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©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield
1
Sourcing Decisions and the Purchasing Process
Introduction
Why purchasing is critical The sourcing decision Sourcing strategies The purchasing process Multi criteria decision models in sourcing and
purchasing Trends in purchasing management
Strategic Sourcing
Strategic Sourcing is the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of the business
Bullwhip Effect O
rder
Q
uan t
ity
Time
Retailer’s Orders
Ord
er
Qua
n tit
y
Time
Wholesaler’s Orders
Ord
er
Qua
n tit
y
Time
Manufacturer’s Orders
The magnification of variability in orders in the supply-chain
The magnification of variability in orders in the supply-chain
A lot of retailers each with little variability in their orders….
A lot of retailers each with little variability in their orders….
…can lead to greater variability for a fewer number of wholesalers, and…
…can lead to greater variability for a fewer number of wholesalers, and…
…can lead to even greater variability for a single manufacturer.
…can lead to even greater variability for a single manufacturer.
Hau Lee’s Concepts of Supply Chain Management
Hau Lee’s approach to supply chain (SC) is one of aligning SC’s with the uncertainties revolving around the supply process side of the SC
A stable supply process has mature technologies and an evolving supply process has rapidly changing technologies
Types of SC’s Efficient SC’s Risk-Hedging SC’s Responsive SC’s Agile SC’s
What is Outsourcing?
Outsourcing is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers
Reasons to Outsource
Organizationally-driven
Improvement-driven
Financially-driven
Value Density
Value density is defined as the value of an item per pound of weight
It is used as an important measure when deciding where items should be stocked geographically and how they should be shipped
Mass Customization
Mass customization is a term used to describe the ability of a company to deliver highly customized products and services to different customers
The key to mass customization is effectively postponing the tasks of differentiating a product for a specific customer until the latest possible point in the supply-chain network
Sourcing decisions – High level, often strategic decisions regarding which products or services will be provided internally and which will be provided by external supply-chain partners
Purchasing – The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance
Sourcing decisions and purchasing activities serve to link a company with its upstream supply chain partners
Focus
Why Purchasing is Critical – I
To compete globally, you need to purchase globally
Global purchasing efforts are supported by advances in information systems
The Changing Global Competitive Landscape
For the average manufacturer, 52.5% of the value of shipments comes from materials
Purchasing represents a major opportunity to increase profitability
Financial Impact
Why Purchasing is Critical – II
Quality Delivery Ability to exploit new technologies
Performance Impact
Why Purchasing is Critical – III
$10 $2
99.8% 95%
Overnight delivery
1 day to 3 weeks
Supplier A Supplier B
Cost per valve
% good
Delivery lead time
Sourcing dialysis machine valves
Why Purchasing is CriticalPerformance Impact - I
Effect of defective dialysis machine valves Interruption in patient treatment Rescheduling difficulties Reduction in the effective capacity for dialysis Possible medical emergencies
Estimated cost of a failed valve = $1,000
Why Purchasing is CriticalPerformance Impact - II
Supplier A Supplier BValve costs Failure costs Backup inventory Total costs
Sourcing dialysis machine valves (Total Costs)
50 x $10 = $500 50 x $2 = $100
0.2% x 50 valves x $1,000 = $100
5% x 50 valves x $1,000 = $2,500
1 valve x $10 = $10 3 valves x $2 = $6
$610 $2,606
Why Purchasing is CriticalPerformance Impact - III
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
Sourcing decisions are high-level, often strategic decisions that address:Which will use resources within the firm
Which will be provided by supply chain partners
The Sourcing Decision
Make or Buy Decision
Advantages and Disadvantages of Insourcing
Advantages High degree of control Ability to oversee the
entire program Economies of scale
and/or scope
Disadvantages Required strategic flexibility Required high investment Loss of access to superior
products and services offered by potential suppliers
Advantages and Disadvantages of Outsourcing
Advantages High strategic flexibility Low investment risk Improved cash flow Access to state-of-the-art
products and services
Disadvantages Possibility of choosing a bad
supplier Loss of control over the
process and core technologies
Communication and coordination challenges
“Hollowing out” of the corporation
Factors Affecting the Decision to Insource or Outsource
Environmental uncertainty low high
Competition in the supplier market low high
Ability to monitor supplier performance low high
Relationship of product/service to high low buying firm’s core competencies
FactorFavors
InsourcingFavors
Outsourcing
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 that are 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
Insourcing and Outsourcing Costs
Direct materialDirect laborFreight costsVariable overhead
Price (from invoice)Freight costs
SupervisionAdministrative supportSuppliesMaintenance costsEquipment depreciationUtilitiesBuilding leaseFixed overhead
PurchasingReceivingQuality control
Insourcing Outsourcing
Directcosts
Indirectcosts
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 a certain part or service and another supplier with the same capabilities for a similar part
Dual sourcing –Using two suppliers for the same purchased product or service
Sourcing Strategies
Invoice clearance & payments
Records maintenance
Receipt and inspection
Follow up and expediting
Purchase order preparation
Supplier selection
Supplier identification and evaluation
Description
Needs identification
Is there a preferred supplier?No
Yes
The Purchasing Process
Ordercycle
The Purchasing ProcessNeeds Identification
Needs identification
Purchase requisition – An internal document completed by a user that informs purchasing of a specific need
Reorder point system – A method used to initiate the purchase of routine items. Typically, each item has a predetermined order point and order quantity
The Purchasing ProcessDescription
Description by market grade/industry standard Description by brand Description by specification Description by performance characteristics Description by prototypes or samples
DescriptionThe communication of a user’s needs to potential suppliers in the most efficient and accurate way possible
The Purchasing ProcessSupplier Identification and Evaluation - I
Supplier identification and evaluation The complexity of the product
or service increases The amount of money that is
committed increases The length of the proposed
buyer-supplier relationship increases
The amount of effort increases as:
Supplier identification and evaluation Process and design capabilities
Management capability Financial condition and cost structures Planning and control systems Environmental regulation compliance Longer-term relationship potential
Criteria for supplier assessment:
The Purchasing ProcessSupplier Identification and Evaluation - II
Supplier selection
Preferred supplier Competitive bidding Negotiation
The Purchasing ProcessSupplier Selection - I
Supplier selection
Preferred supplierA supplier that has demonstrated its performance capabilities through previous purchase contracts and therefore receives preference during the supplier selection process
The Purchasing ProcessSupplier Selection - II
Supplier selection The buying firm can provide qualified
suppliers with clear descriptions of the items or services
Volume is high enough to justify the cost and effort
The firm does not have a preferred supplier
Competitive bidding is most effective when:
The Purchasing ProcessSupplier Selection - III
Supplier selection
The item is new or technically complex with only vague specifications
The purchase requires agreement about a wide range of performance factors
The supplier must participate in the development effort
The supplier cannot determine risks and costs without input from the buyer
Negotiation is most effective when:
The Purchasing ProcessSupplier Selection - IV
Purchase order preparation
Records maintenance
Invoice clearing and payment
Receipt and inspection
Follow-up and expediting
Purchase order preparation74% of firms currently have electronic data interchange (EDI) with some part of their supply base
Follow-up and expediting Receipt and inspection Invoice clearance and payment Records maintenance
The Purchasing ProcessThe Order Cycle
Multi-Criteria Decision Models in Sourcing and Purchasing
How do we evaluate alternatives when criteria include both quantitative measures (such as costs and on-time delivery performance) and qualitative factors (such as
management stability and trustworthiness)?
Weighted-Point Evaluation System - I
Assign weights to performance dimensions Rate the performance of each supplier with regard to each
dimension Calculate the total score
Evaluating potential suppliers Tracking suppliers’ performance over time /
ranking current suppliers
Purpose:
The Process:
$4/unit $5/unit $2/unit
5% defects 1% defects 10% defects
95% on time 80% on time 60% on time
Aardvark Beverly Conan the Electronics Hills Inc. Electrician
Performance Dimension
Price
Quality
Delivery reliability
Weighted-Point Evaluation System - II
Summary Data for Alternative Suppliers
Weighted-Point Evaluation System - III
5 = excellent
4 = good
3 = average
2 = fair
1 = poor
Scoring Scheme Criteria Weights
WPrice = 0.3
WQuality = 0.4
WDelivery = 0.3reliability
4 3 5
3 5 1
4 2 1
Aardvark Beverly Conan the Electronics Hills Inc. Electrician
Performance Dimension
Price
Quality
Delivery reliability
Weighted-Point Evaluation System - IV
Performance Values for Alternative Suppliers
Weighted-Point Evaluation System - V
Total Scores for Alternative SuppliersScore 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 qualityBeverly Hills should improve their delivery and priceConan is out of the running as a potential supplier
Trends in Purchasing Management
Long-term Contracts and Consolidation Supply Base Reduction Global Purchasing Supplier Performance Measurement Supplier Technology Information Technology Professionalism in Purchasing
Trends in Purchasing Management - I
Contract length Competitive bidding, reviewed annually or semiannually
Long-term contracts (> 2 years) with performance improvement clauses
Purchase consolidation
Products and services purchased by individual business units
Purchases consolidated across business units to leverage volumes and purchasing efforts
Number of suppliers
Suppliers switched often, with many suppliers for each purchased item
Firms more likely to single-source or dual-source in order to improve performance and reduce costs
Area of Traditionally In the FuturePurchasing
Trends in Purchasing Management - II
Location of suppliers
Primarily domestic or even local
Global sourcing to access the best suppliers in the world
Top management’s perception of purchasing
Purchasing seen as a nuisance or non-value added activity
Purchasing sees as a way to harness suppliers’ capabilities
Importance of time
Long cycle times tolerated; little involvement of suppliers in new product development
Cycle times a critical order-winner; suppliers cooperate in new product development to reduce development time
Area of Traditionally In the FuturePurchasing
Trends in Purchasing Management - III
Improvement of suppliers’ capabilities
Suppliers expected to improve . . . or else!
Buying organizations improving supplier performance through supplier development programs
Supplier performance measurement
Random or nonexistent monitoring of suppliers, quality, delivery, and price over time
Detailed, formal performance measurement systems to track price, delivery, quality and other measures
Supplier performance standards
Low standards, if any Increasing levels of performance expected
Area of Traditionally In the FuturePurchasing
Trends in Purchasing Management – IV
Reliance on supplier product and process technology
Little to none; suppliers expected to deliver exactly what was asked for and no more
Suppliers active in new product/process development
Information systems linking buyers and suppliers
Little or none Increasing use of EDI, B2Bs, Cad/CAM, and Web to link supply chain partners
Purchasing responsibilities
Primarily clerical – processing purchase orders
Increased use of technology for routine activities; more time spent managing key supplier relationships
Area of Traditionally In the FuturePurchasing
©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield
45
Logistics
Logistics
Logistics defined
Logistics decision areas
Logistics strategies in action Kraft Foods, page 336.
Logistics
Planning, implementing, and controlling the effective flow and storage of goods and materials from the point of origin to the point of consumption
(CLM)
Key Decision Areas
Transportation Warehousing (and more generally, location) Packaging Material handling Logistics information systems Logistics service providers
(And some would put inventory here as well!)
Why the Increasing Interest?
Deregulation
Globalization
Technological breakthroughs
Environmental concerns
Performance impact
Deregulation
Transportation providers Elimination of artificial barriers Unrestricted markets Multi-modal solutions Price, schedule, and terms flexibility
Buyers have greater freedom Negotiate prices, terms, and conditions Ownership issues
BUT…
Deregulation (continued)
… With greater freedom comes new responsibilities
Key pointLogistics has evolved from being a
“tactical” area to a “strategic” one
Globalization(US Statistics)
Year Exports Imports
1992 $449 Billion $700 Billion
1998 $670 Billion $917 Billion
Change +49% +31%
What is driving this activity?
Technological Breakthroughs I
Information Systems Global positioning systems Bar-coding applications
RFID on the horizon as replacement Real-time simulation and optimization Precise coordination of multi-modal solutions
Technological Breakthroughs II
Transportation Systems Standardized containers for ease of transfer “Roadrailers,” etc. Multi-modal solutions
Ship Truck Train Truck ?
Environmental Concerns
Even while certain aspects of logistics have been deregulated, other areas are being controlled more stringently
Fuel efficiency Pollution Recovery, recycling, and reuse of packaging,
containers, and products
Performance Impact I
RegionGross Domestic
ProductLogistics
ExpenditureLogistics % of
GDP
North America 8,495 915 10.8
Europe 7,981 941 11.8
Pacific 5,605 652 11.6
Other 7,080 916 12.9
Total 29,161 3,424 11.7
Comparative GDP and Logistics Expenditures (billions of $, 1998)
Source: D. Bowersox and R. Calantone, “Executive Insights: Global Statistics,” Journal of International Marketing, Vol. 8, no. 4, 1998, pp 83-93.
Performance Impact II
Customer “touch points” Delivery reliability Delivery speed Delivery tracking Quality
Performance Impact III
2000 2004
Manufacturing Time 2 days 0.5 days
Shipping Time 4 days 4 days
Total Time to the Customer 6 days 4.5 days
Total time to the customer at WolfByte Computer
75% decrease in manufacturing time, but only 25% decrease in time to customer. Where is the leverage now?
The Evolution of Logistics Strategy
From functional silos to strategic positioning
Strategic Disconnect
OrganizationStrategy
MarketingStrategy
OperationsStrategy
FinancialStrategy
Strategic Disconnect
TransportationDecisions
InformationSystems
InventoryDecisions
LocationDecisions
Who “Owns” Logistics?
OrganizationStrategy
MarketingStrategy
OperationsStrategy
FinancialStrategy
Executive-level of representationDifficult goal of functional integrationOrganizational question: Who really ‘owns’ logistics?
Transportation?Marketing?Operations?
LogisticsStrategy
Logistics Decision Areas
Transportation… Modes Formats Pricing
Warehousing Consolidation Cross Docking and Break-Bulk Hub and Spoke Inventory
Major Transportation Modes
Highway (truck)
Water
Rail
Air
Pipeline
Modal Shares of Shipments(within US, 1999)
Mode Value (%) Tons (%) Ton Miles (%)
Highway (trucking, parcel, postal, courier)
80.3 58.5 28.4
Water 2.5 11.1 20.4
Rail 4.8 11.2 26.7
Air 2.7 0 0.2
Pipeline 4.2 13.7 17.6
Other/Unknown 5.5 5.5 6.7
Highway Mode
Strengths Flexibility to pick up and
deliver where and when needed
Often the best balance between cost/flexibility and delivery reliability/speed
Can be available 24/7
Weaknesses Not the fastest Not the cheapest
Water Mode
Strengths Highly cost effective for
bulky items Most effective when linked
into multimodal system
Weaknesses Limited locations Relatively poor delivery
reliability/speed Often limited operating hours
at docks
Rail Mode
Strengths Highly cost effective for
bulky items Can be most effective when
linked into multimodal system
Weaknesses Limited locations, but better
than for water. Better delivery
reliability/speed than water
Air Mode
Strengths Quickest delivery over longer
distances Can be very flexible when
linked to highway mode
Weaknesses Often the most expensive,
particularly on a per pound basis
Question
How can businesses design solutions that exploit the strengths of each mode?
Transportation “Formats”
Common carriers Published rates and schedules “Nondiscriminatory” pricing Increased flexibility to partner
Contract carriers Service for select customers Unlimited number of customers
Private carriers
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