©2006 Pearson Prentice Hall — Introduction to Operations and ...

©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield

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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