Lecture 4: Sourcing Strategies

Insourcing and Outsourcing

Local, Domestic and Global Sourcing

Individual and Cooperative Sourcing Example on slide 30.

Unit, Modular and System Sourcing

External and Internal Sourcing

Traditionally, a supplier’s value creation took place in her own facilities.
From the buyer’s perspective, value creation took place externally.
Recently, integration has led to physical proximity between suppliers and buyers.
Industrial parks allow key suppliers to be located close to the buyer’s facilities.
Value creation takes place virtually on the buyer’s facilities, i.e. Internally.

Sole, Single, Dual and Multiple Sourcing

Time to Recovery and Time to Survive

Multiple Sourcing with Default Dependence
Duala and Multiple Sourcing Can Create a False
Security if Suppliers’ Risks Are Dependent (Slide 57)

Example: Negative Supplier Default Dependence (Slide 67)

A Framework for
“Capability” Sourcing

Core of the Core:
The first step is to identify the components of your business that
represent the core of the core. These are the activities that your
company does better and cheaper than its rivals. For 7-Eleven, the core of the core is in-store merchandising and product ordering. Everything else exists to support the core of the core.

Sourcing opportunity:
By plotting each of your required capabilities on a sourcing
opportunities map, you can judge the relative merits of your
company’s outsourcing possibilities. The vertical axis measures how proprietary a process or function is; the horizontal axis assesses the degree of commonality, both within and outside your industry.

Capabilities:
A capability assessment map plots each capability according to its cost and quality relative to top-performing competitors or suppliers. This map will help you determine which key capability gaps your company needs to fill and will identify any current activities that you could perform with less rigor without incurring any strategic penalty.

Core of the Core
“For years, ‘sourcing’ has been just another word for procurement – a […] strategically peripheral, corporate function. Now, globalization [and innovation], is changing the basis of competition. It’s no longer a company’s ownership of capabilities that matters but rather its ability to control and make the most of critical capabilities, whether or not they reside on the company’s balance sheet.” Gottfredson et al. (2005)

Last Century: Assets

Companies competed on the basis of the assets they owned.

Today: Intangible Capabilities

The basis of competition has shifted
from to intangible capabilities.

Example 7-Eleven

Sourcing Opportunities Map: What Should You Outsource? (Slide 8)
Using the sourcing opportunities map you can determine which functions have the highest outsourcing potential and which should remain under the companies control.

Capability Assessment Map: How Strong Are Your Capabilities? (Slide 9) Once you have determined which capabilities offer the highest potential value from outsourcing, you need to see how well and efficiently your company currently performs each of them

Outsourcing Turns
Fixed Costs into Variable Costs

Outsourcing can help to turn fixed costs in to variable costs.
As a consequence, capacities can be used more flexible.
Fixed costs can be reduced by adjusting capacities, shifting human resources, divesting operation facilities,

An Alternative Framework for Insourcing/Outsourcing Decisions (slide 12)

Factors Deemed Influential in Outsourcing Decisions (Slide 13)

Information

Example: Apparel Industry (slide 17)

Labor Costs Are Rising Across Asia (slide 18)

U.S. Trade with Selected Countries:
Imports, Exports in Billion US-$ (2015) (Slide 19)

Considering Assembly Time for a Midsize Car, Labor Costs are $600 Lower in Mexico (slide 20)

Difference Between Costs in Mexico
vs. U.S. for Small Cars Sold in Europe (slide 21)

Tariffs Avoided by Mexico in Countries
Where U.S. Has No Free-Trade Agreement (Slide 22)

Current Nearshoring Trend in the High-tech Industry (slide 23)

High-tech Companies in Emerging Markets

Drivers and Barriers to Nearshoring in the High-tech Industry (slide 25)

Drivers

Barriers

Improving service levels by bringing production closer to demand

Improving control over quality and intellectual property

Diversification of manufacturing due to natural and socio-economic risks

Cost benefit of China or other low cost manufacturing is no longer compeeling

Location of Key suppliers

Fixed infrastructure is not movable

Current sourcing footprint best supports expected global demand demographics

Cost benefit of China or other low cost manufacturing remains compeeling

Barriers to Expansion in Emerging
Markets in the High-tech Industry (slide 26)

Meeting Regulatory Requirements

Country Specific Trade Requirements

Understanding Free Trade Agreements and Government Sponsored Trade Initiatives

Global Sourcing: Downsides (Slide 27) A result of the attendees's internal and external factors

Where Do Companies in Denmark Source From? (slide 16)

Growth Opportunities for High-tech Companies in Emerging Markets (Slide 24)

Operational Performance

Financial Performance

Long lead time

High inventories

Operational complexity

Quality issues

Direct costs

Overhead costs

Dynamic cost

Hidden costs

“Rightshoring” Decision Options Framework (Slide 28)

Offshoring

Outsourcing

Insourcing

Reshoring

Unit Sourcing (Slide 32)

Modular and System Sourcing

Modular Sourcing
Modular sourcing refers to a
sourcing strategy that aims to shift
the complexity of manufacturing
processes to the supply side.

System Sourcing
System sourcing is a special case
of modular sourcing where a
module or set of modules
constitute(s) a fully functional good.

Shop-in-Shop

Shop-in-shop arrangements help to integrate manufacturing or retailing.
The supplier’s production processes can be located on the buyer’s facilities.
Hereby, production equipment remains the property of the supplier.
Similarly, a retailing company can rent parts of another company’s retail space.
This concept is widespread among supermarkets and department stores

Sourcing Strategies
Related to Multiple Sourcing

Sole Sourcing
Buyer–supplier relationship where the
supply base contains only one supplier.

Single Sourcing
Buyer chooses single supplier although
other comparable suppliers exist.

Dual Sourcing
Buyer employs two suppliers, one of which may dominate the other in terms of share, price, reliability, and others.

Multiple Sourcing
Buyer does business with several suppliers and plays one supplier against the other (price advantage!).

Single vs. Multiple Sourcing (Slide 40)

Single Sourcing

Multiple Sourcing

Advantage:

Enables JIT processes
Higher quality at lower total cost to the buyer
Higher levels of buyer-supplier cooperation
Lower transaction costs, as it is just one supplier
Builds loyalty and trust

Disadvantage:

Greater risk of supply chain disruption
Creates lock-in
Higher cost due to lack of supplier competition
Higher risk of missing critical changes in supplier markets

Advantage:

Creates competition between suppliers
Best price advantage for the buyer, as supplier compete
Lower risk by reducing exposure to disruptions
Increased flexibility as it creates additional options

Disadvantage:

Higher total transaction costs with supplier base
Decreases supplier responsiveness

Apple Case (slide 43)

Decision Tree Model for Determining
the Optimal Number of Suppliers (slide 44)

Expected Profits under Various
Sourcing Alternatives (slide 46)

What is Time to Recovery?
The time it would take for a particular node – a supplier facility, a distribution center, or a transportation hub – to be restored to full
functionality after a disruption. Simchi-Levi (2015)

TTR values are determined by examining historical experience and surveying the firm’s buyers or suppliers.
But, suppliers tend to be optimistic about their TTR since they know that a long TTR is not going to be accepted by the manufacturer.
What is needed is to identify bottleneck suppliers for which it is critical to obtain accurate TTR information. (For non-bottleneck suppliers even ±30% error in TTR information will have little supply chain impact.)

What is Time to Survive?
The maximum duration that the supply chain can match supply with demand after the disruption of a node – a supplier facility, a
distribution center, or a transportation hub. Simchi-Levi (2015)

To determine TTS associated with a specific node, the node is removed from the supply chain and it is calculated how long – using inventory in the pipeline and other available supply sources – customer demand can be served without that node.
If TTS > TTR: Site does not expose the firm to any risk since during the time it is recovering, the firm can still match supply with demand.
If TTS < TTR: The disruption of the site will expose the firm to financial and operational problems.

Assessing the Level of Strategic Inventory Using TTS and TTR

TTS and TTR metrics can be combined to determine how much strategic inventory the firms needs and where to position this inventory so each site’s TTS is greater than its TTR.
This leads to a robust supply chain, one in which each node has a TTS greater than its TTR and thus a disrupted node will always recover before it exceeds its ability to apply the mitigation strategies the firm has in place.
Doing this, Ford is monitoring risk exposure on an ongoing basis and making adjustments based on changes in the environment.
For example, as inventory levels change in the supply chain, the risk exposure changes.
When risk exposure is above a certain level, perhaps due to low inventory levels or delayed supply, the risk metrics trigger an alert that requires procurement managers to review the drivers of risk increase.

TTS and TTR Can Be Used for
Three Levels of Decisions

Strategic decisions:
To identify exposure to risk associated with parts and suppliers,
prioritize and allocate resources effectively, develop mitigation
strategies, and identify opportunities to reduce risk mitigation cost.

Tactical decisions:
To monitor changes in risk exposure on a daily or weekly basis.

Operational decisions:
To identify an effective way to allocate resources after a disruption.

Positive Supplier Default Dependence
“Positive default dependence between two firms implies that if one firm defaults, the other firm may have a higher probability of
defaulting. This may lead to defaults that are ‘induced’ by defaults of other firms.” Wagner, Bode & Koziol (2011)

Negative Supplier Default Dependence
“In a supplier network, defaults must not necessarily reduce the survival probability of the competing suppliers. The default of a supplier may even increase the survival probabilities of the other suppliers in the network.” Wagner, Bode & Koziol (2011)

Common or correlated risk factors (e.g., governmental or environmental laws, labor unions, competitive pressure, negative shocks to cash flows across an industry, similar customers)

Contagious default events (i.e., the default of one firm causes the default of another firm)

“Learning from defaults” (also called “updating of beliefs”) which
arises when a default reveals information about others firm (e.g., fraud activities)

Shifting customer preference: After a supplier default, customers might shift business to another supplier in the network.

More qualified staff: The default of a supplier can result in lay-offs and the competitor will be able to hire more and qualified staff.

Higher profit margins: The buying firm may become more dependent on the surviving supplier who, through the gained power, may be able to incur higher profit margins and, thus, gain in financial stability

Copulas: A Popular Instrument to
Model Joint Default Distributions
A copula is a function that links univariate marginals to their full
multivariate distribution (Slide 60)
.