Analysis

Bottleneck Critical

Routine Leverage

Value Potential

High

Complexity or Risk Impact

HighLow

Low

Critical Quadrant

• Critical to profitability and operations

• Few qualified sources of supply

• Large expenditures• Design and quality critical• Complex and/or rigid

specification

• Strategy– Form partnerships with

suppliers

• Tactics– Increase role of selected

suppliers

• Actions– Heavy negotiation– Supplier process

management– Prepare contingency plans– Analyze

market/competitions– Use functional

specifications

Bottleneck Quadrant

• Complex specifications requiring complex manufacturing or service process

• Few alternate productions/sources of supply

• Big impact on operations/maintenance

• New technology or untested processes

• Strategy– Ensure supply continuity

• Tactics– Decrease uniqueness of

suppliers– Manage supply

• Actions– Widen specification– Increase competition– Develop new suppliers– Medium-term contracts– Attempt competitive

bidding

Leverage Quadrant

• High expenditures, commodity items

• Large marketplace capacity, ample inventories

• Many alternate products and services

• Many qualified sources of supply

• Market/price sensitive

• Strategy– Maximize commercial

advantage

• Tactics– Concentrate business– Maintain competition

• Actions– Promote competitive

bidding– Exploit market cycles/trends– Procurement coordination– Use industry standards– Active sourcing

Routine Quadrant

• Many alternative products and services

• Many sources of supply

• Low value, small individual transactions

• Everyday use, unspecified items

• Anyone could buy it

• Strategy– Simplify acquisition

process

• Tactics– Increase role of systems– Reduce buying effort

• Actions– Rationalize supplier base– Automate requisitioning,

e.g., EDI, credit cards– Stockless procurement– Minimize administration

costs– Little negotiating

• Single sourcing –The buying firm depends on a single company for all or nearly all of an item or service

• Multiple sourcing –The buying firm shares its business across multiple suppliers

• Cross sourcing –Using a single supplier for a certain part or service and another supplier with the same capabilities for a similar part

• Dual sourcing –Using two suppliers for the same purchased product or service

Sourcing Strategies

Multicriteria Decision Models in Sourcing and Purchasing

How do we evaluate alternatives when criteria include both quantitative measures (such as costs and on-time delivery performance) and qualitative

factors (such as management stability and trustworthiness)?

Weighted-Point Evaluation System - I

• Assign weights to performance dimensions

• Rate the performance of each supplier with regard to each dimension

• Calculate the total score

• Evaluating potential suppliers

• Tracking suppliers’ performance over time

• Ranking current suppliers

Purpose:

The Process:

$4/unit $5/unit $2/unit

5% defects 1% defects 10% defects

95% on time 80% on time 60% on time

Aardvark Beverly Conan the Electronics Hills Inc. Electrician

Price

Quality

Delivery reliability

Weighted-Point Evaluation System - II

Summary Data for Alternative Suppliers

Performance Dimension

Weighted-Point Evaluation System - III

5 = excellent

4 = good

3 = average

2 = fair

1 = poor

Scoring Scheme Criteria Weights

WPrice = 0.3

WQuality = 0.4

WDelivery = 0.3

n

YYXYX WePerformancScore

1

4 3 5

3 5 1

4 2 1

Aardvark Beverly Conan the Electronics Hills Inc. Electrician

Performance Dimension

Price

Quality

Delivery reliability

Weighted-Point Evaluation System - IV

Performance Values for Alternative Suppliers

Weighted-Point Evaluation System - V

Total Scores for Alternative SuppliersScore Aardvark = (4 x 0.3) + (3 x 0.4) + (4 x 0.3) = 3.6

Score Beverly = (3 x 0.3) + (5 x 0.4) + (2 x 0.3) = 3.5

Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2

Aardvark should improve their qualityBeverly Hills should improve their delivery and priceConan is out of the running as a potential supplier

Trends in Supply Management

• Sustainable Supply*

• Supply Base Reduction

• Global Sourcing– Supply Chain Disruptions

– Supply Chain Capacity

– Transportation Costs

Case Study in Sourcing Decisions

Pagoda.Com