Paavai Institutions Department of CSE

UNIT IV

SOURCING AND COORDINATION

IN SUPPLY CHAIN

Unit - IV 4.1
 Paavai Institutions Department of CSE

CONTENTS

4.1. Role of Sourcing Supply Chain

4.2. Supplier Selection Assessment and Contracts
4.2.1. Supplier Assessment Factors
4.2.2. In-House or Outsource
4.2.3. Risks of Using A Third Party
4.3. Design Collaboration
4.4. Sourcing Planning and Analysis
4.5. Supply Chain Co-Ordination
4.6. Bull Whip Effect
4.7. Effect of Lack of Co-Ordination in My Supply Chain and Obstacles
4.8. Building Strategies Partnerships and Trust with in a Supply Chain
4.9. Question Bank

Unit - IV 4.2
Paavai Institutions Department of CSE

Technical Terms

1. Conflict - A serious disagreement or argument, typically a protracted one.

2. Resolution - A formal expression of opinion or intention agreed on by a legislative body or

other formal meeting, typically after taking a vote.

3. Collaboration - The action of working with someone to produce something

4. Bullwhip - Strike or thrash with a bullwhip

5. Obstacles - A thing that blocks one's way or prevents or hinders progress

6. Optimization - The action of making the best or most effective use of a situation or resource

7. Aggregated - Collect (related items of content) so as to display or link to them.

8. Demand - The desire of consumers, clients, employers, etc. for a particular commodity,
service, or other item.

9. Replenishment - Restoration of a stock or supply to a former level or condition

10. Inventory - A complete list of items such as property, goods in stock, or the contents of a
building.

Unit - IV 4.3
 Paavai Institutions Department of CSE

4.1. Role of Sourcing 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 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 decisions are important and tend to vary across firms and industries. For
example, W.W. Grainger, an MRO distributor, has consistently owned and managed its
distribution centers.

 Effective sourcing processes within a firm can improve profits for the firm, as well as 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.

 The following are some of the benefits from effective sourcing decisions:

 Identifying the right source can result in an activity performed at higher quality and lower
cost.

 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 most important for components that
contribute a significant amount to product cost and value.

 Good procurement processes can facilitate coordination with the supplier and improve
forecasting and planning. Better coordination lowers inventories and improves the
matching of supply and demand.

Unit - IV 4.4
 Paavai Institutions Department of CSE

 Appropriate sharing of risk and benefits can result in higher profits for both the supplier
and the buyer.
 Firms can achieve a lower purchase price by increasing competition through the use of
auctions.Sourcing is the set of business processes required to purchase goods and services.

 Sourcing processes include:

o Supplier scoring and assessment

o Supplier selection and contract negotiation
o Design collaboration
o Procurement
o Sourcing planning and analysis

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

4.2. Supplier Selection Assessment and Contracts

 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

4.2.1. SUPPLIER ASSESSMENT FACTORS

 Replenishment Lead Time

 On-Time Performance
 Supply Flexibility
 Delivery Frequency / Minimum Lot Size
 Supply Quality
Unit - IV 4.5
Paavai Institutions Department of CSE

 Inbound Transportation Cost

 Pricing Terms
 Information Coordination Capability
 Design Collaboration Capability
 Exchange Rates, Taxes, Duties
 Supplier Viability

4.2.2. IN-HOUSE OR OUTSOURCE

 A firm Offshores a supply chain function if it moves its production facility offshores. In
contrast, a firm outsources if the firm hires an outside firm to perform an operation rather
than executing the operation within the firm.

 The decision of outsource is based on the growth in the supply chain surplus provided by
the third party and the increase in risk incurred by using a third party.

 Performing the function in-house is preferable if the growth in surplus is small or

increase in risk is large.

4.2.3. RISKS OF USING A THIRD PARTY

 The process is broken: risk of losing control of the process. Poor cost-benefit analysis.

 Understanding the cost of coordination: underestimating the effort required to

coordinate activities across multiple entities performing supply chain tasks.

 Reduce customer/supplier contract: the firm may lose contract by introducing an

intermediary. The loss is particularly significant for firms that sell directly to customers.

 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.

 Leakage of sensitive data and information: using third party requires the firm to share
demand information and in some cases intellectual property. If the third party also serves
the competitor, then leakage is danger.

Unit - IV 4.6
 Paavai Institutions Department of CSE

4.3. Design Collaboration

 50-70 percent of spending at a manufacturer is through procurement

 80 percent of the cost of a purchased part is fixed in the design phase

 Design collaboration with suppliers can result in reduced cost, improved quality, and
decreased time to market

 Important to employ design for logistics, design for manufacturability

 Manufacturers must become effective design coordinators throughout the supply chain

4.4. Sourcing Planning and Analysis

 A firm should periodically analyze its procurement spending and supplier performance and
use this analysis as an input for future sourcing decisions

 Procurement spending should be analyzed by part and supplier to ensure appropriate

economies of scale

 Supplier performance analysis should be used to build a portfolio of suppliers with

complementary strengths.Cheaper but lower performing suppliers should be used to supply
base demand

 Higher performing but more expensive suppliers should be used to buffer against variation
in demand and supply from the other source

MAKING SOURCING DECISIONS IN PRACTICE

 Use multifunction teams

 Ensure appropriate coordination across regions and business units
 Always evaluate the total cost of ownership
 Build long-term relationships with key suppliers

Unit - IV 4.7
 Paavai Institutions Department of CSE

4.5. Supply Chain Co-Ordination

 Supply chain coordination improves if all stages of the chain take actions that together
increase total supply chain profits. Supply chain coordination requires each stage of the supply
chain to take into account the impact its actions have on other stages.

 A lack of coordination occurs either because different stages of the supply chain have
objectives that conflict or because information moving between stages is delayed and
distorted.

 Different stages of a supply chain may have conflicting objectives if each stage has a different
owner. As a result, each stage tries to maximize its own profits, resulting in actions that often
diminish total supply chain profits

4.6. Bull Whip Effect

 Fluctuations in orders placed and demand increase as we move up the supply chain from
retailers to wholesalers to manufacturers to suppliers. This is called as Bullwhip effect.

 The Bullwhip effect distorts demand information within the supply chain, with each stage
having a different estimate of what demand looks like. The result is a loss of supply chain
coordination.

 P&G has observed the bullwhip effect in the supply chain for Pampers diapers. The company
found that raw material orders from P&G to its suppliers fluctuated significantly over time.

 Farther down the chain, when sales at retail stores were studied, it was found that the
fluctuations, while present, were small.

CAUSES FOR THE BULLWHIP EFFECT

Forecasting updating – Multiple forecast updates by each entity in the chain leads to
significant distortions. Each member of the chain updates forecast based on orders
received at his end and not based on the demand raised by the end customer.

Order batching – Each member of the chain has his own economies of scale in production
Unit - IV 4.8
 Paavai Institutions Department of CSE

and transportation resulting in planning practices leading to order batching.

Price Fluctuations – Discounts or price promotions result in forward buying, causing much
distortion. Further frequent price changes affect the ordering pattern of the buyer.

Shortage Gaming – In a situation of shortages the suppliers usually resort to rationing,

which in turn provides incentives to buyers to inflate orders.

Long Lead Time – Long lead times increase the planning horizon of other partners in the
chain. Further, each partner is forced to keep large amounts of safety stock, resulting in an
overall distortion increase.

4.7. Effect of Lack of Co-Ordination in My Supply Chain and Obstacles

 A supply chain lacks coordination if each stage optimizes only its local objectives, without
considering the impact on the complete chain. Total supply chain profits are thus less than
what could be achieved through coordination.

 Manufacturing Cost – Increases manufacturing cost. As a result of the Bullwhip

effect, manufacturer must satisfy a stream of orders that is much more variable than
customer demand. Manufacturer can respond to the increased variability by either
building excess capacity or holding excess inventory, both of which increases the
manufacturing cost.

 Inventory Cost – Bullwhip effect increases inventory cost. To handle the increased
variability in demand, manufacturer has to carry a higher level of inventory, than
would be required in the absence of the Bullwhip effect.

 Replenishment Lead Time – Increases replenishment lead times. Increased

variability makes scheduling at manufacturers much more difficult and the available
capacity and inventory cannot supply the orders coming in.

 Transportation Cost – Increases transportation cost. Transportation requirements

fluctuate significantly over time and thus surplus transportation capacity needs to be
maintained to cover high demand periods.

Unit - IV 4.9
 Paavai Institutions Department of CSE

 Labor cost for shipping and receiving – Increases labor costs. Labor requirements
fluctuate with orders and thus manufacturers have the option of either carrying excess
labor capacity or varying labor capacity, both of which increases total labor cost.

 Level of product availability – Hurts the level of product availability and result in
more stock outs in the supply chain. Large fluctuations in orders make it difficult for
manufacturer to supply all distributor and retailer orders on time.

 Relationships across the Supply Chain – Has a negative effect on performance at

every stage and thus hurts the relationships between different stages of the supply
chain.

4.8. OBSTACLES TO COORDINATION IN A SUPPLY

 Any factor that leads to either local optimization by different stages of the supply chain or an
increase in information delay, distortion and variability within the supply chain, is an
obstacle to coordination

4.8.1.INCENTIVE OBSTACLES

 Local optimization within functions or stages of a supply chain

 Incentives that focus only on the local impact of an action result in decisions that do not
maximize total supply chain profits.

 If the compensation of a transportation manager at a firm is linked to average transportation

cost per unit, manager is likely to take actions that reduce transportation cost even if they
increase inventory cost or hurt

 Sales Force Incentives

 In many firms, sales force incentives are based on the amount the sales force sells during an
evaluation period of a month. The sales typically measured by a manufacturer are the quantity
sold to distributors or retailers (sell-in), not the quantity sold to final customers (sell-through).

Unit - IV 4.10
Paavai Institutions Department of CSE

4.8.2. OPERATIONAL OBSTACLES

 Ordering in Large Lots – When a firm places orders in lot sizes that are much larger than the
lot sizes in which demand arises, variability of orders is magnified up in the supply chain.
Firms may order in large lots because there is a significant fixed cost associated with placing,
receiving or transporting an order and supplier offers quantity discounts based on lot size.

 Large Replenishment Lead times – Consider a situation in which a retailer has

misinterpreted a random increase in demand as a growth trend. If the retailer faces a lead time
of two weeks, it will incorporate the anticipated growth over two weeks when placing the
order.

 Rationing and Shortage Gaming – Rationing schemes that allocate limited production in
proportion to the orders placed by retailers lead to a magnification of the bullwhip effect. This
can occur when a high demand product is in short supply.

4.8.3. PRICING OBSTACLES

 Lot-size based quantity discounts – Lot size based quantity discounts Increase the lot size
of orders placed within the supply chain and thus magnify the bullwhip effect.

 Price fluctuations – Trade promotions and other short-term discounts offered by a

manufacturer result in forward buying, by which a wholesaler or retailer purchases large lots
during the discounting period to cover demand during future periods. Forward buying results
in large orders during the promotion period followed by very small orders after that.

4.8.4.ALIGNING OF GOALS AND INCENTIVES

 Aligning Incentives across Functions – To ensure that the objective any function uses to
evaluate a decision is aligned with the firm’s overall objective. All facility, transportation
and inventory decisions should be evaluated based on their effect on profitability and not
total costs.

 Pricing for Coordination – A manufacturer can use lot-size based quantity discounts to
achieve coordination for commodity products if the manufacturer has large fixed costs
associated with each lot. Manufacturers can use buy-back, revenue sharing and quantity
flexibility contracts to spur retailers to provide levels of product availability that maximize
supply chain profits.

Unit - IV 4.11
 Paavai Institutions Department of CSE

 Altering sales force incentives from Sell-in to sell-through – Any change that reduces the
incentive for a salesperson to push product to the retailer reduces the bullwhip effect.
Managers should link the incentives for the sales force to sell the units to the end customer
(sell through) and not to the retailer (sell in).

4.9. Building Strategies Partnerships and Trust with in a Supply Chain

 A better relationship also tends to lower the transaction cost between supply chain stages.

 A trust-based relationship between two stages of a supply chain includes dependability of the
two stages, and the ability of each stage to make a leap of faith. Trust involves a belief that
each stage is interested in the other’s welfare and will not take actions without considering
their impact on the other stages.

 There are two views regarding how cooperation and trust can be built into any supply chain
relationship:

 Deterrence based view – In this view the parties involved use a variety of formal
contracts to ensure cooperation.

 Process-based view – With this view, trust and cooperation are built over time as a
result of a series of interactions between the parties involved.

 Coordination and trust within the supply chain help improve performance for the following
reasons:

o When stages trust each other, they are more likely to take the other party’s objectives
into consideration when making decisions.

o Action oriented managerial levers to achieve coordination become easier to implement.

Sharing of information is natural between parties that trust each other.

 There are two phases to any long-term supply chain relationship.

o Design phase – Ground rules are established and the relationship is initiated.

Unit - IV 4.12
Paavai Institutions Department of CSE

o Management phase – Interactions based on the ground rules occur and the
relationships as well as the ground rules evolve.

 Designing a Relationship with Cooperation and Trust Key Steps in designing a

relationship

 Step I Assessing the value of the relationship – The first step in designing a supply
chain relationship is to clearly identify the contribution of each party as well as the
mutual benefit that the relationship provides. The next step is to identify the criteria
used for evaluating the relationship as well as the contribution of each party. Equity
defined as fair dealing measures the fairness of the division of the total profits among
the parties involved.

 Step II. Identifying operational roles and decision rights for each party –When
identifying operational roles and decision rights for different parties in a supply chain
relationship, managers must consider the resulting interdependence between the
parties. A source of conflict may arise if the tasks are divided in ways that make one
party more dependent on the other. The allocation of tasks results in a sequential
interdependence if the activities of one partner precede the other.

 Step III. Creating Effective Contracts Managers can help promote trust by creating
contracts that encourage negotiations as unplanned contingencies arise. Contracts are
most effective for governance when complete information is available and all future
contingencies can be accounted for. Over time, the informal understandings and
commitments between the individuals tend to be formalized when new contracts are
drawn up.

 Designing effective conflict-resolution Mechanisms

 Effective conflict-resolution mechanisms can significantly strengthen any

supply chain relationship. Unsatisfactory resolution causes the relationship to
worsen whereas satisfactory resolutions strengthen the partnership.

 A good conflict resolution mechanism should give the parties an opportunity to

communicate and work through their differences, in the process building
greater trust.

Unit - IV 4.13
 Paavai Institutions Department of CSE

 Managing Supply Chain Relationships for Cooperation and Trust

 Effectively managed supply chain relationships foster cooperation and trust,

thus increasing supply chain coordination. In contrast, poorly managed
relationships lead to each party being opportunistic, resulting in a loss of total
supply chain profits.

4.10. Question Bank

Part – A (2 Marks)

1. What is sourcing in supply management?

Sourcing describes all those activities within the procurement process concerned with
identifying and evaluating potential suppliers, engaging with selected suppliers and selecting the
best value supplier(s).

2. What is the main focus of strategic sourcing?

Strategic sourcing is the process of developing channels of supply at the lowest total cost,
not just the lowest purchase price. It expands upon traditional purchasing activities to embrace all
activities within the procurement cycle, from specification to receipt and payment of goods and
services

3. What is bullwhip effect with example?

The bullwhip effect often occurs when retailers become highly reactive to demand,
and in turn, amplify expectations around it, which causes a domino effect along the supply
chain. Suppose,for example, a retailer typically keeps 100 six-packs of one soda brand in
stock.

Unit - IV 4.14
 Paavai Institutions Department of CSE

4. What is bullwhip effect and how do you control it?

7 Ways to Cope with the Bullwhip Effect

 Focus on the customer. Optimal network design centered on your customer.

 Define the right push-pull boundaries and strategy. Optimize your inventory
allocation based on demand certainty.
 Share Information.
 Manage Your Product Portfolio.
 Break order batches.
 Stabilize prices.
 Eliminate gaming in shortage situations.

5. What is design collaboration?

Collaborative design is a process that brings together different ideas, roles and team
members. Collaborative design is a multi-staged UX (user experience) process that involves
planning and strategy developed by user feedback. The design phase of the UX process is
iterative.

6. Who benefits most from collaborative supply chain relationships?

The Longer the Collaboration, the Lower the Costs. One of the greatest benefits from
long-term supply chain collaboration (and one that consistently delights operationally
oriented managers) is the cost savings that result from routinized procedures over the life of
the relationship

7. What is design collaboration?

Collaborative design is a process that brings together different ideas, roles and team
members. Collaborative design is a multi-staged UX (user experience) process that involves
planning and strategy developed by user feedback. The design phase of the UX process is iterative.

8. Which amongst are the objectives of routing and scheduling?

The main objective of both routing and route scheduling is to cut down on your expenses,
such as mileage and vehicle capital costs. But other objectives come into play as well. For example,
in school bus routing and route scheduling, the objective could be to minimize the total number of
student-minutes on the bus.

Unit - IV 4.15
 Paavai Institutions Department of CSE

9. What is vehicle routing in logistics?

Vehicle Routing Problem In the VRP a number of vehicles located at a central depot has to
serve a set of geographically dispersed customers. Each vehicle has a given capacity and each
customer has a given demand. The objective is to minimize the total distance traveled. Type of
decisions: assigning routing.

10. How do you optimize a route?

Route optimization is the process of determining the most cost-efficient route. It's more
complex than simply finding the shortest path between two points. It needs to include all relevant
factors, such as the number and location of all the required stops on the route, as well as time
windows for deliveries

Part - B (16 Marks)

1. What are some ways in which a firm such as Walmart benefits from good sourcing
decisions?
2. What factors led Walmart to own its trucks although many retailers outsource all their
transportation?
3. How can a supplier with a lower price end up costing the buyer more than a supplier with a
higher price?
4. Explain why, for the same inventory level, a revenue-sharing contract results in a lower sales
effort from the retailer than if the retailer has paid for the product and is responsible for all
remaining inventory.
5. For a manufacturer that sells to many retailers, why does a quantity flexibility contract result
in less information distortion than a buyback contract?

Unit - IV 4.16