Sourcing in the Supply Chain

In this section, we discuss the role that sourcing plays in the supply chain and key sourcing- related decisions that managers need to make.

1. Role in the Supply Chain

Sourcing is the set of business processes required to purchase goods and services. Managers must first decide whether each task will be performed by a responsive or efficient source and then whether the source will be internal to the company or a third party. Sourcing decisions should be made to increase the size of the total surplus to be shared across the supply chain. Out­sourcing to a third party is meaningful if the third party raises the supply chain surplus more than the firm can on its own. In contrast, a firm should keep a supply chain function in-house if the third party cannot increase the supply chain surplus or if the risk associated with outsourcing is significant. For example, W.W. Grainger outsources package delivery to a third party because it is very expensive to build this capability in-house. In contrast, Grainger owns and operates its warehouses because there is sufficient scale to justify this choice. Sourcing decisions should aim to provide the appropriate level of responsiveness at the lowest cost.

The following example illustrates how Zara has sourced appropriately to be efficient for basic products and responsive for trendy products.

EXAMPLE 3-6 Zara

Zara has a sourcing strategy that varies by product type. For basic products such as white T-shirts, Zara aims for efficiency because demand is predictable. These products are sourced from suppli­ers in low cost countries. For trendy products for which demand is unpredictable, in contrast, Zara sources from company-owned factories in Europe. These factories are not low cost, but they are flexible and responsive to the rapidly evolving needs of the trendy market.

2. Components of sourcing Decisions

We now consider key sourcing decisions that are made within a firm.

In-house or outsource The most significant sourcing decision for a firm is whether to perform a task in-house or outsource it to a third party. Within a task such as transportation, man­agers must decide whether to outsource all of it, outsource only the responsive component, or outsource only the efficient component. This decision should be driven in part by its impact on the total supply chain surplus. It is best to outsource if the growth in total supply chain surplus is significant with little additional risk.

SUPPLIER SELECTION Managers must decide on the number of suppliers they will have for a particular activity. They must then identify the criteria along which suppliers will be evaluated and how they will be selected.

PROCUREMENT Procurement is the process of obtaining goods and services within a supply chain. Managers must structure procurement with a goal of increasing supply chain surplus. For example, a firm should set up procurement for direct materials to ensure good coordination between the supplier and buyer. In contrast, the procurement of MRO products should be struc­tured to ensure that transaction costs are low.

SOURCING-RELATED METRICS Sourcing decisions have a direct impact on the cost of goods sold and accounts payable. The performance of the source also affects quality, inventories, and inbound transportation costs. A manager should track the following sourcing-related metrics that influence supply chain performance:

• Days payable outstanding measures the number of days between when a supplier per­formed a supply chain task and when it was paid for.
• Average purchase price measures the average price at which a good or service was pur­chased during the year. The average should be obtained by weighting each price by the quantity purchased at that price.
• Range of purchase price measures the fluctuation in purchase price during a specified period. The goal is to identify if the quantity purchased correlated with the price.
• Average purchase quantity measures the average amount purchased per order. The goal is to identify whether a sufficient level of aggregation is occurring across locations when placing an order.
• Supply quality measures the quality of product supplied.
• Supply lead time measures the average time between when an order is placed and when the product arrives. Long lead times reduce responsiveness and add to the inventory the supply chain must carry.
• Percentage of on-time deliveries measures the fraction of deliveries from the supplier that were on time.
• Supplier reliability measures the variability of the supplier’s lead time as well as the delivered quantity relative to plan. Poor supplier reliability hurts responsiveness and adds to the amount of inventory the supply chain must carry.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.