SMChap016

Chapter16- Global Sourcing and Procurement

CHAPTER 16 GLOBAL SOURCING AND PROCUREMENT Discussion Questions 1. What recent changes have caused supply chain management to gain importance? Changes include: a. Competitive pressures from foreign firms. b. Elevation of product quality to a very high level of importance. c. International marketing and international purchasing. d. Trends towards choosing sole-source suppliers and long term relationships. e. Product varieties and ranges are rapidly changing, and speed of delivery to market is essential. f.

Product life cycles have shortened necessitating knowledge and control of inventories in the various pipelines.

g. Adoption of JIT production has changed supplier relationships and has also increased the focus on reducing inventories. h. Trends in the legal system hold manufacturers liable for product failures, even though causes of failure may lie outside of the production system itself. i.

Use of EDI in purchasing.

j.

The growth of supplier development.

2. Describe the differences between functional and innovative products. Functional products are staples that people buy in a wide range of retail outlets. Typically, they do not change much over time; and have low profit margins, stable predictable demand and long life cycles. Innovative products, on the other hand, give customers additional reasons to buy. Fashionable clothes and personal computers are examples of innovative products. Innovative products have short life cycles, high profit margins, and volatile demand. 3. What are characteristics of efficient, responsive, risk-hedging and agile supply chains? Can a supply chain be both efficient and responsive? Risk-hedging and agile? Why, or why not? Efficient supply chains are designed to minimize cost that requires high utilization, minimizing inventory, and selecting vendors based primarily on cost and quality, and designing products that are produced at minimum cost. Market-responsive supply chains are designed to minimize lead time to respond to unpredictable demand, thus minimizing stockout costs and obsolete

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Chapter16- Global Sourcing and Procurement

inventory costs. Risk sharing supply chains are those that share resources so that risks in the supply chain can be shared. Agile are those supply chains that are flexible while still sharing risks of shortages across the supply chain. Generally, these supply chains carry excess capacity and higher buffer stocks. Vendor in responsive supply chains would be selected for speed, flexibility, and quality. It is possible to be both efficient and responsive, and both Risk-hedging and Agile, but Exhibit 16.4 helps illustrate why supply chains are generally not both. 4. With so much productive capacity and room for expansion in the United States, why would a company based in the United States choose to purchase items from foreign firm? Discuss the pros and cons. The use of foreign firms can provide a U.S. firm more alternatives in selecting a supplier. The pros are: more choices, potentially reduced costs in the areas of materials, transportation, production, and distribution, and potentially moving closer to a foreign market. The cons are: the distance is generally increased; communications problems are increased due to distance, culture, and technology; and there may be problems with customs, government regulations, political stability, etc. 5. As a supplier, which factors would you consider about a buyer (your potential customer) to be important in setting up a long-term relationship? The financial stability and credit worthiness of the company is of primary importance. The reputation of the company vis-à-vis their supplier is also very important. For example, is this a company that is fair with its suppliers and honors its payables in a timely fashion? Is the technological match between supplier and customer sufficient? Will delivery schedules and quantities be stable, facilitating smooth operations? 6. Describe how outsourcing works. Why would a firm want to outsource? Outsourcing is the act of moving some of a firm's internal activities and decision responsibilities to outside providers. The terms of the agreement are established in a contract. Outsourcing goes beyond the more common purchasing and consulting contracts because not only are the activities transferred, but also resources that make the activities occur are transferred. Reasons for outsourcing are listed in Exhibit 16.6. Some of the major categories from this exhibit include organizational, improvement, financial, revenue, cost, and employee driven reasons. 7. Have you ever purchased a product based on purchase price alone and were surprised by the eventual TCO, either in money or in time? Describe the situation. Answers will vary. A common example will likely be the purchase of a printer, especially an inkjet print. They are notorious for having extremely high operating costs due to the price of repeated ink purchases. Other examples might include buying an inexpensive car only to spend unexpected amounts of money on upkeep and repair.

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Chapter16- Global Sourcing and Procurement

8. Why might managers resist buying a more expensive piece of equipment that is known to have a lower TCO than a less expensive item? One reason may simply be ignorance on the part of the individual when it comes to TCO analysis, so the higher purchase price is difficult to justify. Also, for very large purchases there may be more concern about the immediate impact the purchase will have on quarterly financial result than there is about the long run cost of ownership. 9. Why is it desirable to increase a company’s inventory turnover ratio? One way to look at it is that it measures the average amount of inventory held as a percent of the total goods moved through the system in a year. It is a relative measure of the amount of inventory held in a company, and as such comparisons across different firms in an industry are meaningful, even if the raw numbers for the firms vary greatly in magnitude. As a general rule, lowering inventory carried reduces the supply chain costs. 10. Research and compare the inventory turnover ratios of three large retailers: Wal-Mart, Target, and Nordstrom’s. Use the same financial web site for all three, and compare numbers from the same time frame. What do these ratios tell you? Are you surprised by what you found? Using Forbes.com, and looking at 1st quarter 2012 figures, the ratios are Wal-Mart: 8.5, Target: 6.4, Nordstrom’s: 5.9. Students may not be surprised the Wal-Mart’s is highest but the magnitude of the difference may not be expected. Generally speaking, the low-price leader would need to have very efficient operations to compete, and Wal-Mart’s ratio indicates they are very good at managing supply chain inventory. The higher-priced, personal-attention approach by Nordstrom’s allows for a less efficient supply chain which is balanced by higher profit margins.

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Chapter16- Global Sourcing and Procurement

Objective Questions 1. What term refers to the development and management of supplier relationships to acquire goods and services in a way that helps achieve the immediate needs of a business? Strategic sourcing 2. Sometimes a company may need to purchase goods or services that are unique, very complex, and/or extremely expensive. These would not be routine purchases, but there may be a number of vendors that could supply what is needed. What process would be used to transmit the company’s needs to the available vendors, asking for a detailed response to the needs? Request for proposal 3. Sony Electronics produces a wide variety of electronic products for the consumer marketplace, like laptop computers, PlayStation game consoles and tablet computers. What type of products would these be considered in Lee’s Uncertainty Framework? Innovative products 4. One product that Staples sells a lot of is copy paper. According to Lee’s Uncertainty Framework, what supply chain strategy is appropriate for this product? Efficient supply chain 5. What is the term used for the act of moving some of a company’s internal activities and decision-making processes to outside providers? Outsourcing 6. What is the term used for a company moving management of the complete cycle of material flow to an outside provider? Logistics outsourcing 7. Many bottled water manufacturers have recently worked with their suppliers to switch over to bottles using much less plastic than before, reducing the amount of plastic that needs to be transported, recycled, and/or disposed of. What sourcing practice is this an example of? Green sourcing

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Chapter16- Global Sourcing and Procurement

8. What term refers to the way some companies focus on what they do best and outsource other functions to key partners? Capability sourcing 9. What three main categories of costs are considered in figuring total cost of ownership? Acquisition costs, ownership costs, post-ownership costs 10. Which category of lifetime product costs is sometimes overemphasized, leading to a failure to fully recognize the total cost of ownership? Acquisition costs 11. Year: Demand Cost of Capital

0

1 200,000

2 300,000

3 500,000

0.1

$20,000.00

$30,000.00

$50,000.00

0.01

$2,000.00

$3,000.00

$5,000.00

0.005

$1,000.00

$1,500.00

$2,500.00

20

$240.00 $23,240.00

$240.00 $34,740.00

$240.00 $57,740.00

$15,000.00 $9,000.00 $4,500.00 $3,300.00 $1,650.00 $9,000.00 $42,450.00

$25,000.00 $15,000.00 $7,500.00 $5,500.00 $2,750.00 $15,000.00 $70,750.00

$7,710.00 0.75614 $5,829.87

$13,010.00 0.65752 $8,554.29

0.15 Purchase Option

Purchase Cost Per Unit Shipping/Unit Inventory charge/Unit Monthly charge Total Purchase Cost

Make Option Direct Material 0.05 $10,000.00 Direct Labor 0.03 $6,000.00 50% Surcharge 0.015 $3,000.00 Indirect Labor 0.011 $2,200.00 50% Surcharge 0.0055 $1,100.00 Overhead 100% DL 0.03 $6,000.00 Total Variable Manufacture Cost $28,300.00 Investment Engineer $30,000.00 Equipment $10,000.00

Make Cost – Buy Cost Discount factor NPV (Make – Buy) Total NPV (Make - Buy)

Cost Comparison Analysis $40,000.00 $5,060.00 1 0.86957 $40,000.00 $4,400.00 $58,784.15

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Chapter16- Global Sourcing and Procurement

Buy Make Difference

Alternative: Option NPV Calculations $143,226.27 $40,000.00 $24,608.70 $84,442.11 $20,208.70 $58,784.15

$32,098.30 $26,268.43

$46,519.27 $37,964.99

Continuing to make in-house would cost us over $58,000 more in current dollars than buying from the supplier. We should accept the bid.

12. Requirement (annual forecast) Weight Order processing cost Inventory carry cost Lot Size (order quantity) Supplier Unit Price Annual Purchase Cost One-Time Tooling Cost Orders per year Order Processing Cost Inventory carry cost Distance Weight per load Transportation (Less-than-truckload) $1.20 per 2,000 lbs. per mile Total Cost We would prefer supplier #2.

12,000 22 $125.00 20% 1,000

units pounds per engine per order of average inventory Units - given in the case

1 $510 $6,120,000 $22,000 12 $1,500 $51,000

2 $505 $6,060,000 $20,000 12 $1,500 $50,500

125

100

22,000 $19,800

$15,840

$6,214,300

$6,147,840

Required lot size for truckload

1818

Supplier Unit Price Annual Purchase Cost One-Time Tooling Cost Orders per year Annual Order Processing Cost Annual Inventory carry cost

1 $500 $6,000,000 $22,000 6.6 $825 $90,900

2 $505 $6,060,000 $20,000 6.6 $825 $91,809

125

100

Distance Weight per load Transportation (truckload) $0.80 per 2,000 lbs. per mile

miles

$66,460

difference

Units (40,000 lbs. max. load/22 lbs. per engine)

miles

40,000 $13,200

$10,560

Total Cost $6,126,925 $6,183,194 $56,269 difference Yes, it would make sense to order in truckload lots as we can reduce total costs. While carrying costs increase,

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Chapter16- Global Sourcing and Procurement

purchase and transportation costs decrease by a greater amount. Note that if ordering in truckload lots, supplier #1 becomes the lowest choice option. In future years the cost would be reduced by the one-time tooling cost included here.

13. Which supply chain efficiency measure is more appropriate when the majority of inventory is held in distribution channels? Weeks of supply 14. What do you call the average total value of all items held in inventory for a firm, at cost? Average aggregate inventory value 15.

a. b.

16. Inventory Turnover 

Cost of Goods Sold 1.00 * 1000 * 52   148 .6 Average Aggregate Inventory Value 350

The problem tells us that we sell 4,000 QUARTER pound burgers a week, therefore we sell 1,000 pounds a week, and each pound of hamburger costs $1.00. The problem also tells us that on average, the store has 350 pounds of inventory on hand. By dividing the Cost of Goods Sold by Average Aggregate Inventory Value, We can figure the Inventory Turns. This means that their inventory turns 148.6 times a year. Weeks of Supply 

Average Aggregate InventoryValue 350 * 52  * 52  .350 Cost of Goods Sold 1.00 *1000 * 52

On average the restaurant has about a third of a week’s supply on hand.

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Chapter16- Global Sourcing and Procurement

17. a. Q1

Q2

Q3

Q4

300 75 30 280

350 60 33 295

405 75 20 340

375 70 15 350

50 100

40 105

55 120

60 150

25 10 5

27 11 4

23 15 5

30 16 5

Total Inventory

190

187

218

261

Inventory Turnover

1.5

1.6

1.6

1.3

Sales United States Canada Europe COGS (Total) Inventory Raw Materials WIP and FG DC Inventory United States Canada Europe

Using the end-of-quarter inventory numbers as a substitute for the average inventory level, we have the following quarterly and annual inventory turn values. Average inventory for the annual figure is based on the average of the 4 quarterly inventory numbers. Q1

Q2

Q3

Q4

Annual

280/190 = 1.474

295/187 = 1.578

340/218 = 1.560

350/261 = 1.341

1265/214 = 5.911

b. To increase the inventory turns, a firm needs to reduce the amount of inventory or increase sales or both. To increase turns, the item most readily within our control is the amount of inventory that the firm has on hand. The raw materials, WIP, and FG inventories are the most obvious targets for reduction. c.

Weeks of Supply 

Average Aggregate InventoryValue 214 * 52  * 52  8.797 Cost of Goods Sold 1265

The 500M does not come into play in this problem.

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Chapter16- Global Sourcing and Procurement

Analytics Exercise: Global Sourcing Decisions – Grainger 1. Evaluate the current China/Taiwan logistics costs. Assume a current total volume of 190,000 CBM and the 89% is shipped direct from the supplier plants in containers. Use the data from the case and assume that the supplier loaded containers are 85% full. Assume that consolidation centers are run at each of the four port locations. The consolidation centers only use 40’ containers and fill them to 96% capacity. Assume that it costs $480 to ship a 20’ container and $600 to ship a 40’ container. What is the total cost to get the containers to the United States? Do not include United States port costs in this part of the analysis. Basic Data Total Current Volume (CBM)

190,000

Direct Ship Percentage

0.89

Direct Ship Volume (CBM)

169,100

Consolidation Center Volume

20,900

Shipping Cost Calculations Direct Ship by Container Type Volume (%) Volume (CBM) Container Capacity Used

20'

40'

21%

79%

35511

133589

85%

85%

Consolidation Center by Container Type Volume (%)

100%

Volume (CBM)

20900

Container Capacity Used

96%

Container Capacity (CBM)

34

Containers Shipped

67

1,229

2,671

Shipping Cost per Container

$

480.00

$

600.00

Shipping Costs by Container Size

$

589,920

$

1,602,600

Total Shipping Cost

$

2,192,520

Consolidation Center Operating Cost Calculations Number of Centers

4

Annual Fixed Cost per Center

$

75,000

Total Annual Fixed Cost

$

300,000

Variable Cost per CBM

$

4.90

Total Annual Variable Cost

$

102,410

Total Annual Consolidation Center Costs

$

402,410

Total China/Taiwan Logistics Cost

$

2,594,930

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Chapter16- Global Sourcing and Procurement

2. Evaluate an alternative that involves consolidating all 20’ volume and using only a single consolidation center in Shanghai/Ningbo. Assume that all the existing 20’ volume and the existing consolidation center volume were sent to this single consolidation center by suppliers. This new consolidation center volume would be packed into 40’ containers filled to 96% and shipped to the United States. The existing 40’ volume would still be shipped direct from the suppliers at 85% capacity utilization. Basic Data Total Current Volume (CBM)

190000

Direct Ship Percentage

0.7031

Direct Ship Volume (CBM)

133589

Consolidation Center Volume

56411

Shipping Cost Calculations Direct Ship by Container Type

20'

40'

Volume (%)

0%

100%

0

133589

85%

85%

Volume (CBM) Container Capacity Used Consolidation Center by Container Type Volume (%)

100%

Volume (CBM)

56411

Container Capacity Used

96%

Container Capacity (CBM)

34

67

0

3223

Containers Shipped Shipping Cost per Container

$

Shipping Costs by Container Size

$

Total Shipping Cost

$

480.00 -

$

600.00

$

1,933,800

1,933,800

Consolidation Center Operating Cost Calculations Number of Centers

1

Annual Fixed Cost per Center

$

75,000

Total Annual Fixed Cost

$

75,000

Variable Cost per CBM

$

1.40

Total Annual Variable Cost

$

78,975

Total Annual Consolidation Center Costs

$

153,975

Total China/Taiwan Logistics Cost

$

2,087,775

Assuming the new consolidation center has the same fixed cost as before (questionable given the increase in volume), the new approach saves $507,155 per year.

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Chapter16- Global Sourcing and Procurement

3. What should be done based on your analytics analysis? What have you not considered that may make your analysis invalid or that may strategically limit success? What do you think Grainger management should do? Consolidating the 20’ volume and using only a single Consolidation Center looks very attractive from this analysis. However, there are other issues to be considered. -

-

-

For one, we have not considered the increased cost to the suppliers that currently pack their own 20’ containers. These suppliers will need to bear the cost of shipping their goods to the Shanghai/Ningbo consolidation center. This cost will probably be pushed back to Grainger in the long run. There will also be some added cost for the suppliers that currently ship to consolidation centers directly. These will all need to use the Shanghai/Ningbo now, which might not be as close as their current consolidation center. The cost calculations also assume that the Shanghai/Ningbo center can handle the increased workload and the fixed cost will remain the same. Neither of these assumptions is guaranteed (or even likely).

We may want to seriously consider using two consolidation centers with the other being in Yantian/Hong Kong. It may be attractive to have consolidation centers in both Shanghai/Ningbo and Yantian/Hong Kong since these are the most heavily used ports. Assumptions regarding the consolidation center fixed costs would need to be tested as well.

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