Chapter 13 Supply Chain Management Strategies

CHAPTER 13
SUPPLY CHAIN MANAGEMENT STRATEGIES
Review and Discussion Questions (on Connect)
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. With so much productive capacity and room for expansion in the Canada, why would a
company based in the Canada choose to purchase items from foreign firm? Discuss the pros
and cons.
The use of foreign firms can provide a Canadian 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. There may be problems with customs,
government regulations, political stability, etc.
3. 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, have low profit margins, stable predictable demand and
long life cycles. Innovative products, on the other hand, give customers additional reasons to

Chapter 13 - Global Sourcing and Procurement

buy. Fashionable clothes and personal computers are examples of innovative products.
Innovative products have short life cycles, high profit margins, and volatile demand.
4. 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 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 10.4 helps illustrate why
supply chains are generally not both.
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--vis their supplier is also very important. For example, is this
a company that is fair with its suppliers and honours 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. What are the advantages of using the postponement strategy?
Process postponement delays the process step that differentiate the product to as late in the
supply chain as possible. The advantages of this approach are that lower levels of inventory,
and fewer models are needed to match customer requirements. This results in higher levels
of customer satisfaction at a lower cost.
7. 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 10.6. Some of the major categories
from this Exhibit include organizational, improvement, financial, revenue, cost, and
employee driven reasons.
8. What are the basic building blocks of an effective mass customization program? What kind
of company wide cooperation is required for a successful mass customization program?
The three organizational design principles for mass customization are 1) A product should be
designed so it consists of independent modules that can be assembled into different forms of
the product easily and inexpensively, 2) Manufacturing and service processes should be
designed so that they consists of independent modules that can be moved or rearranged easily

Chapter 13 Global Sourcing and Procurement

to support different distribution network designs, 3) The supply network--the positioning of

inventory and the location, number, and structure of service, manufacturing, and distribution
facilities--should be designed to provide two capabilities. First, it must be able to supply the
basic product to the facilities performing the customization in a cost-effective manner.
Second, it must have the flexibility and the responsiveness to take individual customer's
orders and deliver the finished, customized good quickly.

Chapter 13 - Global Sourcing and Procurement

Problems
1. Inventory turnover = cost of goods sold/average aggregate inventory value
= (4,000 hamburgers * $1 per pound * 1/4 pound per hamburger * 52 week per year)/(350
pounds * $1
per pound)
= 148.5 turns/year
Day of supply = (average aggregate inventory value/cost of goods sold)*365
= ((350 pounds * $1 per pound)/( 4,000 hamburgers * $1 per pound * 1/4 pound per
hamburger * 52
week per year))*365
= 2.46 days
2.
a. Inventory turnover = costs of good sold/average aggregate inventory value.
Quarter
Cost of goods sold
Raw material
WIP
Distribution Center
Inventory
Aggregate Inventory

1
2
3
4 Total
280 295 340 350 1265
50 40 55 60
100 105 120 150
40 42 43 51
190 187 218 261

Average aggregate inventory value = (190 + 187 + 218 + 261)/4 = 214

Inventory turnover = 1265/214 = 5.91
b. Focus on reducing WIP.
c. Average raw material inventory value = (50 + 40 + 55 + 60)/4 = 51.25
Day of supply = (average aggregate raw material inventory value/cost of goods sold)*52
= (51.25/500)*52 = 5.33

3.
Year:
Demand
Cost of Capital
Purchase Cost
Per Unit
Shipping/Unit
Inventory
charge/Unit
Monthly charge

1
200,000

2
300,000

3
500,000

Purchase Option
$20,000.0
0.1
0
0.01
$2,000.00

$30,000.0
0
$3,000.00

$50,000.0
0
$5,000.00

$1,500.00

$2,500.00

0.15

0.005

$1,000.00

20

$240.00
$23,240.0
0

Total Purchase Cost

$240.00
$34,740.0
0

$240.00
$57,740.0
0

Chapter 13 Global Sourcing and Procurement

Make Option
$10,000.0
0

$15,000.0
0

Direct Material

0.05

Direct Labor

0.03

$6,000.00

$9,000.00

50% Surcharge
0.015
Indirect Labor
0.011
50% Surcharge
0.0055
Overhead 100%
0.03
DL
Total Variable Manufacture
Cost

$3,000.00
$2,200.00
$1,100.00

$4,500.00
$3,300.00
$1,650.00

$6,000.00

$9,000.00

Investment Engineer
Equipment

$28,300.0
0

$42,450.0
0

$30,000.
00
$10,000.
00

Cost Comparison Analysis

$40,000.
Make Cost Buy Cost
$5,060.00 $7,710.00
00
Discount factor
1
0.86957
0.75614
$40,000.
NPV (Make Buy)
$4,400.00 $5,829.87
00
Total NPV
$58,784.1
(Make - Buy)
5

Buy
Make
Difference

$25,000.0
0
$15,000.0
0
$7,500.00
$5,500.00
$2,750.00
$15,000.0
0
$70,750.0
0

Alternative: Option NPV Calculations

$143,226 $40,000. $24,608.7 $32,098.3
.27
00
0
0
$84,442.
$20,208.7 $26,268.4
11
0
3
$58,784.
15

$13,010.0
0
0.65752
$8,554.29

$46,519.2
7
$37,964.9
9

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.

Chapter 13 - Global Sourcing and Procurement

4.
Requirement (annual forecast)
Weight
Order processing cost
Inventory carry cost
Lot Size (order quantity)
Supplier
Unit Price

12,000.0
0
22
$125.00
20%
1,000

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

1
$510
$6,120,0
00
$22,000
12
$1,500
$51,000

2
$505
$6,060,0
00
$20,000
12
$1,500
$50,500

125

100

Weight per load

22,000
Transportation (Less-than-truckload)
$1.20 per 2,000 lbs. per mile
$19,800

$15,840

$6,214,3
00

$6,147,8
40

Annual Purchase Cost

One-Time Tooling Cost
Orders per year
Order Processing Cost
Inventory carry cost
Distance

Total Cost
We would prefer supplier #2.
Required lot size for truckload
Supplier
Unit Price
Annual Purchase Cost
One-Time Tooling Cost
Orders per year
Annual Order Processing Cost
Annual Inventory carry cost
Distance
Weight per load
Transportation (truckload)
$0.80 per 2,000 lbs. per mile

1818

miles

$66,460

difference

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

engine)

1
$500
$6,000,0
00
$22,000
6.6
$825
$90,900

2
$505
$6,060,0
00
$20,000
6.6
$825
$91,809

125

100

miles

40,000
$13,200

$10,560

$6,126,9
$6,183,1
Total Cost
25
94 $56,269 difference
Yes, it would make sense to order in truckload lots as we can reduce total costs. While
carrying costs increase, 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.

Chapter 13 Global Sourcing and Procurement

CASE
Pepe Jeans Teaching Note
This case is designed to illustrate the use of process postponement in the manufacturing of
fashion jeans. The case can be done with a marketing instructor very effectively. Pepe Jeans
is a real company in the UK, but the data given in the case is fictitious, so you might
anticipate some questions that relate to whether Pepe actually made the changes that are
developed in the case.
The HP Deskjet case, in Chapter 13 also illustrates postponement, but from the viewpoint of
inventory cost saving through pooling synergy. Using Pepe Jeans and HP Deskjet together is
a good way to illustrate the types of changes companies are making today as they globalize
operations.
The following are the answers to the discussion questions:
1. Acting as an outside consultant, what would you recommend that Pepe do? Given the
data in the case, perform a financial analysis to evaluate the alternatives that you have
identified. (Assume that the new inventory could be valued at six weeks worth of the yearly
cost of sales. Use a 30 percent inventory carrying cost rate.) Calculate the payback period
for each alternative.
Assume that Sales are 200M
Cost of Sales @ 40% = 80M
Operating Expense @ 28% = 56M
Profit @ 32% = 64M
If lead-time is cut to 6 weeks then cost of sales go up 30%
80 + 24 = 104M
Assuming that operating expenses stay the same, Pepe would only make 40M/yr assuming
that sales to not go up.
Locating the finishing operation in the UK requires the following investment:
Equipment = 1M
Renovation = .3M
Inventory investment cost. First, assume that the cost of the jeans would be reduced by 10%
or 80M x .1 = 8M. The basic jeans would then cost about 72M.
Inventory investment
(6 weeks supply of basic jeans) = 72 x (6/52) = 8.31M (Value of inventory)
Inventory Carrying Cost (yearly) = 8.31M x .3 = 2.49M
Total cost of the investment = 1M + .3M + 2.49M = 3.79M
Yearly savings for the option is the cost of sales reduction of 10% accompanied by a yearly
increase in UK operating expenses of .5M.
8M + .5M = 7.4M savings per year.
Profit would improve to 71.4M and increase of 11.6%.
The payback on the investment is then
3.79M / 7.4M = .5 years
This looks like a very attractive investment.

Chapter 13 - Global Sourcing and Procurement

2. Are there other options that Pepe should consider?

Pepe may want to consider sourcing the Jeans in Europe, but this would probably not be very
attractive, since costs would go up due to the much higher labour costs.
Another option would be to keep with the current supplier arrangement, but carry inventory
in the UK. In this case, Pepe could deliver orders from stock, rather than manufacturing
everything directly to order. The investment in the inventory and the cost to manage that
inventory would need to be offset by increased sales. Some interesting issues can be
discussed relating to this option including the need to forecast sales, how unsold (obsolete)
inventory would be sold, how would returns be handled, and how the distribution center
would be operated.

Case: Global Sourcing Decisions Grainger: Reengineering the China/U.S. Supply

Chain
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

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Chapter 13 Global Sourcing and Procurement

Containers Shipped

1,229
$
480.00
$
589,920
$
2,192,520

Shipping Cost per Container

Shipping Costs by Container Size
Total Shipping Cost

2,671
$
600.00
$
1,602,600

Consolidation Center Operating Cost

Calculations
Number of Centers

Total Annual Consolidation Center Costs

$
75,000
$
300,000
$
4.90
$
102,410
$
402,410

Total China/Taiwan Logistics Cost

$
2,594,930

Annual Fixed Cost per Center

Total Annual Fixed Cost
Variable Cost per CBM
Total Annual Variable Cost

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 is 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'

Volume (%)
Volume (CBM)
Container Capacity Used

40'
0%

100%

133589

85%

85%

Consolidation Center by Container Type

Volume (%)

100%

Volume (CBM)

56411

Container Capacity Used

96%

Chapter 13 - Global Sourcing and Procurement

Container Capacity (CBM)

Containers Shipped

34

67

3223
$
600.00
$
1,933,800

$
480.00
$
$
1,933,800

Shipping Cost per Container

Shipping Costs by Container Size
Total Shipping Cost
Consolidation Center Operating Cost
Calculations
Number of Centers

Total Annual Consolidation Center Costs

$
75,000
$
75,000
$
1.40
$
78,975
$
153,975

Total China/Taiwan Logistics Cost

$
2,087,775

Annual Fixed Cost per Center

Total Annual Fixed Cost
Variable Cost per CBM
Total Annual Variable Cost

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.
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

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Chapter 13 Global Sourcing and Procurement

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.

11