Identifying Procurement Contract Risk

Supply Chain Case Study on, 

“Identifying Contract Risk and Contingency Planning”

by Jimmy Alyea

This case study’s thesis is that “the Defense Supply Center Columbus (DSCC) was justified in terminating for default an indefinite-delivery purchase order (IDPO) contract at a firm fixed price (FFP) when New Era Contract Sales (New Era) failed to supply coupling tubes as required by a June 29, 2006, delivery order.

Contract performance. 

When New Era, a government contractor, made delivery on a July 6, 2004, IDPO received from DSCC for coupling tubes, a contract was formed.  The contract obligated New Era to supply parts for two years at a firm fixed price.  New Era’s pricing to DSCC was based on a two-year quote from its supplier, Harrison.  New Era’s contract with DSCC contained a standard supply contract default clause but no price adjustment clause.

When New Era received DSCC’s second IDPO on June 30, 2006, it found that Harrison had been sold and its new owner would not honor the original price quote.  On July 5, 2006, New Era asked DSCC to cancel its contract with no liability for either party because its supplier refused to honor the quoted pricing due to an increase in material costs.  When DSCC refused, New Era asked to negotiate a new price based on a new supplier’s higher price quote.  DSCC again refused and terminated the contract for default when New Era did not fill the order.  New Era appealed the decision to the Armed Services Board of Contract Appeals (ASBCA) based on the provisions of the default clause, Federal Acquisition Regulation (FAR) 52.249-8.

           

FAR 52.249-8.   

The clause stated DSCC’s default contract rights but provided an exception for contractor liability if the following occurred: “If the failure to perform is caused by the default of a subcontractor at any tier, and if the cause of the default is beyond the control of both the Contractor and subcontractor, and without the fault or negligence of either . . . .unless the subcontracted supplies or services were obtainable from other sources in sufficient time for the Contractor to meet the required delivery schedule.”

New Era’s opposing view of the thesis. 

New Era believes that its nonperformance is excusable under FAR 52.249-8.  The refusal of its subcontractor’s new owner to honor the original price quoted to New Era was “beyond its [New Era’s] control and without its fault or negligence.”  Similarly, the subcontractor’s refusal to perform was also “beyond its [the subcontractor’s] control and without its fault or negligence” because Harrison had quoted an unusually low price two years ago and because the present cost of titanium had increased dramatically.  As a result, New Era’s subcontractor would have only been able to supply product from its distributor at a cost/unit of more than three times the original contract price.  New Era states that as a small business owner, it could not absorb the resulting $23,904.66 loss.

New Era also asserts that it had taken “all reasonable action” to perform the contract by looking for alternative sources from which to obtain the product in time to meet the contract delivery date.  However, since none of these alternative suppliers carried stock of the needed item and produced only on an “as-needed basis,” this option would not have enabled New Era to deliver in a timely manner.  Although DSCC offered to extend the delivery date in exchange for a $510.18 contract price reduction, New Era believed it should not have had to incur this extra cost because DSCC did not respond for eight months to New Era’s request to cancel the contract without liability because it could not perform.

Because these unforeseen circumstances regarding pricing and product availability were beyond its control, New Era asserts that it was not negligent in its nonperformance of DSCC’s June 29, 2006, order and should be discharged without liability from its contract with DSCC. 

DSCC’s supporting view of the thesis. 

New Era entered into a binding IDPO contact when it fulfilled DSCC’s July 6, 2004 delivery order, obligating itself to honor the offered prices for two years.  As the FFP contract contained no price adjustment clause, New Era accepted the risk of increased prices from its subcontractor.  Thus, New Era’s claim that a price increase was beyond both it and its subcontractor’s control was not a basis on which to abandon performance under the contract’s default clause.  New Era and its subcontractor did not take “all reasonable action” to perform because they could have provided the ordered parts, even though at a loss.

DSCC seeks affirmation from ASBCA of its decision to terminate New Era’s contract for default and to recover costs from having to reprocure from a new source.  The Board found New Era in default of the contract and affirmed DSCC’s actions and request for reimbursement for additional procurement costs.  The Board stated that renegotiating a contract because of a supplier’s price increase would defeat the purpose of a firm-fixed-price contract, which was to protect DSCC from price variations.  It also noted that DSCC had grounds for termination when New Era notified it on July 5, 2006, that it could not make delivery on DSCC’s second order. 

Implications. 

Lessons for contract managers include the importance of protecting against contract risk and of making contingency plans.  New Era should have taken the time to understand the contract terms, particularly the implications of filling the first order of an IDPO contract at a FFP, as well as the consequences of default and the lack of a price escalation clause.   It should have also locked its supplier into a contractual agreement as to pricing and the subcontractor’s liability for default, instead of depending solely upon a price quote.  New Era would have ultimately been better off had it performed the contract at a loss and then brought suit against its supplier.  Good advice for contract managers would be to expect the best but plan for the worse, and when in doubt, seek legal advice quickly before a problem escalates.

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

Case Study Reference:

“IDENTIFYING CONTRACT RISK AND CONTINGENCY PLANNING” by Jack Horan, Contract Management, Aug., 2009. Retrieved from http://www.mckennalong.com/media/site_files/1140_August%202009.pdf

Analyzing Wal-Mart's Distribution and Logistics System

Wal-Mart has been able to achieve respectable leadership in the retail industry because of its focus on supply chain management.  Discuss in detail the distribution and logistics system adopted by Wal-Mart.

Supply Chain Case Study by Jimmy Alyea

As the world’s largest retailer with net sales of almost $419 billion for the fiscal year 2011, Wal-Mart is considered a “best-in-class” company for its supply chain management practices.  These practices are a key competitive advantage that have enabled Wal-Mart to achieve leadership in the retail industry through a focus on increasing operational efficiency and on customer needs     Wal-Mart’s corporate website calls “logistics” and “distribution” the heart of its operation, one that keeps millions of products moving to customers every day of the year.

Wal-Mart’s highly-automated distribution centers, which operate 24 hours a day and are served by Wal-Mart’s truck fleet, are the foundation of its growth strategy and supply network.  In the United States alone, the company has more than 40 regional distribution centers for import flow and more than 140 distribution centers for domestic flow (Logistics, 2011).  When entering a new geographic arena, the company first determines if the area will be able to contain enough stores to support a distribution center.  Each distribution center supports between 75 to 100 retail stores within a 250-mile area.  Once a center is built, stores are gradually built around it to saturate the area and the distribution network is realigned to maximize efficiencies through a process termed “reoptimization” (Troy, 2003).  The result is a “trickle-down” effect:  trucks do not have to travel as far to retail stores to make deliveries, shorter distances reduce transportation costs and lead time, and shorter lead time means holding less safety inventory.  If shortages do occur, replenishment can be made more quickly because stores receive daily deliveries from distribution centers.

The company’s hub-and-spoke distribution network utilizes a system of manufacturer storage with customer pickup.  No inventory is stored at Wal-Mart’s distribution centers.  Wal-Mart’s fleet of 6,500 dedicated trucks and over 50,000 trailers (SC Digest’s editorial staff, 2011) are used to pick up goods directly from manufacturers’ warehouses, thus eliminating intermediaries and increasing responsiveness.  The use of trucks raises transportation costs but is justified in terms of reduced inventory.   Merchandise brought in by truck to distribution centers is sorted for delivery to stores within 24 to 48 hours.  However, certain goods, such as automotive and drug products, are delivered directly to stores by suppliers.  Wal-Mart, a pioneer in the logistics technique of cross-docking, also has store-specific orders packed and shipped directly to the store by the manufacturer. 

Because Wal-Mart’s fast, responsive transportation operations are such a major part of the company’s successful logistics system, great care is taken in the hiring, training, supervising, and assigning of drivers’ schedules and job responsibilities.  From the onset of his retailing career, Wal-Mart founder Sam Walton recognized the importance of hiring experienced people and of building loyalty not only in his customers but also in his employees.  The company hires only experienced drivers who have driven more than 300,000 accident-free miles and whom it believes will be committed to customer service.  Its retail stores are considered important “customers” of the distribution centers.  As stated in the “Private Fleet Driver Handbook” that each driver is given a copy of, drivers are expected to be “polite” and “kind” when dealing with store personnel and others.

In addition to containing a driver’s code of conduct, the Private Fleet Driver Handbook gives instructions and rules for following pre-planned travel routes and schedules, the responsible unloading of a truck trailer at a retail store, and the safe-guarding of Wal-Mart’s property.  For example, although drivers deliver loaded trailers in the afternoon and evening hours, a trailer can be brought to the store’s docks only at its scheduled unloading time.  Because unloading is done at two-hour intervals during the night, a driver is expected to spend the night, returning to the distribution center at a pre-scheduled time with an empty trailer.  Coordinators closely monitor the detailed records of each driver’s activities for adherence to rules.  Violations are dealt with according to handbook procedures, which include employee education to prevent future occurrences of incorrect actions.  By effectively managing every aspect of its transportation operations and treating its drivers fairly, Wal-Mart gets results that are unrivaled in the logistics arena.  This philosophy parallels the successful coaching style of New York Giant’s football coach Tom Coughlin who believes that rules are more than just discipline.  Rules are a key to consistency, which leads to preparedness, which then leads to proper execution (Pennington, 2012).

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

References

Chandran, P. M. (2003).  Wal-Mart’s supply chain management practices. ICFAI Center for Management Research.  Retrieved from www.icmrndia.org

Chopra, S., & Meindl, P.  (2010).  Supply chain management:  strategy, planning, and operation. 4^th ed.  Prentice Hall: New York.

Logistics. (2011). Walmartstores.com.  Retrieved from http://walmartstores.com/AboutUs/7794.aspx.

Pennington, B. (2012, January 22). Tom Coughlin goes by the book and wins.  New York Times.  Retrieved from http://www.nytimes.com/2012/01/22/sports/football/tom-coughlin-goes-by-the-book-and-wins.html?pagewanted=all

SC Digest’s editorial staff. (2011, October 12).  Wal-Mart tells CSCMP audience it is more flexible on inbound transportation program.  Supply Chain Digest.  Retrieved from http:www.scdigest.com/ONTARGET/11-10-12-1_Walmart_Inbou…

Troy, M. (2003).  Logistics still cornerstone of competitive advantage. Retailing Today.  Retrieved from http://search.proquest.com.ezproxy.udh.edu/docprintview/22851744…

Examining Near Sourcing

Near sourcing has found favor over global sourcing in import circles.  What does this suggest?  Why are we beginning to replace, or supplement, global sourcing?

Supply Chain Analysis by Jimmy Alyea

Near sourcing has been variously defined in professional  publications as “producing products closer to where they are ultimately sold,” or “the practice of getting work done or services performed in neighboring countries rather than in your own country.”  It is a concept in which a company decides to relocate its business processes to countries which are geographically nearer and, generally cheaper.  An example would be a U.S. firm moving its sourcing from China to Canada or Mexico.  More specifically, the terms refer to companies moving from one foreign sourcing or manufacturing locale to another in search of the lowest-cost labor and materials.

The growing popularity of near shoring, rather than offshoring, not only includes seeking lower-cost labor and materials due to inflation in the supply chain caused by changing wage structures and higher employee turnover rates in some countries, but also that other costs of doing business far away from home are increasing.  These include the worldwide economic crisis, the rising price of oil and thus higher costs of transportation, as well as supply chain interruptions from natural disasters such as the recent earthquake in China.  As a result, companies are rethinking their long distribution systems and sourcing patterns and redesigning them with fewer links to reduce network costs.

The advantages of reversing low-cost supply chain strategies and embracing near sourcing are many, including:   no  time-zone differences or lag time that prevents real-time communication and collaboration, fewer language and cultural barriers, lower business travelling costs to plan and oversee projects and work, shorter time to market in the case of manufacturing and reduced inventory holdings because of shortened transit times.  Near sourcing also supports the increased focus by firms on the importance of customer accommodation and fulfillment in order to achieve a strategic competitive advantage.   Ultimately, a well-run, shortened supply chain is in large part dependent upon a firm’s logistical expertise.

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

What Does a Perfect Order Mean in Logistics?

What does a “perfect order” mean in logistics? 

by Jimmy Alyea

A perfect order is what is “perfect” for end customers since they ultimately provide profit to the company.  A more technical definition is perfect orders mean delivering the desired assortment and quantity of products to the right location on time, damage-free, and correctly invoiced.  Thus, the goal of the supply chain is to find a perfect balance between efficiency and responsiveness in order to make the most profit.

Information is now traveling at a very fast speed thanks to advancements in technology such as computers, the Internet, and smart phones.  Because of these advancements, global competition among firms is increasing so firms must rely on their supply chains to provide competitive advantages. 

While the goal in logistics is to have everything in the supply chain go according to plan, it rarely happens.  Humans are imperfect by nature and, according to Murphy’s Law, “If anything can go wrong, it will” (www.murphys-laws.com).  For example, an order might have the wrong quantity or the wrong items, arrive late or too early, go to the wrong destination, or contain damaged items.  Unfortunately, the speed of information makes these mistakes visible quickly, and customers can easily develop a negative perception of a firm’s service.

It is possible to change customers’ negative perceptions, though.  While a picture is worth a thousand words, actions speak volumes.  A firm must overcome a negative perception by working to improve it, and the first step is admitting its shortcomings.  In the 1960’s, Hertz was the number one rental car service in America, and Avis was a distant second.  However, that did not intimidate ad agency executive Bill Bernbach who said, “We knew our ad campaign, which stated ‘Avis is only number 2.  We try harder.’ would work because if there is one thing America loves, it's the story of an underdog finding a way to win.”  Sure enough, customers responded by using Avis’ services, and the company gained a larger market share because of this approach!

The next step in improving a company’s image is to set goals and then work towards reaching them.  As Hall of Fame Football Coach Vince Lombardi once stated, “Perfection is not attainable but, if we chase perfection, we can catch excellence” (www.vincelombardi.com).  We are what we repeatedly do.  A firm has to take action and make corrections to their mistakes.  Then, they must strive to do better each and every day.  The last steps include making sure customers are aware of the firm’s responsiveness and ability to solve problems through the use of advertising and public relations.  Once this tactic has been implemented, it is up to the company’s Sales and Marketing Department to ask for the customers’ business!

Copyright 2012 JamesL. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

E-Business Distribution Networks

How Amazon has used its distribution system in e-business, and general features of e-business distribution networks

by Jimmy Alyea

Distribution systems have been used in e-business to improve customer service in terms of access, customization, and convenience and to lower costs in supply chains.  For example, Amazon.com has lower inventory and facility costs due to their use of e-business for sales rather than bricks-and-mortar retail stores, but their transportation costs are high because they must ship books to customers. Shipping costs are a big portion of their book costs.  However, inventory costs are low compared to retail stores because Amazon.com is able to aggregate inventory in a few geographical locations.  They keep mainly medium- to high-demand books in their own warehouses and purchase low-demand books from a distributor when a customer orders.  This reduces inventory costs considerably, but their facility costs are growing since business is increasing and they have had to add warehouses. 

In the customer-service area, customer experience is very positive in terms of access, customization, and convenience.  Customers, however, must be willing to wait for delivery of books they have ordered unless products can be downloaded.  Benefits to customers also include better order visibility and quicker access to new products.

Basic features of an e-business distribution network include low facility and inventory costs but high transportation costs.  An e-business can carry a wide variety of products, but response times are longer than those at retail stores, excluding products that can be downloaded.  In terms of product availability, e-businesses communicate customer demand information throughout the supply chain faster, so their forecasts are much more accurate.  Also, they can launch new products faster by shipping directly to the customer instead of having to first stock retail shelves.  Overall, the customer experience is very personal due to access, customization, and convenience of online shopping.

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

Example of how a manufacturer would sell and distribute widgets to Wal-Mart

An example of how a manufacturer would sell and distribute widgets to Wal-Mart stores nationwide

by Jimmy Alyea

As a manufacturer of widgets, a fast-moving, low-value consumer goods product, sold mainly to Wal-Mart stores nationwide, I would utilize a distribution network incorporating manufacturer storage with customer pickup.  To facilitate compatibility with Wal-Mart’s focus on customer needs and strategy of reducing costs through efficient supply chain management practices, widgets from our three geographically- disbursed factories would be stored at our warehouse/distribution centers located within acceptable driving distance of selected Wal-Mart distribution centers (DCs).  With Wal-Mart’s approximately 150 distribution centers centrally located within its network of stores, our storage facilities could be located to serve more than one Wal-Mart distribution center.  Additionally, sufficient storage could be provided at our three manufacturing plants to accommodate direct pickup by trucks from Wal-Mart distribution centers located nearby.

The significant increase in processing and new facilities costs incurred because of the number of distribution centers we would require in order to be located close to selected Wal-Mart DCs would have to be weighed against the increase in revenues received because of better responsiveness.  The capacity of each of our facilities would be determined by the number of Wal-Mart DCs served:  the more facilities, the lower the inventory required at each facility.  Accordingly, the more facilities, the more coordination and investment required in information systems.  With global giant Wal-Mart as our number-one customer, the most effective distribution network for our widget company would be one of manufacturer storage with customer pickup, even though facilities most likely would have to be added beyond the total logistics cost-minimizing point. 

Copyright 2012 JamesL. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

What is Cross Docking and Why You Would Use It

What is cross-docking, and why you would use it

by JimmyAlyea

Cross-docking is a flexible operations arrangement between firms that involves multiple suppliers arriving at a designated time at the handling facility where inventory receipts are sorted and consolidated into outbound trailers for direct delivery to the customer.  Cross-docking is typically used to avoid storage and materials handling.  Mass merchants in the retail industry using cross-docking receive store-specific assortments and are able to maintain continuous inventory replenishment without having to hold large stocks of inventory.

Cross-docking is defined as a system in which inventory is not stocked in a warehouse but rather is shipped for stores from the manufacturer.  Shipments from manufacturers to Wal-Mart, a pioneer in cross-docking, arrive at Wal-Mart distribution centers where they are quickly sorted and transferred to trucks for direct delivery to stores.  Because products are stocked only at stores, Wal-Mart significantly reduces inventory and thus handling, storage, and operating costs.  Cross-docking streamlines the supply chain from the point of origin to the point of sale, which increases supply chain efficiency.  

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master of Business Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.

How a manufacturer can increase its responsiveness to customers through inventory management

How a manufacturer can increase its responsiveness to customers through inventory management

by Jimmy Alyea

The location and quantity of inventory can be used by manufacturers to increase supply chain responsiveness to customers. Generally, increasing inventory increases responsiveness.  “Responsiveness”  includes handling a large variety of products, meeting short lead times, meeting a high service level, handling supply uncertainty, responding to wide ranges of quantities demanded, and building highly innovative products.  The more of these capabilities a supply chain has, the more responsive it is.  However, a trade-off is involved between responsiveness and efficiency.  A manufacturer focusing on improving responsiveness may choose to increase inventory in the form of raw materials, work in process, and finished goods, but at the same time it decreases its efficiency by incurring higher inventory holding costs.

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For example, a furniture manufacturer using a flexible manufacturing process could increase its raw materials inventory to become more responsive to customers’ special orders, demand for variety, and/or for innovative products.  A manufacturer could also increase its responsiveness by locating large amounts of finished-goods inventory close to its customers, or a manufacturer with centralized inventories could ship direct to end customers or accommodate customer pickup at the factory.

Copyright 2012 James L. Alyea. All Rights Reserved.

About Jimmy Alyea:

Jimmy Alyea lives in Houston, Texas, and holds two Bachelor of Business Administration degrees (Supply Chain Management and Marketing) and a Master ofBusiness Administration degree.  Follow Jimmy Alyea (James L. Alyea) on LinkedIn, Twitter, or Blog.