An Analysis of Incentive Strategies for Single - Source Suppliers to Drive Cost Reduction

An organization's decision on which aspects of its operations to outsource represents a key, strategic issue that should be based on maximizing performance throughout the entire value chain. In certain instances strategic outsourcing decisions make it ideal for firms to source from one particular supplier. Singlesource relationships, in particular, necessitate strategic contract development to ensure incentives are aligned throughout the value chain. Much of the existing research in contract development focuses on mitigating fluctuations in demand. Forecasting demand is highly uncertain and can lead to inefficiencies throughout the value chain that contracts can alleviate. However, the defense industry typically has low uncertainty in demand, which offers a unique environment to study contract development. This thesis focuses on contract development with certain demand through case studies in the defense industry. The essence of this thesis revolves around a strategic framework for developing contracts. This framework begins with a discussion of methods for performing a strategic analysis of suppliers. Next an overview of investigating supplier alternatives is provided. The framework then addresses the execution of a contract, which includes writing and negotiating the contract. Finally, contract maintenance is discussed, which includes contract validation as well as managing latent concerns. After the framework is laid out, four different single-source supplier relationships are analyzed. Each of these supplier relationships is investigated to understand the motivation for initiating these particular relationships. The four supplier case studies revolve around the issues of supplier investment costs, internal competition, commodity negotiations, and supplier power. After each case study, the pertinent aspects of the contract development framework are applied to the specific supplier relationship and conclusions are drawn. Thesis Supervisor: David Simchi-Levi Title: Professor of Engineering Systems and Civil & Environmental Engineering Thesis Supervisor: Roy Welsch Title: Professor of Statistics and Management Science, MIT Sloan School of Management This page intentionally left blank. Acknowledgments I would like to thank PDS for sponsoring the internship. In particular, Nathan was involved with every step of the project and offered much needed guidance for building support for initiatives. Furthermore, I would like to thank Bryan for his assistance with navigating the legal aspects of the contracts. Additionally, I would like to thank Jeff, who provided great insight into the current operations at PDS. Finally, I would also like to thank Richard, Gayle, Stu, Alex, & Matt who provided additional support throughout my internship. I also had the great fortune to work with Roy Welsch and David Simchi-Levi who were my thesis advisors. They both provided awareness of issues in supply chain management that I would not have realized on my own. Their involvement was critical to the success of this thesis and my education. Lastly I would like to thank Mom, Dad, Brad, Amy, and Eva for their support during my two years at MIT. As well as Erin Dowdall who's support and motivation during my thesis was critical to completing it.