Chap 013 Global Sourcing and Procurement

Chapter 13

global sourcing and procurement

Review and Discussion Questions

What recent changes have caused supply chain management to gain importance?

Changes include:

Competitive pressures from foreign firms.

Elevation of product quality to a very high level of importance.

International marketing and international purchasing.

Trends towards choosing sole-source suppliers and long term relationships.

Product varieties and ranges are rapidly changing, and speed of delivery to market is essential.

Product life cycles have shortened necessitating knowledge and control of inventories in the various pipelines.

Adoption of JIT production has changed supplier relationships and has also increased the focus on reducing inventories.

Trends in the legal system hold manufacturers liable for product failures, even though causes of failure may lie outside of the production system itself.

Use of EDI in purchasing.

The growth of supplier development.

With so much productive capacity and room for expansion in the United States, why would a company based in the United States choose to purchase items from foreign firm? Discuss the pros and cons.

The use of foreign firms can provide a U.S. 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; and there may be problems with customs, government regulations, political stability, etc.

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

buy. Fashionable clothes and personal computers are examples of innovative products. Innovative products have short life cycles, high profit margins, and volatile demand.

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 13.4 helps illustrate why supply chains are generally not both.

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-à-vis their supplier is also very important. For example, is this a company that is fair with its suppliers and honors 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?

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 13.6. Some of the major categories from this exhibit include organizational, improvement, financial, revenue, cost, and employee driven reasons.


  Year: 0 1 2 3
Demand     200,000 300,000 500,000
Cost of Capital 0.15        
Purchase Cost Per Unit 0.1   $20,000.00 $30,000.00 $50,000.00
Shipping/Unit 0.01   $2,000.00 $3,000.00 $5,000.00
Inventory charge/Unit 0.005   $1,000.00 $1,500.00 $2,500.00
Monthly charge 20   $240.00 $240.00 $240.00
  $23,240.00 $34,740.00 $57,740.00
Direct Material 0.05   $10,000.00 $15,000.00 $25,000.00
Direct Labor 0.03   $6,000.00 $9,000.00 $15,000.00
50% Surcharge 0.015   $3,000.00 $4,500.00 $7,500.00
Indirect Labor 0.011   $2,200.00 $3,300.00 $5,500.00
50% Surcharge 0.0055   $1,100.00 $1,650.00 $2,750.00
Overhead 100% DL 0.03   $6,000.00 $9,000.00 $15,000.00
  $28,300.00 $42,450.00 $70,750.00
$40,000.00 $5,060.00 $7,710.00 $13,010.00
1 0.86957 0.75614 0.65752
$40,000.00 $4,400.00 $5,829.87 $8,554.29
Total NPV(Make – Buy) $58,784.15        
Buy $143,226.27 $40,000.00 $24,608.70 $32,098.30 $46,519.27
Make $84,442.11   $20,208.70 $26,268.43 $37,964.99
Difference $58,784.15        
Requirement (annual forecast) 12,000.00 units      
Weight 22 pounds per engine    
Order processing cost $125.00 per order      
Inventory carry cost 20% of average inventory    
Lot Size (order quantity) 1,000 Units – given in the case  
Supplier 1 2      
Unit Price $510 $505      
Annual Purchase Cost $6,120,000 $6,060,000      
One-Time Tooling Cost $22,000 $20,000      
Orders per year 12 12      
Order Processing Cost $1,500 $1,500      
Inventory carry cost $51,000 $50,500      
Distance 125 100 miles    
Weight per load 22,000        
$1.20 per 2,000 lbs. per mile $19,800 $15,840      
Total Cost $6,214,300 $6,147,840 $66,460 difference
We would prefer supplier #2.          
Required lot size for truckload 1818 Units (40,000 lbs. max. load/22 lbs. per engine)
Supplier 1 2      
Unit Price $500 $505      
Annual Purchase Cost $6,000,000 $6,060,000      
One-Time Tooling Cost $22,000 $20,000      
Orders per year 6.6 6.6      
Annual Order Processing Cost $825 $825      
Annual Inventory carry cost $90,900 $91,809      
Distance 125 100 miles    
Weight per load 40,000        
Transportation (truckload)          
$0.80 per 2,000 lbs. per mile $13,200 $10,560      
Total Cost $6,126,925 $6,183,194 $56,269 difference


  • 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.

The problem tells us that we sell 4,000 QUARTER pound burgers a week, therefore we sell 1,000 pounds a week, and each pound of hamburger costs $1.00. The problem also tells us that on average, the store has 350 pounds of inventory on hand. By dividing the Cost of Goods Sold by Average Aggregate Inventory Value, We can figure the Inventory Turns. This means that their inventory turns 148.6 times a year.

On average the restaurant has about a third of a week’s supply on hand.


  Q1 Q2 Q3 Q4
United States 300 350 405 375
Canada 75 60 75 70
Europe 30 33 20 15
COGS (Total) 280 295 340 350
Raw Materials 50 40 55 60
WIP and FG 100 105 120 150
DC Inventory        
United States 25 27 23 30
Canada 10 11 15 16
Europe 5 4 5 5
Total Inventory 190 187 218 261
Inventory Turnover 1.5 1.6 1.6 1.3

Using the end-of-quarter inventory numbers as a substitute for the average inventory level, we have the following quarterly and annual inventory turn values. Average inventory for the annual figure is based on the average of the 4 quarterly inventory numbers.

Q1 Q2 Q3 Q4 Annual
280/190 = 1.474 295/187 = 1.578 340/218 = 1.560 350/261 = 1.341 1265/214 = 5.911

If you were given the assignment to increase inventory turnover, what would you focus on? Why?

To increase the inventory turns, a firm needs to reduce the amount of inventory or increase sales or both. To increase turns, the item most readily within our control is the amount of inventory that the firm has on hand. The raw materials, WIP, and FG inventories are the most obvious targets for reduction.

The company reported that it used 500M worth of raw material during the year. On average, how many weeks supply of the raw material are on hand at the factory?

The 500M does not come into play in this problem.

Analytics Exercise: Global Sourcing Decisions – Grainger

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 20′ 40′
Volume (%) 21% 79%
Volume (CBM) 35511 133589
Container Capacity Used 85% 85%
Consolidation Center by Container Type    
Volume (%)   100%
Volume (CBM)   20900
Container Capacity Used   96%
Container Capacity (CBM) 34 67
Containers Shipped 1,229 2,671
Shipping Cost per Container $ 480.00 $ 600.00
Shipping Costs by Container Size $ 589,920 $ 1,602,600
Total Shipping Cost $ 2,192,520  
Consolidation Center Operating Cost Calculations    
Number of Centers 4  
Annual Fixed Cost per Center $ 75,000  
Total Annual Fixed Cost $ 300,000  
Variable Cost per CBM $ 4.90  
Total Annual Variable Cost $ 102,410  
Total Annual Consolidation Center Costs $ 402,410  
Total China/Taiwan Logistics Cost $ 2,594,930  

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′ 40′
Volume (%) 0% 100%
Volume (CBM) 0 133589
Container Capacity Used 85% 85%
Consolidation Center by Container Type    
Volume (%)   100%
Volume (CBM)   56411
Container Capacity Used   96%
Container Capacity (CBM) 34 67
Containers Shipped 0 3223
Shipping Cost per Container $ 480.00 $ 600.00
Shipping Costs by Container Size $ – $ 1,933,800
Total Shipping Cost $ 1,933,800  
Consolidation Center Operating Cost Calculations    
Number of Centers 1  
Annual Fixed Cost per Center $ 75,000  
Total Annual Fixed Cost $ 75,000  
Variable Cost per CBM $ 1.40  
Total Annual Variable Cost $ 78,975  
Total Annual Consolidation Center Costs $ 153,975  
Total China/Taiwan Logistics Cost $ 2,087,775  

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.

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 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.

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