Supply Management

Chapter 7

2

Chapter Objectives

Identify and describe the various steps of the strategic sourcing process. Use portfolio analysis to identify the appropriate sourcing

strategy for a particular good or service.

Describe the rationale for outsourcing and discuss when it is appropriate.

Show how multi-criteria decision models can be used to evaluate suppliers and interpret the results.

Discuss some of the longer-term trends in supply management and why they are important.

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Supply Management

Supply Management – The broad set of activities carried out by organizations to

analyze sourcing opportunities,

develop sourcing strategies,

select suppliers, and,

carry out all the activities required to procure goods and services.

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Why is Supply Management critical?

Global Sourcing

Competition against global competitors and their supply chains.

Advances in information systems have helped.

Applies to services and manufacturing environments.

Outsourcing routine business processes (e.g. invoice processing, file checking, call centers).

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Why is Supply Management critical?

Financial Impact

Table 1

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Profit Leverage – Example 1

Financial Impact

Selected Financial Data for Target Corporation Table 2

Profit Margin = 100% X ($4,629 / $65,786) = 7%

Return on Assets = 100% X (4,629 / $17,213) = 26.9%

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Profit Leverage – Example 1

Financial Impact

Every dollar saved in purchasing lowers COGS by $1 and increases pretax profit by $1.

• Profit leverage effect – A term used to describe the effect of $1 in cost savings increasing pretax profits by $1 and a $1 increase in sales increasing pretax profits only by $1 multiplied by the pretax profit margin.

Every dollar saved in purchasing lowers the merchandise inventory figure – and as a result, total assets – by $1.

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Profit Leverage – Example 1

3% purchasing reduction in COGS

Earnings and Expenses Current Reflecting Savings

Sales $65,786 $65,786

COGS $45,725 $44,353

Pretax earnings $4,629 $6,001

Selected Balance Sheet Items

Merchandise inventory $7,596 $7,368

Total assets $17,213 $16,985

Pretax earnings increase by $1372

(30%)

ROA increases from 26.9% to

35.3%

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Why is Supply Management critical?

Performance Impact

Purchased goods and services can have a major effect on other dimensions such as quality and delivery performance.

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Performance Impact – Example 2

Sourcing dialysis machine valves

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Performance Impact – Example 2

Effect of defective dialysis machine

Interruption in patient treatment

Rescheduling difficulties

Reduction in the effective capacity for dialysis

Possible medical emergencies

Estimated cost of a failed valve = $1,000

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Performance Impact – Example 2

Sourcing 50 dialysis machine valves (Total Costs)

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The Strategic Sourcing Process

Figure 1

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Step 1: Assess Opportunities

Spend Analysis: The application of quantitative techniques to purchasing data in an effort to better understand spending patterns and identify opportunities for improvement.

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Assess Opportunities – Example 3

Examine the trends and impact of spending.

Table 3

Figure 2

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Step 2: Profile Internally and Externally

Two approaches to creating profiles:

Category profile – An approach to understand all aspects of a particular sourcing category that could ultimately have an impact on the sourcing strategy.

Example: Breakdown of the total category spend by subcategories, suppliers, and locations; how the purchased components/services are used.

Industry Analysis – An approach to provide a more detailed understanding of the characteristics of the external supply base. (Major forces or trends)

Example: Pricing, competition, regulatory forces, substitution, technology changes, supply/demand trends.

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Step 3: Develop the Sourcing Strategy

The Make-or-Buy Decision

A high-level, often strategic, decision regarding which products or services will be provided internally and which will be provided by external supply chain partners.

• Insourcing – The use of resources within the firm to provide products or services.

• Outsourcing – The use of supply chain partners to provide products or services.

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Develop the Sourcing Strategy

Advantages and Disadvantages of

Insourcing and Outsourcing

Table 6

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Develop the Sourcing Strategy

Factors that affect the decision

to Insource or Outsource.

Table 7

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Develop the Sourcing Strategy

Total cost analysis – A process by which a firm seeks to identify and quantify all of the major costs associated with various sourcing options.

Direct costs – Costs tied directly to the level of operations or supply chain activities.

Indirect costs – Costs that are not tied directly to the level of operations or supply chain activity.

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Develop the Sourcing Strategy

Insourcing and Outsourcing Costs

Table 8

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Develop the Sourcing Strategy

Portfolio analysis – A structured approach used by decision makers to develop a sourcing strategy for a product or service, based on the value potential and the relative complexity or risk represented by a sourcing opportunity.

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Portfolio Analysis – Strategic Quadrants

The Routine Quadrant – Readily available products or services (small % of total expenditures) (e.g. office supplies, cleaning services)

Automating processes, reducing number of suppliers, using Electronic Data Interchange.

The Leverage Quadrant – Standardized and readily available products or services (large % of total expenditures).

Leverage firm’s spending levels to get the most favorable terms, use Preferred suppliers

The Bottleneck Quadrant – Unique or complex products or services supplied by few potential suppliers.

Don’t run out, ensure supply continuity, carry extra inventory against interruptions, contract multiple vendors.

The Critical Quadrant - Unique or complex products or services supplied by a few suppliers, representing large % of total expenditures.

Negotiate favorable deals, build partnerships, prepare contingency plans

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Develop the Sourcing Strategy

Bottleneck

Critical

Routine

Leverage

Value Potential

High

Complexity or Risk Impact

High

Low

Low

Portfolio Analysis

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Develop the Sourcing Strategy

Single sourcing – The buying firm depends on a single company for all or nearly all of an item or service.

Multiple sourcing – The buying firm shares its business across multiple suppliers.

Cross sourcing – Using a single supplier for one product or service and another supplier with the same capabilities for another, similar product or service.

Dual sourcing – Using two suppliers for the same purchased product or service.

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Step 4: Screen Suppliers and Create Selection Criteria

Quantitative Criteria

Cost, on-time delivery, quality, etc.

Qualitative Criteria

Process and design capabilities, Management capability, Financial condition and cost structure, Longer-term relationship potential

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Step 5: Conduct Supplier Selection

Weighted-point evaluation system – An evaluation system to evaluate potential suppliers, track supplier’s performance over time, and rank current suppliers.

Method Assign weights to performance dimensions.

Rate the performance of each supplier with regard to each dimension.

Calculate the total score.

where X = Supplier X

Y = performance dimension Y

n

YYXYX WePerformancScore

1

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Supplier Selection – Example 6

Summary Data for Three Possible Suppliers

Table 11

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Supplier Selection – Example 6

5 = excellent

4 = good

3 = average

2 = fair

1 = poor

Scoring Scheme Criteria Weights

WPrice = 0.3

WQuality = 0.4

WDelivery = 0.3

n

YYXYX WePerformancScore

1

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Supplier Selection – Example 6

Performance Values for Alternative Suppliers

Table 13

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Supplier Selection – Example 6

Total Scores for Alternative Suppliers Score Aardvark = (4 x 0.3) + (3 x 0.4) + (4 x 0.3) = 3.6

Score Beverly = (3 x 0.3) + (5 x 0.4) + (2 x 0.3) = 3.5

Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2

Aardvark should improve their quality. Beverly Hills should improve their delivery and price.

Conan is out of the running as a potential supplier.

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Step 6: Negotiate and Implement Agreements

Competitive bidding – A request for bids from suppliers with whom a buyer is willing to do business.

Request for quotation – A formal request for the suppliers to prepare bids, based on the terms and conditions set by the buyer. • Description by market grade/industry standard

• Description by brand

• Description by specification

• Description by performance characteristics

Competitive bidding is most effective when • The buying firm can provide qualified suppliers with clear descriptions of

the items or services to be purchased;

• Volume is high enough to justify the cost and effort; and,

• The buying firm does not have a preferred supplier.

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Negotiate and Implement Agreements

Negotiating – A more costly, interactive approach to final supplier selection.

Negotiation is used best when:

The item is a new or technically complex item with only vague specifications.

The purchase requires agreement about a wide range of performance factors.

The buyer requires the supplier to participate in the development efforts.

The supplier cannot determine risks and costs without additional input from the buyer.

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Negotiate and Implement Agreements

Contracting – The process of creating a detailed purchasing contract to formalize the buyer-supplier relationship.

Fixed-price contract – Stated price does not change.

Cost-based contract – Price of the good or service is tied to the cost of some other key input or economic factor such as interest rates.

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The Procure-to-Pay Cycle

Ordering Purchase order (PO) – A document that authorizes a supplier to deliver

a product or service and includes the terms and conditions of the sale.

Follow-up and expediting Monitor the status of open POs.

Receipt and inspection Statement of work (scope of work) – Terms and conditions for a

purchased service.

Settlement and payment May be paid through Electric Funds Transfer (EFT)

Records maintenance Record of critical events associated with the purchase.

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Trends in Supply Management

Sustainable Supply

Becoming more conscious of the importance of being environmentally friendly and using environmental performance in selecting suppliers.

Ensuring compliance with regulations.

Reducing packaging, promoting recycling, reducing costs.

Supply Chain Disruptions

Caused by natural disasters, economic/political events.

Cause a big threat to revenue streams.

Increased risk due to outsourcing to global suppliers.