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Chapter 7: Strategic Sourcing. Strategic Sourcing. Strategic Sourcing is the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of the business. Ford Manufacturing Supply Chain.

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Strategic Sourcing

  • Strategic Sourcing is the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of the business

Ford Manufacturing SupplyChain

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What is the bullwhip effect?

  • Demand variability increases as you move up the supply chain from customers towards supply


Tier 1 Supplier





First noticed regarding Pampers

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Bullwhip effect in the US PC supply chain

Annual percentage changes in demand (in $s) at three levels of the semiconductor supply chain: personal computers, semiconductors and semiconductor manufacturing equipment.

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Consequences of the bullwhip effect

  • Inefficient production or excessive inventory.

  • Low utilization of the distribution channel.

  • Necessity to have capacity far exceeding average demand.

  • High transportation costs.

  • Poor customer service due to stockouts.

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Causes of the bullwhip effect

  • Order synchronization

  • Order batching

  • Trade promotions and forward buying

  • Reactive and over-reactive ordering

  • Shortage gaming

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Order synchronization

  • Customers order on the same order cycle, e.g., first of the month, every Monday, etc.

  • The graph shows simulated daily consumer demand (solid line) and supplier demand (squares) when retailers order weekly: 9 retailers order on Monday, 5 on Tuesday, 1 on Wednesday, 2 or Thursday and 3 on Friday.

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Order batching

  • Retailers may be required to order in integer multiples of some batch size, e.g., case quantities, pallet quantities, full truck load, etc.

  • The graph shows simulated daily consumer demand (solid line) and supplier demand (squares) when retailers order in batches of 15 units, i.e., every 15th demand a retailer orders one batch from the supplier that contains 15 units.

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Trade promotions and forward buying

  • Supplier gives retailer a temporary discount, called a trade promotion.

  • Retailer purchases enough to satisfy demand until the next trade promotion.

  • Example: Campbell’s Chicken Noodle Soup over a one year period:

Total shipments and consumption

One retailer’s buy

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Reactive and over-reactive ordering

  • Each location forecasts demand to determine shifts in the demand process.

  • How should a firm respond to a “high” demand observation?

    • Is this a signal of higher future demand or just random variation in current demand?

    • Hedge by assuming this signals higher future demand, i.e. order more than usual.

  • Rational reactions at one level propagate up the supply chain.

  • Unfortunately, it is human to over react, thereby further increasing the bullwhip effect.

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Shortage gaming

  • Setting:

    • Retailers submit orders for delivery in a future period.

    • Supplier produces.

    • If supplier production is less than orders, orders are rationed, i.e., retailers are “put on allocation”.

  • … to secure a better allocation, the retailers inflate their orders, i.e., order more than they need…

  • … So retailer orders do not convey good information about true demand …

  • This can be a big problem for the supplier, especially if retailers are later able to cancel a portion of the order:

    • Orders that have been submitted that are likely be canceled are called phantom orders.

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Strategies to combat the bullwhip effect

  • Information sharing:

    • Collaborative Planning, Forecasting and Replenishment (CPFR)

  • Smooth the flow of products

    • Coordinate with retailers to spread deliveries evenly.

    • Reduce minimum batch sizes.

    • Smaller and more frequent replenishments (EDI).

  • Eliminate pathological incentives

    • Every day low price

    • Restrict returns and order cancellations

    • Order allocation based on past sales in case of shortages

  • Vendor Managed Inventory (VMI): delegation of stocking decisions

    • Used by Barilla, P&G/Wal-Mart and others.

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Supply Chain Design Strategy

Based on concepts developed by Marshall Fischer at Wharton (Penn)

  • Functional Products

    • Staples that people buy at retail outlets

    • Predictable demand and long life cycles

    • Physical costs

    • Strategy: Minimize physical costs

  • Innovative Products

    • Life cycle is just a few months (e.g. fashion clothes & computers)

    • Demand is unpredictable

    • Market mediation costs (inventory & stockouts)

    • Strategy: Maximize responsiveness & flexibility

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Hau Lee’s Concepts of Supply Chain Management

  • Hau Lee’s approach to supply chain (SC) is one of aligning SC’s with the uncertainties revolving around the supply process side of the SC

  • A stable supply process has mature technologies and an evolving supply process has rapidly changing technologies

  • Types of SC’s

    • Efficient SC’s

    • Risk-Hedging SC’s

    • Responsive SC’s

    • Agile SC’s

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Hau Lee’s SC Uncertainty Framework

Demand Uncertainty

Low (Functional products)

High (Innovative products)









Efficient SC

Ex.: Grocery

Responsive SC

Ex.: Computers

Risk-Hedging SC

Ex.: Hydro-electric power

Agile SC

Ex.: Telecom

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Outsourcing is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers

Reasons to Outsource




ABC News Report on Outsourcing Part 2

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Inventory Turnover

Obtaining data

Look up inventory value on the balance sheet

Look up cost of goods sold (COGS) from earnings statement – not sales!!

Common benchmark is inventory turns

Inventory Turns = COGS/ Inventory Value

A manufacturing company producing medical devices reported $60 million in sales last year. At the end of the year, they had $20 million worth of inventory in ready-to ship devices. Assuming that units are valued at $1000 per unit and sold at $2000 per unit, what is the turnover rate?

Sales = $60,000,000 per year / $2000 per unit = 30,000 units sold per year @ $1000 COGS per unit

Inventory = $20,000,000 / $1000 per unit = 20,000 units in inventory

Turns = COGS/Inventory =

$30,000,000/$20,000,000 = 1.5 turns

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Inventory Turnover Statistics


Hardware stores: 3.5

Retail Nurseries & Garden Supply: 3.3

General Merchandise Stores: 4.7

Grocery Stores: 12.7

New & Used Car Dealers: 6.8

Gas stations & mini-marts: 39.3

Apparel & Accessories: 3.5

Furniture & home furnishings: 4.1

Drug Stores: 5.3

Liquor Stores: 6.6

Other Retail Stores: 4.3


Groceries & related: 17.8

Vehicles & automotive: 6.9

Furniture & fixtures: 5.5

Sporting goods: 4.8

Drug store items: 8.5

Apparel & related: 5.5

Petroleum & related: 42.4

Alcoholic beverages: 8.5

Industries with higher gross margins tend to have lower inventory turns


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Value Density

  • Value density is defined as the value of an item per pound of weight

    • It is used as an important measure when deciding where items should be stocked geographically and how they should be shipped

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Mass Customization

  • Mass customization is a term used to describe the ability of a company to deliver highly customized products and services to different customers

    • The key to mass customization is effectively postponing the tasks of differentiating a product for a specific customer until the latest possible point in the supply-chain network