[MUSIC] The fourth step in the outsourcing framework is to evaluate the attractiveness of outsourcing by considering both the qualitative test of alignment with competitive priorities. As well as the quantitative economic test, using the concept of total cost of ownership. Originally, total cost of ownership accounted for all the costs associated with buying an owning an asset. Nowadays, the application of the TCO concept has been broadened to include the evaluation of the total cost of sourcing, and of using any activity provided by a given supplier. However, computing these can be extremely hard and thus, we will take a more practical approach and compute the total landed cost which pertains for products. Total landed cost is the total end-to-end supply chain cost. Starting from origin to destination for a given service level. It is estimated by tracking flow units along their routes through the activity network and recording incurred cost along the way. Total line of cost can include the acquisition and processing of inputs at one origin location to the delivery and storage of outputs at a destination. >> TLC analysis quantifies how various candidate locations perform in supplying a given destination. It enables improved business decisions without sacrificing customer service. Including answering the question of where to procure goods. Where and how to deploy assets, how to allocate resources to optimize costs, and how to optimize transportation services. TLC starts with the typical cost of goods sold, COGS, that includes the direct material, direct labor, and overhead costs at the origin destination. The insight from TLC analysis, however, derives from adding all the hidden supply chain-related costs that are not captured in COGS. The first additional costs are outbound freight, customs, duties, and taxes, and inbound freight. For example, the following figure compares the TLC of a Hoodie made in Asia and made in the US. According to the founder of the apparel maker, American Giant. Cost of fabric includes turning cotton into yarn, knitting yarn into fabric, and dyeing fabric. Given that those can be automated, increased US automation can beat Asian costs. In contrast, the labor for a sweatshirt made in the US is about three times as expensive as in Asia. >> The second set of additional cost to include in the total end cost consist of the start-up cost of a new location and quality control costs. Especially for offshore locations, these costs include quality control and training of the new work force to bring them down the learning curve. Supply or relationship management costs, including travel costs for managers to visit suppliers, translation costs, and other soft costs. For example, the hassle of managers getting up at 3 a.m., to place phone calls to their supplier. These costs are often underestimated. In 2007, Honeywell International announced that it would move its up to 70 year old equipment to produce its non-premium Autolite sparkplugs from Fostoria, Ohio to Mexico. Production was supposed to start in 2008. However, the start-up was reeled by quality problems. Honeywell even ended up re-hiring its retired union workers, and sending them to Mexico. It took three years for the Mexican location to get to the 2007 quality levels. In 2011, Honeywell sold the Autolite brand to New Zealand-based investment firm, Rank Group. >> The third additional cost to include in TLC are driven by service and responsiveness. Lead time, where the US has the big advantage. When comparing off-shore versus near-shore locations, lead time typically differs substantially and the difference in response and transportation times results in different inventory of service levels. Therefore, to enable an apples to apples comparison of locations, it is important to evaluate the respective TLC for the same service level. >> We can now summarize. Strategic sourcing decides on the appropriate supply relationship for each activity in the value chain. It starts by identifying the activity, its requirements, and any potential qualified suppliers. It specifies who will perform the activity, in or outsource, and under which conditions? Finally, it establishes and manages the supply of relationship to align incentives. Strategic sourcing amounts to configuring the operating system and its interfaces with suppliers. To ensure that the resulting operation works well and is aligned with a competitive strategy, sourcing must be integrated with all the parts that comprise operation strategy. Our general VGAP framework can help in that process by highlighting the interaction of sourcing and supply management with the other levers of operation strategy. >> A five steps framework may assist in the outsourcing decision, sometimes the answer can be derived from two go/no-go decisions. Outsourcing may be infeasible or necessary. Otherwise one should check whether outsourcing is aligned with the strategic priorities and risks. Whether external suppliers can supply it better and whether we have the ability to contract and manage the relationship and the ongoing risk. This concludes our course on scaling operations. >> We hope that what you have learned will be valuable in your future and that you continue to learn more about the role of operations. [MUSIC]
