Unit-V

Sourcing, Transportation and Pricing Products.

Sourcing decision in a supply chain

Sourcing is the set of business processes required to purchase goods and

services

Sourcing processes include:

Supplier scoring and assessment

• Supplier selection and contract negotiation

• Design collaboration
• Procurement
• Sourcing planning and analysis

The role of Sourcing in A supply Chain:

Purchasing, also called procurement is the process by which companies
acquire raw materials, components, products, services, or other resources
from suppliers to execute their operations. Sourcing is the entire set of
business processes required to purchase business goods and services. For
any Supply chain function, the most significant decision is whether to
outsource the function or perform it in house. Outsourcing results in the
supply chain function being performed by a third party. Outsourcing is one
of the most important issues facing a firm, and actions across industries
tend to be varied.

It is important to clarify the distinction between outsourcing and off shoring

before we proceed. Firm off-shores a supply chain function if it maintains
ownership but moves the production facility off-shore.

Firm outhouses if the firm hires an outside firm to perform an operation

rather than executing the operation within the firm

We address the outsourcing of supply chain activities based on the following

two questions:

1) Will the third party increase the supply chain surplus relative to
performing the activity in house?
2) To what extent do risks grow upon outsourcing?

Supplier scoring and assessment is the process used to rate supplier

performance. Suppliers should be compared based on their impact on
the supply chain surplus and total cost. Unfortunately, sourcing decisions
are often driven based solely on the price charged by a supplier. Many
 other supplier characteristics, such as lead time, reliability, quality, and
design capability, also affect the total cost of doing business with a
supplier. A good supplier scoring and assessment process must identify
and track performance along all dimensions that affect the total cost of
using a supplier. Supplier selection uses the output from supplier scoring
and assessment to identify the appropriate supplier(s).

Benefits of Effective Sourcing Decisions

• Better economies of scale can be achieved if orders are aggregated

• More efficient procurement transactions can significantly reduce
the overall cost of purchasing
• Design collaboration can result in products that are easier to
manufacture and distribute, resulting in lower overall costs
• Good procurement processes can facilitate coordination with
suppliers
• Appropriate supplier contracts can allow for the sharing of risk
• Firms can achieve a lower purchase price by increasing competition
through the use of auctions

Key Sourcing-Related process

Supplier scoring and assessment > Supplier Selection and Contract

Negotiation > Design Collaboration > Procurement > sourcing planning and
analysis.
Given that about 80% of the cost of product is determined during design, it
is crucial that suppliers be actively involved at this stage. Design
collaboration allows the suppliers and the manufacturer to work together.
When designing the components for the final product. Design collaboration
also ensures that any design changes are communicated effectively to all
parties involved with designing and manufacturing the product. Once the
product has been designed the procurement is the process whereby the
supplier sends product in orders to be placed and delivered on schedule at
the lowest possible overall cost. Finally, the role of sourcing planning and
analysis is to analyze spending across various suppliers and component
categories to identify opportunities for decreasing the total cost.

Effective sourcing process within firm can improve profits for the firm and
total supply chain surplus in a variety of ways. It is important that the drivers
of improved profits be clearly identified when making sourcing decisions.
Some of the benefits from effective sourcing decisions are the following:

• Better economies of scale can be achieved if orders within a firm are

aggregated.
• More efficient procurement transactions can significantly reduce the
overall cost of purchasing. This is most important for items for which a
large number of low- value transactions occur.
• Design collaboration can result in products that are easier to
manufacture and distribute, resulting in lower overall costs. This factor
is the most important for supplier’s products that contribute a
significant amount to product cost and value.
• Good procurement process can facilitate co ordination with the
supplier improve forecasting and planning. Better coordination lowers
inventories and improves the matching of supply and demand.
 • Appropriate suppliers contracts can allow for the sharing of risk,
resulting in higher profits for both supplier and the buyer.
• Firms can achieve a lower purchase price by increasing competition
through the use of auctions.

How do third parties increase the supply chain surplus?

They increase the supply chain surplus if they either increase value for the
customer or decrease the supply chain cost relative to a firm performing the
task in-house.

1. Capacity aggregation: A third party can increase the supply chain

surplus by aggregating demand across multiple firms and gaining
production economies of scale that no single firm can on its own. This
is the most common reason for outsourcing production in a supply
chain. One of the reasons that DELL out sources design and production
of the processors in its Pc’s to Intel is that Intel supplies many
computer manufacturers and gains economies of scale that are not
available to Dell if it designs and produces its own processors.

2. Inventory aggregation: A third party can increase the supply chain

surplus by aggregating inventories across a large number of
customers. W.W.Grainger and McMaster-Carr are MRO suppliers that
provide value primarily by aggregating inventory for hundreds of
thousands of customers.
3. Transportation aggregation by transportation intermediaries: A third
party may increase the surplus by aggregating the transportation
function to a higher level than any shippers can its own. UPS, FedEx,
and a host of LTL carriers are examples of transportation across a
variety of shippers. The value provided in each case is driven by the
inherent economies of scale in transportation. Each shipper wants to
send less than the capacity of the transportation mode. The
transportation intermediary aggregates shipments across multiple
shippers, thus lowering the cost of each shipment below what could
be achieved by the shipper alone.

4. Transportation aggregation by storage intermediaries: A third party

stores inventory can also increase the supply chain surplus by
aggregating inbound and outbound transportation. For example,
storage intermediaries such as W.W.Grainger and McMaster-Carr
Stock products from over a thousand manufactures each and sell to
hundreds of thousands of customers. On the inbound side they are
able to aggregate shipments from several manufacturers onto a single
truck.

5. Warehousing aggregation: a third party may increase the supply chain

surplus by aggregating warehousing needs over several customers.
The growth in surplus is achieved in terms of lower real estate costs as
well as lower processing costs within the warehouse. Savings through
warehousing aggregation arise if a supplier’s warehousing needs are
small or if its needs fluctuate over time.

6. Procurement aggregation: a third party increases the supply chain

surplus if it aggregates procurement for many small players and
facilitates economies of scale in production and inbound
 transportation. Procurement aggregation is most effective across
many small buyers.

7. Information aggregation: a third party may increase the surplus by

aggregation information to a higher level than can be achieved by a
firm performing the function in-house. All retailers aggregate
information on products from many manufacturers in a single
location. This information aggregation reduces search costs for
customers.

8. Receivables aggregation: a third party may increase the supply chain

surplus if it can aggregate the receivables risk to a higher lever than
the firm or it has a lower collection cost than the firm. Bright Star is a
distributor for a Motorola in most Latin American countries other than
Brazil .Cell phones in the area are sold through many small,
independently owned retail outlets. Collecting receivables from each
retail outlet is a very expensive propositions fro a manufacturer. Given
that a retailer buys from many manufactures, the power of each
manufacturer to collect is also reduced.

9. Relationship aggregation: an intermediary can increase the supply

chain surplus by decreasing the number of relationships required
between multiple buyers and sellers. Without an intermediary,
connecting a thousand sellers to a million buyers requires a billion
relationships.

10. Lower costs and higher quality: a third party can increase the
supply chain surplus if it provides lower cost or higher quality relative
to the firm. If these benefits come from specialization and learning,
they are likely to be sustainable over the longer term.
These important factors that affect the increase in surplus that a third
arty provides: scale, uncertainty, and the specificity of assets. If the scale
is large, it is very likely that sufficient economies of scale are achieved
internal to the firm itself.

The second important factor is the uncertainty of firm’s needs. If the

needs are very predictable, the increase in surplus from a third party is
limited, especially if the firm has sufficient scale. In contrast, if the firm’s
needs are highly variable over time, the third party can increase the
surplus through aggregation with other customers.

Finally, the growth in surplus is influenced by the specificity of assets

required by the third party. If the assets required are specific to a firm
and cannot be used for others, a third party is unlikely to increase the
surplus because all it does is moving the assets from one firm to another.

RISKS OF USING A THIRD PARTY

Firms must evaluate the following risks when they move any function to a
third party.

1. The Process is broken. The biggest problems arise when a firm

outsources supply chain functions simply because it has lost control of
the process. Keep in mind that introducing a third party into a broken
supply chain process only makes it worse and harder to control.
 2. Underestimation of the cost of coordination. A common mistake
when outsourcing is to underestimate the effort required to
coordinate activities across multiple entities performing supply chain
tasks. This is especially true if a firm plans to outsource specific supply
chain functions to different third parties.

3. Reduced customer/supplier contact. A firm may lose

customer/supplier contact by introducing an intermediary. The loss of
customer contact is particularly significant for firms that sell directly to
consumers but decide to use a third party to either collect incoming
orders or deliver outgoing product.

4. Loss of internal capability and growth in third-party power. A firm

may choose to keep a supply chain function in-house if outsourcing
will significantly increase the third party’s power.

5. Leakage of sensitive data and information. Using a third party

requires a firm to share demand information and in some cases
intellectual property. If the third party also serves competitors, there
is always the danger of leakage.

6. Ineffective contracts. Contracts with performance metrics that distort

the third party’s incentives often significantly reduce any gains from
outsourcing. This form of pricing eliminates incentives for the third
party to innovate further to reduce costs. The onus for improvement
falls back on the firm.

THIRD- AND FOURTH-PARTY LOGISTICS PROVIDERS

A third party logistics (3PL) provider performs one or more of the logistics
activities relating to the flow of product, information, and funds that could
be performed by firm itself.

Table on Services provided by 3P

Service category Basic service Some specific value-

added services

Transportation Inbound, outbound by Tendering,

ship, truck, rail air. track/trace, mode
conversion, dispatch,
freight pay, contract
management.

Warehousing Storage, facilities Cross-dock, in-transit

management merge, pool
distribution across
firms, pick/pack,
kitting, inventory
control, labeling,
order fulfillment,
home delivery of
catalog orders.

Information Provide and maintain Transportation

technology advanced management systems
information/computer warehousing
 systems management,
network modeling
and site selection,
freight bill payment,
automated broker
interfaces, end-toend
matching forecasting,
EDI, worldwide track
and trace, global
visibility.

Reverse logistics Handle reverse flows Recycling, used-asset

disposition, customer
returns, returnable
container
management

Other 3PL services Brokering, freight

forwarding, purchase-
order management,
order taking, loss and
damage claims,
freight bill audits,
consulting time-
definite delivery

International Customs brokering,

port services, export
crating, consolidation

Special skills/handling Hazardous materials,

temperature
 controlled,
packaged/parcel
delivery food-grade
facilities/equipment,
bulk

Supplier scoring and assessment

When comparing suppliers, many firms make the fundamental mistake of

focusing only n the quoted price, ignoring the fact that suppliers may differ
on other important dimensions that affect the total cost of using a supplier.

• Replenishment lead time

• On-time performance
• Supply flexibility
• Delivery frequency/minimum lot size
• Supply quality
• Inbound transportation cost
• Pricing terms
• Information coordination capability
• Exchange rates, taxes and duties
• Supplier viability

Supplier Scoring and Assessment

• Supplier performance should be compared on the basis of the

supplier’s impact on total cost
 • There are several other factors besides purchase price that
influence total cost

1) Replenishment lead time: as the Replenishment lead time from a

supplier grows, the amount of safety inventory that needs to be held by
the buyer also grows proportional to the square root of the
Replenishment lead time.

2) On-time performance: On-time performance affects the variability of

the lead time. A reliable supplier has low variability of lead time, whereas
an unreliable supplier has high variability.

3) Supply flexibility: Supply flexibility is the amount of variation in order

quantity that a supplier can tolerate without letting other performance
factors deteriorate.

4) Delivery frequency/minimum lot size: the delivery frequency and the

minimum lot size offered by a supplier affect the size of each
replenishment lot ordered by a firm.

5) Supply Quality: A worsening of supply quality increases the variability

of the supply of components available to a firm. Quality affects the
lead time taken by the supplier to complete the replenishment order
and also the variability of this lead time because follow-up often need
to be fulfilled to replace defective products.
 6) Inbound transportation cost: the total cost of using a supplier includes
the inbound transportation cost of bringing material in from the
supplier.

7) Pricing terms: Pricing terms include the allowable time delay before
payment has to be made any quantity discounts offered by the
supplier. Allowable time delays in payment to suppliers save the buyer
working capital. The cost of working capital savings fro each supplier
can be quantified.

8) Information coordination capability: the information coordination

capability of a supplier is harder to quantify, but it affects the ability of
a firm to mach supply and demand. Good coordination results in
better replenishment planning, thus decreasing both the inventory
carried as well as the sales lost because of lack of availability.

9) Design collaboration capability: Given that a large part of product

cost is fixed at design, collaboration capability of a supplier is
significant. Good design collaboration for manufacturability and supply
chain can also decrease required inventories and transportation cost.

10) Exchange rates, taxes and duties: although exchange rates,

taxes, and duties are not supplier dependent, they can be significant
fro a firm with a global manufacturing and supply base.

11) Supplier Viability: Given the impact that suppliers have on a

company’s performance, an important factor in picking a supplier is
the likelihood that it will be around to fulfill the promises it mistakes.

Contracts to Induce Performance Improvement

 1) A buyer may want performance improvement from a supplier who
otherwise would have little incentive to do so

2) A shared savings contract provides the supplier with

a fraction of the savings that result from the performance
improvement

3) Particularly effective where the benefit from improvement accrues

primarily to the buyer, but where the effort for the improvement
comes primarily from the supplier

4) Focus for indirect materials should be on decreasing the

transaction cost for each order

5) Procurement for both should consolidate orders where possible to

take advantage of economies of scale and quantity discounts

Sourcing Planning and Analysis

1) A firm should periodically analyze its procurement spending and

supplier performance and use this analysis as an input for future
sourcing decisions

2) Procurement spending should be analyzed by part and supplier

to ensure appropriate economies of scale
 3) Supplier performance analysis should be used to build a
portfolio of suppliers with complementary strengths

4) Cheaper but lower performing suppliers should be used to

supply base demand

5) Higher performing but more expensive suppliers should be used

to buffer against variation in demand and supply from the other
source

Supplier selection – auctions and negotiations

Before selecting suppliers, a firm must decide whether to use sourcing or

multiple suppliers. Single sourcing guarantees the supplier sufficient
business when the supplier has to make a significant buyer-specific
investment.

Commonly used mechanism for these auctions are:

• Sealed-bid first price auctions require each potential supplier to

submit a sealed bid for the contract by a specified time. These bids are
then opened and the contract is assigned to the lowest bidder.

• In English auctions, the auctioneer starts with a price and suppliers can
make bids as long as each successive bid is lower than the previous
bid. The supplier with the last bid receives the contract. The difference
 in this case is that all suppliers get to see the current lowest bid as the
suction unfolds.

• In Dutch auctions, the auctioneer starts with a low price and then
raises it slowly until one of the suppliers agrees to the contract at that
price.

• In second- price auctions, each potential supplier submits a bid. The

contract is assigned to the lowest bidder but at the price quoted by
the second lowest bidder.

The following factors influence the performance of an auction:

• Is the supplier’s cost structure private

• Are suppliers symmetric or not, that is, ex ante, are they expected
to have similar cost structures?

• Do suppliers have all the information they need to estimate their

cost structure?

• Does the buyer specify a maximum price it willing to pay for the
supply chain?
Basic principles of Negotiation

In some instances, the third party that will perform a given supply chain
function has been identified and the firm enters into a negotiation to set the
terms of the contract. Negotiation is likely to result in a positive outcome
only if the value the buyer places on outsourcing the supply chain function
to his supplier is at least as large as the value the supplier places on
performing the function of the buyer.

Supplier Selection and Contracts

1) Contracts for Product Availability and Supply Chain Profits

1) Buyback Contracts
2) Revenue-Sharing Contracts
3) Quantity Flexibility Contracts

2) Contracts to Coordinate Supply Chain Costs

3) Contracts to Increase Agent Effort

Contracts to Induce Performance Improvement

Contracts and supply chain performance

A supply contract specifies parameters governing the buyer-supplier
relationship. In addition to making the terms of the buyer-supplier
relationship explicit, contracts have significant impact on the behavior and
performance of all stages in a supply chain. Contracts should be designed to
facilitate desirable supply chain outcomes and minimize actions that hurt
performance.

1) How will the contract affect the firm’s profits and total supply chain
profits?

2) Will the incentives in the contract introduce any information

distortion?

3) How will the contract influence supplier performance along key

performance measures.

Contracts for Product Availability and Supply Chain Profits: Buyback

Contracts

a. Allows a retailer to return unsold inventory up to a specified

amount at an agreed upon price

b. Increases the optimal order quantity for the retailer, resulting in

higher product availability and higher profits for both the retailer
and the supplier
 c. Most effective for products with low variable cost, such as music,
software, books, magazines, and newspapers

d. Downside is that buyback contract results in surplus inventory that

must be disposed of, which increases supply chain costs
Can also increase information distortion through the supply chain because
the supply chain reacts to retail orders, not actual customer deem

Contracts for Product Availability and Supply Chain Profits: Buyback

Contracts

1. Allows a retailer to return unsold inventory up to a specified

amount at an agreed upon price

2. Increases the optimal order quantity for the retailer, resulting in

higher product availability and higher profits for both the retailer
and the supplier

3. Most effective for products with low variable cost, such as music,
software, books, magazines, and newspapers

4. Downside is that buyback contract results in surplus inventory that

must be disposed of, which increases supply chain costs

Can also increase information distortion through the supply chain

because the supply chain reacts to retail orders, not actual customer
demand
Buyback Contracts

A buy-back or returns clause in a contract allows a retailer to return

unsold inventory up to a specified amount at an agreed-upon price. In a
buy-back contract, the manufacturer specifies a wholesale price c along
with a buy-back price b at which the retailer can return any unsold units
at the end of the season. The manufacturer can salvage $SM for any units
that the retailer returns.

The structure of a buy-back clause leads to the entire supply chain

reacting to the order placed by the retailer and not actual customer
demand. If a supplier is selling to multiple retailers, it produces based on
the orders placed by each retailer. Each retailer bases its order on its cost
of over- and under stocking. After actual sales materialize, unsold
inventory is returned to the supplier separately from each retailer. The
structure of the buy-back clause increases information distortion when a
supplier is selling to multiple retailers. At the end of sales season, the
supplier does obtain information on actual sales. Information distortion is
driven primarily by the fact that inventory is disaggregated at the
retailers. If inventory is centralized at the supplier and sent out only as
needed to the retailer, information distortion can be reduced. With
centralized inventory, the suppliers can exploit independent most buy-
back contracts, however, have decentralized inventory at retailers. As a
result, there is a high level of information distortion.
Contracts for Product Availability and Supply Chain Profits: Revenue
Sharing Contracts

1. The buyer pays a minimal amount for each unit purchased from the
supplier but shares a fraction of the revenue for each unit sold

2. Decreases the cost per unit charged to the retailer, which effectively
decreases the cost of overstocking

3. Can result in supply chain information distortion, however, just as in

the case of buyback contracts

In revenue contracts the manufacturer charges the retailer a low

wholesale price c, and shares a fraction f of the retailer’s revenue. Even if
no returns are allowed, the lower wholesale price decreases the cost to
the retailer in case of an overstock. The retailer thus increases the level of
product availability resulting in higher profits for both the manufacturer
and the retailer.

Expected Manufacturer’s profits = (c-v) O* + fp (O* - expected overstock at

retailers)
Expected retailers profit = (1 – f) p (O* - expected overstock at retailer) + Sr
× expected overstock at retailer – cO*

Contracts for Product Availability and Supply Chain Profits: Quantity

Flexibility Contracts

1. Allows the buyer to modify the order (within limits) as demand

visibility increases closer to the point of sale

2. Better matching of supply and demand

3. Increased overall supply chain profits if the supplier has flexible

capacity

4. Lower levels of information distortion than either buyback

contracts or revenue sharing contracts

Under quantity flexibility contracts, the manufacturer allows the retailers to

change the quantity ordered after observing demand. If a retailer orders O
units, the manufacturer commits to providing Q = (1 + α) O units, whereas
the retailer is committed to buying at least q = (1 – β) O units. Both α and β
are between 0 and 1.
Contracts for Product Availability and Supply Chain Profits

1. Many shortcomings in supply chain performance occur because the

buyer and supplier are separate organizations and each tries to
optimize its own profit

2. Total supply chain profits might therefore be lower than if the

supply chain coordinated actions to have a common objective of
maximizing total supply chain profits

3. An approach to dealing with this problem is to design a contract

that encourages a buyer to purchase more and increase the level of
product availability

4. The supplier must share in some of the buyer’s demand

uncertainty, however

Design collaboration

Two important statistics highlight the importance of design collaboration

between a manufacturer and supplier. Today, typically between 50 and 70
percent of the spending at a manufacturer is through procurement,
compared to only about 20 percent several decades ago. It is generally
accepted that about 80 percent of the cost of a purchased part is fixed
during the design stage. Thus it is crucial for a manufacturer to collaborate
with suppliers during the design stage if product costs are to be kept low.
Design collaboration can lower the cost purchased material and also lower
logistics and manufacturing costs. Design collaboration is also important for
a company trying to provide a lot of variety and customization, because
failure to do so can significantly raise the cost of variety.

Communicate better with your suppliers, your customers and yourself

The pressures on product design continually increase: customers are

demanding more from your products while you are simultaneously trying to
make them cheaper and easier — often through design outsourcing. A well-
balanced product design strategy which seamlessly shares information among
customers, suppliers and manufacturers can accelerate time to market and
create a foundation for true long-term growth.

However, it's difficult to coordinate teams from different functional areas or

organizations to harness their capabilities Product design begins to take a
back seat to product maintenance. It doesn’t have to be that way.

Building bridges, not fighting fires

Although the ultimate value of product design is in the realization of

successful products in the marketplace, making sure that all members of the
design team are 'on the same page' can reap benefits far beyond the design
process itself. A single source of accurate product design data can also serve
as an invaluable aid to product engineering and provide orderable item views
for future installation and service businesses. Our design collaboration
experience shows us that consistently extracting short-term and long-term
value from the design process requires robust and consistent design processes
which harness the ideas and capabilities that came before, not those which
create anew for each new design.

What about my outsourced design partners?

Follow-the-sun design allows you to reduce time-to-market by tapping

resources around the world; however, this requires stronger product
management processes and collaborative design tools engage customers,
suppliers and manufacturing divisions. Cross-functional and cross-enterprise
teams can introduce efficiencies into ad hoc design process efforts and can
yield significant financial benefits for all design partners, including reduction
in time to market, reduction in COGS and an increase in design and
component reuse.

Approach

1. Robust design process

at the heart of collaborative design environments are solid processes
supported by configuration and product data management discipline.
2. Cross functional & cross enterprise design
Timely inclusion of all functional areas into new designs is critical in
order to effectively meet customer needs and provide high quality
products. Integrating resources from multiple enterprises creates unique
challenges to processes, information technology and design cultures.
3. Design techniques
Modular design approach with a focus on design re-use shortens
development time and costs while improving product quality
improvement. Target costing/value engineering principles combine
business and engineering disciplines to yield innovative, cost-effective
designs.
4. Design collaboration structures
Globalization and technology advances have enhanced two other
structures: design outsourcing and global development.
5. Collaborative design tools
Best-in-class environments integrate critical design data between
stakeholders/systems with supporting management functionality.

In the end, we believe that the benefits of design collaboration speak for
themselves.

Contracts to Increase Agent Effort

 1. There are many instances in a supply chain where an agent acts on
the behalf of a principal and the agent’s actions affect the reward
for the principal
2. Example: A car dealer who sells the cars of a manufacturer, as well
as those of other manufacturers

3. Examples of contracts to increase agent effort include two-part

tariffs and threshold contracts

4. Threshold contracts increase information distortion, however

Strategic Sourcing Definitions and Models

Several strategic sourcing definitions have been offered in the literature;
interestingly, a commonality among definitions is an emphasis on the
integration of business processes.

To ensure the purchasing function is aligned with the organization's long-

term goals, many organizations have transitioned from tactical buying to
strategic sourcing. Tactical buying focuses on the basic transactions needed
to acquire the organization's raw material and service requirements. Strategic
sourcing is a systematic and comprehensive process of acquiring inputs as
well as managing supplier relations in a manner that achieves value in
obtaining the organization's long-term objectives. The literature indicates that
negotiation should be an essential element in tactical buying as well as
strategic sourcing; however, the extent to which negotiation planning and
strategic sourcing practices are integrated is not known.
To understand the possible relationship between strategic sourcing and
negotiation, the current definitions of strategic sourcing are first reviewed.
This is followed by a discussion of the role of planning in negotiation. But
first, the rudiments of business processes in relationship to strategic sourcing
and negotiation are briefly reviewed to validate the fact that these are
business processes.
A business process is:
The interaction of some combination of people, materials, equipment,
method, measurement, and the environment to produce an outcome or an
Input to another process
Clearly, strategic sourcing and negotiation both fit the concept of process,
given this perspective. However, the purchasing and negotiations literature
does not generally consider sourcing and negotiation as a set of integrated
processes. The strategic sourcing process and negotiation planning are
generally considered separate processes.
Due to the complexity and number of interrelated tasks that compose the
integrated process of strategic sourcing, multiple sourcing models have been
proposed. Novak and Simco (1991), two of the earliest authors to propose a
sourcing process, established a four-step model. Subsequently, many firms,
both consulting and industrial, have developed sourcing models, each with a
variety of antecedent and consequential steps or stages. For instance, Mercer
Management Consulting has described a six-step process that encompasses
the creation of an annual plan to managing supplier relationships (Andersen
and Katz 1998). Although these models may contain differing numbers of
steps, they have several concepts in common. All of the models place
importance on negotiations within the process and include a negotiation or
negotiation-planning step. It could be argued that the purpose of each
strategic sourcing process is to ensure the development and implementation
of a negotiated agreement that satisfies the long-term goals of the firm. If the
process is viewed from this perspective, negotiation planning is the
culmination of all the preceding steps in the strategic sourcing process.
A noteworthy point is that none of these models discuss the integration of
negotiation as having a significant contribution. It seems to be either assumed
or neglected that negotiation is integrated within the strategic sourcing
process.
The Role of Negotiation Planning
Several studies conducted in the late 1990s indicated that negotiation is a
critical aspect of purchasing and supply chain management and forecast that
negotiation will remain a vital. The strategic sourcing process, especially
market and cost/price analysis, can be viewed as the planning that leads to
negotiation; as such, the processes are integrated.
The importance of planning as a prerequisite for successful negotiations
cannot be overstated "The dominant force for success in negotiation is the
planning that takes place prior to the negotiation... the most important step for
success in negotiation is how one gets ready for the game." Also, Baron
(1998) reviewed the empirical evidence and substantiated the importance of
the negotiation planning process on economic outcomes.
The most commonly cited steps in negotiation planning generally include:
defining issues, assembling issues, defining the bargaining mix, defining
interests, identifying limits, setting targets, analyzing the power base of both
parties, and developing supporting arguments (Asherman and Asherman
1990; Bernstein 1995; Lewicki and Hiam 1998). Strategic sourcing processes
are directly related to these negotiation planning processes. For instance, each
of the strategic sourcing models emphasizes the importance of clearly
defining the good or service to be negotiated. This is usually stated in terms
of commodity or service category analysis. Setting goals consists of market
analysis to establish benchmark prices. Total cost analysis includes
determining the various points for negotiation, including where the cost
reduction emphasis should be placed. Additionally, industry and market
analyses are necessary to determine each party's power base.
Strategic sourcing has become a more common practice and it can be argued
that negotiation effectiveness has contributed to sourcing success. However,
only limited connection has been made in the literature between sourcing and
negotiation. More specifically, Doctorff (1998) addressed negotiation
reengineering and stated that it is important to integrate internal and external
considerations. This may be broadly interpreted to imply that factors such as
market forces should be integrated with the negotiation plan. Similarly, Ertel
(1999) maintained that in order for negotiations to be considered a corporate
capability, the process must consider a wide array of variables. Again, it can
be inferred that when dealing with suppliers, considering the different steps
involved in strategic sourcing is necessary.
A culmination of the prior literature suggests that strategic souring and
negotiation are important supply management processes; however, the extent
that the initial stages of strategic sourcing and negotiation are integrated is
not known. If supply management professionals fail to use a strategic
sourcing process, negotiation goals and strategies may be formed from an
intuitive, poorly structured process that may lead to inappropriate negotiation
outcomes The research reported here investigates the extent to which supply
management professionals use strategic sourcing as the planning process for
negotiation.
Contracts to Coordinate Supply Chain Costs

1. Differences in costs at the buyer and supplier can lead to decisions

that increase total supply chain costs

2. Example: Replenishment order size placed by the buyer. The buyer’s

EOQ does not take into account the supplier’s costs.

3. A quantity discount contract may encourage the buyer to purchase a

larger quantity (which would be lower costs for the supplier), which
would result in lower total supply chain costs

4. Quantity discounts lead to information distortion because of order

batching

Product Categorization by Value and Criticality

 High
Critical Items Strategic Items

General Items Bulk Purchase

Items
Low
Low High
Value/Cost

The Procurement Process

1. The process in which the supplier sends product in response to

orders placed by the buyer

2. Goal is to enable orders to be placed and delivered on schedule at

the lowest possible overall cost

3. Two main categories of purchased goods:

1. Direct materials: components used to make finished goods
 2. Indirect materials: goods used to support the operations of a
firm
3. Differences between direct and indirect materials

4. Focus for direct materials should be on improving coordination and

visibility with supplier

5. Procurement for both should consolidate orders where possible to

take advantage of economies of scale and quantity discounts