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Who Offers Free Delivery And Hook Up Of Appliances Online

The fourteenth edition of Purchasing and Supply Management focuses on decision making throughout the supply chain. Based on the conviction that supply managers, in concert with suppliers and distributors, have to contribute to organizational goals and strategies, this edition continues to focus on how to make that mission a reality.
Fourteenth Edition
Highlights of the Fourteenth Edition: More than 40 real-life supply chain cases afford the opportunity to apply
of the acquisition process. Criteria for supply decisions have been organized into three categories: (1) strategic, (2) operational, and (3) additional. In this third category, new factors such as balance sheet and income statement considerations, dimensions of risk, and environmental and social considerations are considered.
Visit the text’s Online Learning Center at www.mhhe.com/Johnson14e
Michiel R. Leenders, D.B.A., PMAC Fellow Professor of Purchasing Management Emeritus Richard Ivey School of Business The University of Western Ontario Anna E. Flynn, Ph.D., C.P.M. Formerly Clinical Associate Professor Supply Chain Management Thunderbird School of Global Management Formerly Associate Professor Institute for Supply Management
TM
Johnson Leenders Flynn
Purchasing and Supply Management Johnson Leenders Flynn
MD DALIM #1093963 06/05/10 BLUE GREEN
P. Fraser Johnson, Ph.D. Leenders Purchasing Management Association of Canada Chair Associate Professor, Operations Management Richard Ivey School of Business The University of Western Ontario
Purchasing and Supply Management
company issues and opportunities.
Fourteenth Edition
Purchasing and Supply Management
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The McGraw-Hill/Irwin Series Operations and Decision Sciences
OPERATIONS MANAGEMENT Beckman and Rosenfield, Operations, Strategy: Competing in the 21st Century, First Edition Benton, Purchasing and Supply Chain Management, Second Edition Bowersox, Closs, and Cooper, Supply Chain Logistics Management, Third Edition Brown and Hyer, Managing Projects: A Team-Based Approach, First Edition Burt, Petcavage, and Pinkerton, Supply Management, Eighth Edition Cachon and Terwiesch, Matching Supply with Demand: An Introduction to Operations Management, Second Edition Finch, Interactive Models for Operations and Supply Chain Management, First Edition Fitzsimmons and Fitzsimmons, Service Management: Operations, Strategy, Information Technology, Seventh Edition Gehrlein, Operations Management Cases, First Edition
Hill, Manufacturing Strategy: Text & Cases, Third Edition Hopp, Supply Chain Science, First Edition Hopp and Spearman, Factory Physics, Third Edition
Simchi-Levi, Kaminsky, and Simchi-Levi, Designing and Managing the Supply Chain: Concepts, Strategies, Case Studies, Third Edition
Jacobs, Berry, Whybark, and Vollmann, Manufacturing Planning & Control for Supply Chain Management, Sixth Edition
Sterman, Business Dynamics: Systems Thinking and Modeling for Complex World, First Edition
Jacobs and Chase, Operations and Supply Management: The Core, Second Edition
Stevenson, Operations Management, Tenth Edition
Jacobs and Chase, Operations and Supply Chain Management, Thirteenth Edition
Swink, Melnyk, Cooper, and Hartley, Managing Operations Across the Supply Chain, First Edition
Jacobs and Whybark, Why ERP? First Edition
Thomke, Managing Product and Service Development: Text and Cases, First Edition
Johnson, Leenders and Flynn, Purchasing and Supply Management, Fourteenth Edition
Ulrich and Eppinger, Product Design and Development, Fourth Edition
Larson and Gray, Project Management: The Managerial Process, Fifth Edition
Zipkin, Foundations of Inventory Management, First Edition
Nahmias, Production and Operations Analysis, Sixth Edition
Harrison and Samson, Technology Management, First Edition
Olson, Introduction to Information Systems Project Management, Second Edition
Hayen, SAP R/3 Enterprise Software: An Introduction, First Edition
Schroeder, Goldstein, Rungtusanatham, Operations Management: Contemporary Concepts and Cases, Fifth Edition
joh77899_fm_i-xviii.indd ii
Seppanen, Kumar, and Chandra, Process Analysis and Improvement, First Edition
QUANTITATIVE METHODS AND MANAGEMENT SCIENCE Hillier and Hillier, Introduction to Management Science: A Modeling and Case Studies Approach with Spreadsheets, Fourth Edition Stevenson and Ozgur, Introduction to Management Science with Spreadsheets, First Edition
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Purchasing and Supply Management Fourteenth Edition P. Fraser Johnson, PhD Leenders Purchasing Management Association of Canada Chair Associate Professor, Operations Management Richard Ivey School of Business The University of Western Ontario
Michiel R. Leenders, DBA, PMAC Fellow Professor of Purchasing Management Emeritus Richard Ivey School of Business The University of Western Ontario
Anna E. Flynn, PhD Formerly Clinical Associate Professor Supply Chain Management Thunderbird School of Global Management Formerly Associate Professor Institute for Supply Management
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PURCHASING AND SUPPLY MANAGEMENT, FOURTEENTH EDITION Published by McGraw-Hill, a business unit of The McGraw-Hill Companies, Inc., 1221 Avenue of the Americas, New York, NY 10020. Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Previous editions © 2006, 2002, and 1997. No part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written consent of The McGraw-Hill Companies, Inc., including, but not limited to, in any network or other electronic storage or transmission, or broadcast for distance learning. Some ancillaries, including electronic and print components, may not be available to customers outside the United States. This book is printed on acid-free paper. 1 2 3 4 5 6 7 8 9 0 DOC/DOC 1 0 9 8 7 6 5 4 3 2 1 0 ISBN 978-0-07-337789-6 MHID 0-07-337789-9 Vice President & Editor-in-Chief: Brent Gordon Vice President EDP/Central Publishing Services: Kimberly Meriwether David Editorial Director: Stewart Mattson Publisher: Tim Vertovec Executive Editor: Richard T. Hercher, Jr. Editorial Coordinator: Rebecca Mann Associate Marketing Manager: Jaime Halteman Project Manager: Robin A. Reed Design Coordinator: Brenda A. Rolwes Cover Designer: Studio Montage, St. Louis, Missouri Buyer: Nicole Baumgartner Media Project Manager: Balaji Sundararaman Compositor: MPS Limited, A Macmillan Company Typeface: 10/12 Times Roman Printer: R. R. Donnelley All credits appearing on page or at the end of the book are considered to be an extension of the copyright page. Library of Congress Cataloging-in-Publication Data Johnson, P. Fraser. Purchasing and supply management / P. Fraser Johnson, Michiel R. Leenders, Anna E. Flynn.—14th ed. p. cm. Rev. ed. of: Purchasing and supply management / Michiel R. Leenders . . . [et al.]. 13th ed. 2006. ISBN 978-0-07-337789-6 (alk. paper) 1. Industrial procurement. 2. Materials management. I. Leenders, Michiel R. II. Flynn, Anna E. III. Purchasing and supply management. IV. Title. HD39.5.L43 2010 658.7—dc22 2010015574
www.mhhe.com
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About the Authors P. Fraser Johnson is the Leenders Purchasing Management Association of Canada Chair at the Richard Ivey School of Business, The University of Western Ontario. Professor Johnson is also the Director of the Ivey MBA Program. He earned a PhD from Ivey in 1995, specializing in Operations Management and, following graduation, joined the faculty of Commerce & Business Administration at the University of British Columbia. Fraser returned to Ivey as a faculty member in 1998 and has taught courses in purchasing and supply, logistics, and operations. Prior to accepting a faculty position, Fraser worked in the automotive parts industry where he held a number of senior management positions in both finance and operations. His experience includes managing automotive manufacturing facilities in Canada and the United States, and overseeing a joint venture partnership in Mexico. Professor Johnson is an active researcher in the area of purchasing and supply chain management, and he is the author of several articles that have been published in a wide variety of magazines and journals. Fraser has also authored a number of teaching cases. He currently is an associate editor for the Journal of Supply Chain Management and sits on the editorial review board for the Journal of Purchasing and Supply Management. Professor Johnson has consulted for organizations in the private and public sectors and has taught in a number of different management development programs in the United States, Canada, and Europe. Michiel R. Leenders is professor emeritus at the Richard Ivey School of Business at the University of Western Ontario. He received a degree in mining engineering from the University of Alberta, an MBA from the University of Western Ontario, and his doctorate from the Harvard Business School. Mike has written a large number of articles in a variety of magazines and journals. His texts have been translated into 10 different languages and include Value-Driven Purchasing: The Key Steps in the Acquisition Process (with Anna E. Flynn), published by Irwin Professional Publishing; Reverse Marketing, The New Buyer-Supplier Relationship (with David Blenkhorn), published by the Free Press; Improving Purchasing Effectiveness through Supplier Development, published by the Harvard Division of Research; Learning with Cases, Writing Cases, and Teaching with Cases with James A. Erskine and Louise Mauffette-Leenders, published by the Richard Ivey School of Business. He has also co-authored 10 editions of Purchasing and Supply Management, published by McGraw-Hill-Irwin. Mike has taught and consulted extensively both in Canada and internationally. He was the educational advisor to the Purchasing Management Association of Canada from 1961–1994. He received PMAC’s Fellowship Award in 1975, the PMAC Chair from 1993 to 2009, the Financial Post Leaders in Management Education Award in 1997, and the Hans Ovelgonne Purchasing Research Award in 2001. He is the director of the Ivey Purchasing Managers Index and a director of ING Bank of Canada. Anna E. Flynn teaches executive and management programs in purchasing and supply management for organizations in the North America, Europe, and Asia. She is a former faculty member at Thunderbird School of Global Management and Arizona State University, where she was also director of the undergraduate program in supply chain v
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vi About the Authors
management. She also served as vice president and associate professor at the Institute for Supply Management (ISM), where she developed and taught two- to five-day seminars in the United States, Canada, Mexico, the Caribbean, Hong Kong, and Lisbon. She has worked as a research associate for CAPS Research, a global network of executives and academics focused on strategic supply management knowledge and practice. Anna is author of Leadership of Supply Management (2008); co-editor (with Cavinato and Kauffman) of The Supply Management Handbook and author of Chapter 7, “Knowledge-Based Supply Management” (McGraw-Hill, 2006); co-author (with Farney, 2000) of the NAPM Supply Management Knowledge Series, Volume IV: The Supply Management Leadership Process; and co-author (with Leenders, 1994) of Value-Driven Purchasing: Managing the Key Steps in the Acquisition Process. She earned a bachelor’s degree in international studies from the University of Notre Dame, an MBA from Arizona State University, and a PhD from Arizona State University.
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Preface Purchasing and supply management has become increasingly visible in a world where supply is a major determinant of corporate survival and success. Supply chain performance influences not only operational and financial risks but also reputational risk. Extending the supply chain globally into developing countries places new responsibilities on supplier and supply, not only to monitor environmental, social, political, and security concerns but also to influence them. Thus, the job of the supply manager of today goes way beyond the scope of supply chain efficiency and value for money spent to search for competitive advantage in the supply chain. Cost containment and improvement represent one challenge; the other is revenue enhancement. Not only must the supply group contribute directly to both the balance sheet and the income statement; it must also enhance the performance of other members of the corporate team. Superior internal relationship and knowledge management need to be matched on the exterior in the supply network to assure that the future operational and strategic needs of the organization will be met by future markets. The joy of purchasing and supply management lives in the magnitude of its challenges and the opportunities to achieve magnificent contributions. For more than 80 years this text and its predecessors have championed the purchasing and supply management cause. Based on the conviction that supply and suppliers have to contribute effectively to organizational goals and strategies, this and previous editions have focused on how to make that mission a reality. Thus, the examples in the text and more than 40 real-life supply chain cases afford the chance to apply the latest research and theoretical developments in the field to real-life issues, opportunities, decisions, and problems faced by practitioners. Continuing advances in MIS and technology provide new ways to improve supply efficiency and effectiveness. New security, environmental, and transparency requirements and the search for meaningful supply metrics have further complicated the challenges faced by supply managers all over the world. In this edition the focus on decision making in the supply chain has been strengthened considerably. Also the chapter sequence has been adjusted accordingly to reflect the chronological order of the acquisition process. Criteria for supply decisions have been identified in three categories: (1) strategic, (2) operational, and (3) additional. It is the third category with balance sheet and income statement considerations, all dimensions of risk, environmental, and social considerations that is growing in relevance, making sound supply decisions an even more complex challenge. Since the sixth edition of this text over 30 years ago, Harold E. Fearon has been an author of this text. As the founder of the supply chain group at Arizona State University, the first editor of the International Journal of Supply Chain Management and the conceptualizer and first director of CAPS Research, Hal Fearon has been one of the true trailblazers of our field for decades. In this edition, Hal has no longer participated, although his past contributions are still evident throughout this text. A second change in authorship for this edition has switched the roles of Michiel R. Leenders, listed as the first author of six previous editions, and P. Fraser Johnson, who has taken over the Leenders PMAC Chair of Purchasing Management at the Richard Ivey School of Business. Anna Flynn continues as a valuable member of the author team. vii
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viii Preface
A book with text and cases depends on many to contribute through their research and writing to expand the body of knowledge of the field. Thus, to our academic colleagues our thanks for pushing out the theoretical boundaries of supply management. For their specific suggestions regarding the manuscript, our appreciation goes to Casey Kleindienst, California State University—Fullerton; William Magrogan, University of Maryland— University College; Jayanth Jayaram, University of South Carolina; and John Hanson, University of San Diego, all of whom provided detailed reviews and offered numerous suggestions for improving the presentation. To many practitioners, we wish to extend our gratitude for proving what works and what does not and providing their stories in the cases in this text. Also many case writers contributed their efforts so that about half of all the cases in this edition are new. Case contributors in alphabetical order included: Collin Ashton, Louis Beaubien, Larry Berglund, Jorge Colazo, Nancy Dai, Niki da Silva, Dev K. Dutta, Tony Francolini, Manish Kumar, Matthew D. Lynall, Louise Mauffette-Leenders, Leane Morfopoulos, Elizabeth O’Neil, Peruvemba Sundaram Ravi, Suhaib Riaz, Frank Tang, Rob Turner, Dave Vannette, Asad Wali, and Marsha Watson. The production side of any text is more complicated than most authors care to admit. The original manuscript preparation largely fell to Elaine Carson, who was obviously not scared off during the previous editions. At McGraw Hill/Irwin, Rebecca Mann, Dick Hercher, Lee Stone, and many others contributed to turn our efforts into a presentable text. Kathleen Little, CPM, ably indexed this text and many previous editions. The support of Dean Carol Stephenson and our colleagues at the Richard Ivey School of Business has been most welcome. The assistance of the Institute for Supply Management in supporting the continuous improvement of supply education is also very much appreciated. P. Fraser Johnson Michiel R. Leenders Anna E. Flynn
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Brief Contents About the Authors v
10 Price
Preface vii
11 Cost Management
288
12 Supplier Selection
313
1
Purchasing and Supply Management 1
253
13 Supplier Evaluation and Supplier Relations 352
2
Supply Strategy
3
Supply Organization
4
Supply Processes and Technology
5
Make or Buy, Insourcing, and Outsourcing 120
26
14 Global Supply Management
45
6
Need Identification and Specification 135
7
Quality
8
Quantity and Inventory
9
Delivery
76
15 Legal and Ethics
383
417
16 Other Supply Responsibilities
463
17 Supply Function Evaluation and Trends 481 INDEXES
165
Case Index 198
513
Subject Index
514
231
ix
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Table of Contents About the Authors
v
Risk Management
Preface vii Chapter 1 Purchasing and Supply Management Purchasing and Supply Management Supply Management Terminology Supply and Logistics 5
1
Strategic Components
3
4
The Size of the Organization’s Spend and Financial Significance 6 Supply Contribution 8 The Operational versus Strategic Contribution of Supply 8 The Direct and Indirect Contribution of Supply 9
The Nature of the Organization 13 Supply Qualifications and Associations Challenges Ahead 18
16
Supply Chain Management 18 Measurement 19 Risk Management 19 Sustainability 19 Growth and Influence 19 Effective Contribution to Organizational Success 20
The Organization of This Text 20 Conclusion 21 Questions for Review and Discussion References 21 Cases 22 1–1 Qmont Mining 22 1–2 Erica Carson 23 1–3 Southeastern University
Chapter 2 Supply Strategy
30
Operational Risk: Supply Interruptions and Delays 30 Financial Risk: Changes in Price 31 Reputational Risk 31 Managing Supply Risks 31 The Corporate Context 32
21
24
26
Levels of Strategic Planning 27 Major Challenges in Setting Supply Objectives and Strategies 29 Strategic Planning in Supply Management 29
33
What? 33 Quality? 34 How Much? 35 Who? 36 When? 36 What Price? 36 Where? 36 How? 36 Why? 37
Conclusion 37 Questions for Review and Discussion References 38 Cases 39
37
2–1 Spartan Heat Exchangers Inc. 39 2–2 Sabor Inc. 40 2–3 Ford Motor Company: Aligned Business Framework 42
Chapter 3 Supply Organization
45
Objectives of Supply Management 47 Organizational Structures for Supply Management 50 Small and Medium-Sized Organizations 50 Large Organizations 51 Centralized and Decentralized Supply Structures 52 Hybrid Supply Structure 52 Specialization within the Supply Function 53 Structure for Direct and Indirect Spend 56 Managing Organizational Change in Supply 57
Organizing the Supply Group
58
The Chief Purchasing Officer (CPO) Reporting Relationship 60
58
x
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Table of Contents
Supply Activities and Responsibilities
61
9. Maintenance of Records and Relationships 92
What Is Acquired 61 Supply Chain Activities 61 Type of Involvement 63 Involvement in Corporate Activities 63 Influence of the Industry Sector on Supply Activities 63
Supply Teams
Linking Data to Decisions 93 Manage Supplier Relationships
A Supply Process Flowchart Strategic Spend 95 Nonstrategic Spend 95
Leading and Managing Teams 64 Cross-Functional Supply Teams 64 Other Types of Supply Teams 66
Benefits of Information Systems Technology Technology Options 99 Types of Information Systems 100 Intranets and Extranets 102
69
78
1. Recognition of Need 80 2. Description of Need 81 Purposes and Flow of a Requisition 81 Types of Requisitions 82 Early Supply and Supplier Involvement 83
84
84
4. Supplier Selection and Determination of Terms 85 5. Preparation and Placement of the Purchase Order 85 6. Follow-up and Expediting 88 Assess Costs and Benefits
7. Receipt and Inspection
89
90
Eliminate or Reduce Inspection
8. Invoice Clearing and Payment
90
90
Aligning Supply and Accounts Payable 91 Cash Discounts and Late Invoices 92
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76
Electronic Procurement Systems 103 Electronic or Online Catalogs 105 Electronic Data Interchange (EDI) 105 E-Marketplaces 106 Online Reverse Auctions 107 Radio Frequency Identification (RFID) 109
Implications for Supply 109 Policy and Procedure Manual 111 Conclusion 111 Questions for Review and Discussion References 112 Cases 113
Strategy and Goal Alignment 78 Ensuring Process Compliance 79 Information Flows 80 Steps in the Supply Process 80
Issue an RFx
98 99
Technology-Driven Efficiency and Effectiveness 102
Chapter 4 Supply Processes and Technology
3. Identification of Potential Sources
94
Information Systems and the Supply Process
3–1 Iowa Elevators 70 3–2 Roger Haskett 73
The Supply Management Process
93
Improving Process Efficiency and Effectiveness 93
64
Consortia 67 Conclusion 69 Questions for Review and Discussion References 69 Cases 70
xi
4–1 Bright Technology International 4–2 Hemingway College 115 4–3 Portland Bus Company 116
112
113
Chapter 5 Make or Buy, Insourcing, and Outsourcing 120 Make or Buy
121
Reasons for Make instead of Buy 123 Reasons for Buying Outside 123 The Gray Zone in Make or Buy 124
Subcontracting 125 Insourcing and Outsourcing 126 Insourcing 126 Outsourcing 127 Outsourcing Supply and Logistics 129
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xii Table of Contents
Supply’s Role in Insourcing and Outsourcing Conclusion 130 Questions for Review and Discussion 130 References 130 Cases 131 5–1 B&L Inc. 131 5–2 Rondot Automotive 132 5–3 Alicia Wong 133
136
1. Strategic Criteria 136 2. Traditional Criteria 137 3. Additional Current Criteria 138
Categories of Needs
140
1. Resale 141 2. Raw and Semiprocessed Materials 141 3. Parts, Components, and Packaging 141 4. Maintenance, Repair, and Operating Supplies 142 5. Capital 142 6. Services 145 7. Other 147
Repetitive or Nonrepetitive Requirements? 147 Commercial Equivalents 148 Early Supply and Supplier Involvement 149 Methods of Description 149 Brand 150 “Or Equal” 150 Specification 150 Miscellaneous Methods of Description 152 Combination of Descriptive Methods 153 Sources of Specification Data 153
Standardization and Simplification 154 Conclusion 155 Questions for Review and Discussion 155 References 156 Cases 156 6–1 Moren Corporation (A) 156 6–2 Moren Corporation (B) 158 6–3 Carson Manor 160
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Chapter 7 Quality 165 Role of Quality in Supply Management 166 Defining Quality 168 Quality 168 Function 168 Suitability 168 Reliability 168 Quality Dimensions 169 “Best Buy” 169 Determining the “Best Buy” 170
Chapter 6 Need Identification and Specification 135 Need Criteria in the Value Proposition
129
The Cost of Quality
170
Prevention Costs 172 Appraisal Costs 172 Internal Failure Costs 172 External Failure Costs 172 Morale Costs 173 An Overall Quality–Cost Perspective 173
Quality Management Tools and Techniques 173 Total Quality Management (TQM) 173 Continuous Improvement 175 Quality Function Deployment (QFD) 175 Six Sigma 176 Statistical Process Control (SPC) 177 Sampling, Inspection, and Testing 180 The Quality Assurance and Quality Control Group 184 Assuring the Quality of Purchased Services 185 Supplier Certification 189
Quality Standards and Awards Programs 190 ISO 9000 Quality Standards 190 ISO 14000 Environmental Standards 191 The Malcolm Baldrige National (U.S.) Quality Award 192 The Deming Prize 192
Conclusion 192 Questions for Review and Discussion References 193 Cases 194
193
7–1 The Power Line Poles 194 7–2 Air Quality Systems, Inc. 196
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Table of Contents xiii
Chapter 8 Quantity and Inventory Quantity and Timing Issues
Cases 227 8–1 Sedgman Steel 227 8–2 Throsel-Teskey Drilling 228
198 199
Quantity and Delivery 200 Time-Based Strategies 200
Forecasting
Chapter 9 Delivery 231
201
Logistics
Forecasting Techniques 202 Collaborative Planning, Forecasting, and Replenishment (CPFR) 203
Determining Order Quantities and Inventory Levels 203 Fixed-Quantity Models 203 Fixed-Period Models 205 Probabilistic Models and Service Coverage 205 Buffer or Safety Stocks and Service Levels 206
Planning Requirements and Resources
208
Material Requirements Planning (MRP) 208 Capacity Requirements Planning (CRP) 209 Manufacturing Resource Planning (MRP II) 209 Enterprise Resource Planning (ERP) Systems 210 Supply Implications of MRP 210
Functions and Forms of Inventories
211
215
Costs of Inventories 215 ABC Classification 217 Vendor- or Supplier-Managed Inventory (VMI/SMI) 219 Lean Supply, Just-in-Time (JIT), and Kanban Systems 219 Managing Supply Chain Inventories 223
Determing Quantity of Services
233
Transportation Regulation and Deregulation 234 Supply’s Involvement in Transportation
Transportation Modes and Carriers
Conclusion 226 Questions for Review and Discussion References 227
235
235
Road 236 Rail and Intermodal 236 Pipelines 236 Air 236 Water 237 Radio Frequency Waves 237
Types of Carriers, Providers, and Service Options 237 Types of Carriers 238 Transportation Service Providers 238 Specialized Service Options 238
239
“Best Value” Delivery Decisions 239 Key Selection Criteria 240 FOB Terms and Incoterms 241 Rates and Pricing 242 Documentation in Freight Shipments 243 Expediting and Tracing Shipments 245 Freight Audits 245
Delivery Options for Services
245
Buyer Location versus Supplier Location 246 On-premise versus Off-premise/Web-based IT Delivery 247
Transportation and Logistics Strategy 247 Organization for Logistics 248 Conclusion 249 Questions for Review and Discussion 249 References 249 Cases 250
224
Aggregating Demand 224 Managing Consumption 224 Dimensions of Services and Quantity Decisions 224
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Transportation
Selection of Mode and Supplier
The Functions of Inventory 211 The Forms of Inventory 213 Inventory Function and Form Framework 213
Inventory Management
232
Role of Logistics in the Economy 233 Role of Supply in Logistics 233
226
9–1 Penner Medical Products 250 9–2 Andrew Morton 251
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xiv
Table of Contents
Chapter 10 Price 253
Limitations of the Exchanges 279 Hedging 279 Sources of Information Regarding Price Trends
Relation of Cost to Price Meaning of Cost
254
Conclusion 281 Questions for Review and Discussion References 282 Cases 282
255
How Suppliers Establish Price
256
The Cost Approach 257 The Market Approach 257
Government Influence on Pricing
257
Legislation Affecting Price Determination
Types of Purchases
258
260
Steps in the Bidding Process 263 Firm Bidding 264 Determination of Most Advantageous Bid Collusive Bidding 265 Public-Sector Bidding 265 The Problem of Identical Prices 267
286
Contract Options for Pricing
264
276
293
Total Cost of Ownership 293 Target Pricing 299 The Learning Curve or Manufacturing Progress Function 300 Value Engineering and Value Analysis 301 Activity-Based Costing 301
Negotiation
302
Negotiation Strategy and Practice 303 Framework for Planning and Preparing for Negotiation 304
Conclusion 306 Questions for Review and Discussion References 307 Cases 308 272
273
Forward Buying versus Speculation 276 Organizing for Forward Buying 277 Control of Forward Buying 277 The Commodity Exchanges 278
290
Cost Management Tools and Techniques
Firm-Fixed-Price (FFP) Contract 273 Cost-Plus-Fixed-Fee (CPFF) Contract 273 Cost-No-Fee (CNF) Contract 273 Cost-Plus-Incentive-Fee (CPIF) Contract 273 Provision for Price Changes 273 Contract Cancellation 275
Forward Buying and Commodities
288
Sources of Competitive Advantage 290 Frameworks for Cost Management 290
268
Cash Discounts 268 Trade Discounts 269 Multiple Discounts 270 Quantity Discounts 270 The Price-Discount Problem 270 Quantity Discounts and Source Selection Cumulative or Volume Discounts 272
Chapter 11 Cost Management
Strategic Cost Management
The Use of Quotations and Competitive Bidding 262
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282
259
Raw Materials/Sensitive Commodities Special Items 260 Standard Production Items 260 Small-Value Items 261 Capital Goods 262 Services 262 Resale 262
Discounts
10–1 Cottrill Inc. 282 10–2 Coral Drugs 284 10–3 Price Forecasting Exercise
280
11–1 Deere Cost Management 11–2 McMichael Inc. 309 11–3 City of Granston 310
Chapter 12 Supplier Selection
308
313
The Supplier Selection Decision Decision Trees
307
314
315
Identifying Potential Sources
316
Information Sources 317 Standard Information Requests
321
Additional Supplier Selection Decisions Single versus Multiple Sourcing
322
322
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Table of Contents xv
Manufacturer versus Distributor 324 Geographical Location of Sources 325 Supplier Size 326
Supplier Development/Reverse Marketing Evaluating Potential Sources 328
326
Level 1—Strategic 328 Level 2—Traditional 333 Level 3—Current Additional 335
341
12–1 Loren Inc. 342 12–2 Russel Wisselink 346 12–3 Kettering Industries Inc. 348
Chapter 13 Supplier Evaluation and Supplier Relations 352 353
Key Supplier Performance Indicators 353
Evaluation Methods
354
Informal and Semiformal Evaluation and Rating 354 Executive Roundtable Discussions 354 Formal Supplier Evaluation and Rating 355 Weighted Point Evaluation Systems 356
Supplier Ranking
357
Unacceptable Suppliers 357 Acceptable Suppliers 358 Preferred Suppliers 358 Exceptional Suppliers 358
Supplier Relations
359
Supplier Relations Context 360 Supplier Goodwill 360 The Purchaser–Supplier Satisfaction Matrix 361 Supplier Relationship Management 364
Partnerships
365
SEMATECH’s Partnering Perspective 365 Early Supplier/Supply Involvement (ESI) 366 Partner Selection 367 The Longer Time Perspective 367 Co-location/In-plants 368 Concerns about Partnerships 368
joh77899_fm_i-xviii.indd xv
370
13–1 APC Europe 371 13–2 Plastic Cable Clips 375 13–3 Delphi Corporation 378
Ranking Potential Suppliers 340 Conclusion 340 Questions for Review and Discussion References 341 Cases 342
Measuring Supplier Performance
Strategic Alliances 369 Conclusion 370 Questions for Review and Discussion References 370 Cases 371
Chapter 14 Global Supply Management The Importance of Global Supply
383 384
Reasons for Global Purchasing 385 Potential Problem Areas 390
Selecting and Managing Offshore Suppliers 398 Global Sourcing Organizations 398 Intermediaries 399 Information Sources for Locating and Evaluating Offshore Suppliers 400
Incoterms
401
Group E—Departure 402 Group F—Main Carriage Unpaid 402 Group C—Main Carriage Paid by Seller 402 Group D—Arrival 403
Tools for Global Supply
404
Countertrade 404 Foreign Trade Zones 407 Bonded Warehouses 409 Temporary Importation Bond (TIB) and Duty Drawbacks 409
Regional Trading Agreements
409
North American Free Trade Agreement (NAFTA) 410 The European Union (EU) 410 ASEAN 410 Mercosur 410 Andean Community 411 The World Trade Organization (WTO) 411
Emerging Markets 411 Conclusion 412 Questions for Review and Discussion References 413 Cases 413
412
14–1 Trojan Technologies 413 14–2 Marc Biron 415
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xvi
Table of Contents
Chapter 15 Legal and Ethics
Corporate Social Responsibility (CSR) 455 Conclusion 455 Questions for Review and Discussion 456 References 456 Cases 457
417
Legal Authority of Buyer and Seller
418
Legal Authority of the Buyer 419 Personal Liability 420 Authority of Suppliers’ Representatives
The Uniform Commercial Code
421
Common Law and the Purchase of Services 431 Principles of the Law of Software Contracts 437 E-Commerce and the Law 437 Electronic Signatures 438 U.S. Uniform Electronic Transactions Act Antitrust and E-Marketplaces 439 Copyright Law 441 Patents 441 Trademarks 442 Industrial Design 442 Geographical Indication
440
443
444
Commercial Arbitration 444 Mediation 445 Internal Escalation 445
445
The Sarbanes-Oxley Act 446 Environmental Regulations 446
Ethics
447
Perceptions 451 Conflict of Interest 451 Gifts and Gratuities 451 Promotion of Positive Relationships with Suppliers 454 Reciprocity 454
joh77899_fm_i-xviii.indd xvi
439
Chapter 16 Other Supply Responsibilities
463
Receiving 464 Logistics and Warehousing 465 Inbound and Outbound Transportation Production Planning 466 Accounts Payable 466 Investment Recovery 466
466
Categories of Material for Disposal 468 Responsibility for Material Disposal 471 Keys to Profitable Disposal 472 Disposal Channels 472 Disposal Procedures 474 Selection of Disposal Partners 475
Conclusion 476 Questions for Review and Discussion References 477 Cases 478
477
16–1 Ross Wood 478 16–2 Raleigh Plastics 479
Product Liability 443 Alternative Dispute Resolution
Regulatory Requirements
457
422
Purpose of a Uniform Commercial Code 422 The Purchase Order Contract 423 Acceptance of Offers 424 Purchases Made Orally—Statute of Frauds 425 Inspection 426 Acceptance and Rejection of Goods 426 Warranties 428 Title to Purchased Goods 429 Protection against Price Fluctuations 429 Cancellation of Orders and Breach of Contract 430
Intellectual Property Laws
15–1 Rocky Plains Brewing Ltd. 15–2 Sinclair & Winston 459
Chapter 17 Supply Function Evaluation and Trends 481 Organizing for Supply Research
483
Full-Time or Part-Time Research Positions Cross-Functional Teams 484
Supply Research Opportunities
486
Purchased Materials, Products, or Services Commodities 489 Suppliers 490 Assessing Research Results 493
Supply Planning Process 493 Supply Budgets 493 Performance Measurement Systems The Value of Supply Metrics
483
486
494
494
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The Challenges 495 Measuring Supplier Performance 496 Supply Management Performance Metrics 496
Establishing Metrics
498
Efficiency Metrics 498 Effectiveness Metrics 498 Operating Reports 499 Validating Results 500 Appraising Team Performance 500 Supply Performance Benchmarking 501
What Is Happening in Supply Management Emphasis on Total Quality Management and Customer Satisfaction 502 Corporate Social Responsibility and Sustainability 503 Globalization versus Local Sourcing 504 Risk Management 505 Safety and Security 505
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Supply Processes and Technology 505 Supply Organizations 506 External and Internal Collaboration 506 Metrics and Performance Measurement 507 Innovation 507 Public Procurement 507
Conclusion 507 Questions for Review and Discussion References 508 Cases 509 502
508
17–1 Randall Corporation 509 17–2 Fairview School Board 510 17–3 Tanton Foods 511
Indexes Case Index 513 Subject Index 514
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Chapter One Purchasing and Supply Management Chapter Outline Purchasing and Supply Management Supply Management Terminology Supply and Logistics The Size of the Organization’s Spend and Financial Significance Supply Contribution The Operational versus Strategic Contribution of Supply The Direct and Indirect Contribution of Supply The Nature of the Organization Supply Qualifications and Associations
Risk Management Sustainability Growth and Influence Effective Contribution to Organizational Success The Organization of This Text Conclusion Questions for Review and Discussion References Cases 1–1 Qmont Mining 1–2 Erica Carson 1–3 Southeastern University
Challenges Ahead Supply Chain Management Measurement
1
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Key Questions for the Supply Decision Maker Should we • Rethink how supply can contribute more effectively to organizational goals and strategies? • Try to find out what the organization’s total spend with suppliers really is? • Indentify opportunities for meaningful involvement in major corporate activities? How can we • Align our supply strategy with the organization’s strategy? • Get others to recognize the profit-leverage effect of purchasing/supply management? • Show how supply can affect our firm’s competitive position?
Every organization needs suppliers. No organization can exist without suppliers. Therefore, the organization’s approach to suppliers, its acquisition processes and policies, and its relationships with suppliers will impact not only the performance of the suppliers, but also the organization’s own performance. No organization can be successful without the support of its supplier base, operationally and strategically, short- and long-term. Supply management is focused on the acquisition process recognizing the supply chain and organizational contexts. Special emphasis is on decision making that aligns the supplier network and the acquisition process with organizational goals and strategies and ensures short- and long-term value for funds spent. There is no one best way of organizing the supply function, conducting its activities, and integrating suppliers effectively. This is both interesting and challenging. It is interesting because the acquisition of organizational requirements covers a very wide and complex set of approaches with different needs and different suppliers. It is challenging because of the complexity and because the process is dynamic, not static. Moreover, some of the brightest minds in this world have been hired as marketing and sales experts to persuade supply managers to choose their companies as suppliers. It is also challenging because every supply decision depends on a large variety of factors, the combination of which may well be unique to a particular organization. For more than 75 years, this text and its predecessors have presented the supply function and suppliers as critical to an organization’s success, competitive advantage, and customer satisfaction. Whereas in the 1930s this was a novel idea, over the past few decades there has been growing interest at the executive level in the supply chain management and its impact on strategic goals and objectives. To increase long-term shareholder value, the company must increase revenue, decrease costs, or both. Supply’s contribution should not be perceived as only focused on cost. Supply can and should also be concerned with revenue enhancement. What can supply and suppliers do to help the organization increase revenues or decrease costs? should be a standard question for any supply manager.
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The supply function continues to evolve as technology and the worldwide competitive environment require innovative approaches. The traditionally held view that multiple sourcing increases supply security has been challenged by a trend toward single sourcing. Results from closer supplier relations and cooperation with suppliers question the wisdom of the traditional arm’s-length dealings between purchaser and supplier. Negotiation is receiving increasing emphasis as opposed to competitive bidding, and longer-term contracts are replacing short-term buying techniques. E-commerce tools permit faster and lower-cost solutions, not only on the transaction side of supply but also in management decision support. Organizations are continually evaluating the risks and opportunities of global sourcing. All of these trends are a logical outcome of increased managerial concern with value and increasing procurement aggressiveness in developing suppliers to meet specific supply objectives of quality, quantity, delivery, price, service, and continuous improvement. Effective purchasing and supply management contributes significantly to organizational success. This text explores the nature of this contribution and the management requirements for effective and efficient performance. The acquisition of materials, services, and equipment—of the right qualities, in the right quantities, at the right prices, at the right time, with the right quality, and on a continuing basis—long has occupied the attention of managers in both the public and private sectors. Today, the emphasis is on the total supply management process in the context of organizational goals and management of supply chains. The rapidly changing supply scene, with cycles of abundance and shortages, varying prices, lead times, and availability, provides a continuing challenge to those organizations wishing to obtain a maximum contribution from this area. Furthermore, environmental, security, and financial regulatory requirements have added considerable complexity to the task of ensuring that supply and suppliers provide competitive advantage.
PURCHASING AND SUPPLY MANAGEMENT Although some people may view interest in the performance of the supply function as a recent phenomenon, it was recognized as an independent and important function by many of the nation’s railroad organizations well before 1900. Yet, traditionally, most firms regarded the supply function primarily as a clerical activity. However, during World War I and World War II, the success of a firm was not dependent on what it could sell, since the market was almost unlimited. Instead, the ability to obtain from suppliers the raw materials, supplies, and services needed to keep the factories and mines operating was the key determinant of organizational success. Consequently, attention was given to the organization, policies, and procedures of the supply function, and it emerged as a recognized managerial activity. During the 1950s and 1960s, supply management continued to gain stature as the number of people trained and competent to make sound supply decisions increased. Many companies elevated the chief purchasing officer to top management status, with titles such as vice president of purchasing, director of materials, or vice president of purchasing and supply. As the decade of the 1970s opened, organizations faced two vexing problems: an international shortage of almost all the basic raw materials needed to support operations
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and a rate of price increases far above the norm since the end of World War II. The Middle East oil embargo during the summer of 1973 intensified both the shortages and the price escalation. These developments put the spotlight directly on supply, for their performance in obtaining needed items from suppliers at realistic prices spelled the difference between success and failure. This emphasized again the crucial role played by supply and suppliers. As the decade of the 1990s unfolded, it became clear that organizations must have an efficient and effective supply function if they were to compete successfully in the global marketplace. The early 21st century has brought new challenges in the areas of sustainability, supply chain security, and risk management. In large supply organizations, supply professionals often are divided into two categories: the tacticians who handle day-to-day requirements and the strategic thinkers who possess strong analytical and planning skills and are involved in activities such as strategic sourcing. The extent to which the structure, processes, and people in a specific organization will match these trends varies from organization to organization, and from industry to industry. The future will see a gradual shift from predominantly defensive strategies, resulting from the need to change in order to remain competitive, to aggressive strategies, in which firms take an imaginative approach to achieving supply objectives to satisfy short-term and long-term organizational goals. The focus on strategy now includes an emphasis on process and knowledge management. This text discusses what organizations should do today to remain competitive as well as what strategic, integrated purchasing and supply management will focus on tomorrow. Growing management interest through necessity and improved insight into the opportunities in the supply area has resulted in a variety of organizational concepts. Terms such as purchasing, procurement, materiel, materials management, logistics, sourcing, supply management, and supply chain management are used almost interchangeably. No agreement exists on the definition of each of these terms, and managers in public and private institutions may have identical responsibilities but substantially different titles. The following definitions may be helpful in sorting out the more common understanding of the various terms.
Supply Management Terminology Some academics and practitioners limit the term purchasing to the process of buying: learning of the need, locating and selecting a supplier, negotiating price and other pertinent terms, and following up to ensure delivery and payment. This is not the perspective taken in this text. Purchasing, supply management, and procurement are used interchangeably to refer to the integration of related functions to provide effective and efficient materials and services to the organization. Thus, purchasing or supply management is not only concerned with the standard steps in the procurement process: (1) the recognition of need, (2) the translation of that need into a commercially equivalent description, (3) the search for potential suppliers, (4) the selection of a suitable source, (5) the agreement on order or contract details, (6) the delivery of the products or services, and (7) the payment of suppliers. Further responsibilities of supply may include receiving, inspection, warehousing, inventory control, materials handling, packaging scheduling, in- and outbound transportation/
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traffic, and disposal. Supply also may have responsibility for other components of the supply chain, such as the organization’s customers and their customers and their suppliers’ suppliers. This extension represents the term supply chain management, where the focus is on minimizing costs and lead times across tiers in the supply chain to the benefit of the final customer. The idea that competition may change from the firm level to the supply chain level has been advanced as the next stage of competitive evolution. In addition to the operational responsibilities that are part of the day-to-day activities of the supply organization, there are strategic responsibilities. Strategic sourcing focuses on long-term supplier relation and commodity plans with the objectives of identifying opportunities in areas such as cost reductions, new technology advancements, and supply market trends. The Sabor case in Chapter 2 provides an excellent example of the need to take a strategic perspective when planning long-term supply needs. Lean purchasing or lean supply management refers primarily to a manufacturing context and the implementation of just-in-time (JIT) tools and techniques to ensure every step in the supply process adds value, that inventories are kept at a minimum level, and that distances and delays between process steps are kept as short as possible. Instant communication of job status is essential and shared.
Supply and Logistics The large number of physical moves associated with any purchasing or supply chain activity has focused attention on the role of logistics. According to the Council of Supply Chain Management Professionals, “Logistics management is that part of supply chain management that plans, implements, and controls the efficient, effective forward and reverse flow and storage of goods, services, and related information between the point of origin and the point of consumption in order to meet customers’ requirements.”1 This definition includes inbound, outbound, internal, and external movements. Logistics is not confined to manufacturing organizations. It is relevant to service organizations and to both private- and public-sector firms. The attraction of the logistics concept is that it looks at the material flow process as a complete system, from initial need for materials to delivery of finished product or service to the customer. It attempts to provide the communication, coordination, and control needed to avoid the potential conflicts between the physical distribution and the materials management functions. Supply influences a number of logistics-related activities, such as how much to buy and inbound transportation. With an increased emphasis on controlling materials flows, the supply function must be concerned with decisions beyond supplier selection and price. The Qmont Mining case at the end of this chapter illustrates the logistics considerations of supplying multiple locations. Some companies, such as Procter & Gamble and Goodyear, are combining supply and logistics into a single organization. For example P&G appointed a new director of logistics purchases in 2006 as part of a broader centralization project at the consumer products company. Global sourcing leader positions were created for transportation, warehousing, pallets, cross border, and inbound logistics. The sourcing leaders worked closely with regional 1
Council of Supply Chain Management Professionals, Glossary of Terms, http://www.cscmp.org (accessed January 10, 2010).
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operations and logistics teams to develop strategies and action plans to improve supply chain effectiveness and reduce costs.2 Supply chain management is a systems approach to managing the entire flow of information, materials, and services from raw materials suppliers through factories and warehouses to the end customer. The Institute for Supply Management (ISM) glossary defines supply chain management as “the design and management of seamless, value-added processes across organizational boundaries to meet the real needs of the end customer. The development and integration of people and technological resources are critical to successful supply chain integration.”3 The term value chain has been used to trace a product or service through its various moves and transformations, identifying the costs added at each successive stage. Some academics and practitioners believe the term chain does not properly convey what really happens in a supply or value chain, and they prefer to use the term supply network or supply web. The use of the concepts of purchasing, procurement, supply, and supply chain management will vary from organization to organization. It will depend on (1) their stage of development and/or sophistication, (2) the industry in which they operate, and (3) their competitive position. The relative importance of the supply area compared to the other prime functions of the organization will be a major determinant of the management attention it will receive. How to assess the materials and services needs of a particular organization in context is one of the purposes of this book. More than 40 cases are provided to provide insight into a variety of situations and to give practice in resolving managerial problems.
THE SIZE OF THE ORGANIZATION’S SPEND AND FINANCIAL SIGNIFICANCE The amount of money organizations spend with suppliers is staggering. Collectively, private and public organizations in North America spend about 1.5 times the GDPs of the United States, Canada, and Mexico combined, totaling at least $26 trillion U.S. Dollars spent with suppliers as a percentage of total revenue are a good indicator of supply’s financial impact. Obviously, the percentage of revenue that is paid out to suppliers varies from industry to industry and organization to organization, and increased outsourcing over the last decade has increased the percentage of spend significantly. In almost all manufacturing organizations, the supply area represents by far the largest single category of spend, ranging from 50 to 80 percent of revenue. Wages, by comparison, typically amount to about 10 to 20 percent. In comparison, the total dollars spent on outside suppliers typically ranges from 25 to 35 percent of revenues. The Delphi Corporation case in Chapter 15 is a good illustration of the significance of spend in a manufacturing organization. Total purchases were $17 billion compared to revenues of $28 billion. The financial impact of the corporate spend is often illustrated by the profit-leverage effect and the return-on-assets effect. 2 3
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D. Hannon, “Purchasing Drives Deeper into Logistics,” Purchasing 138, no. 7 (2009), p. 76. Institute for Supply Management, “Glossary of Key Supply Management Terms,” http://www.ism.ws.
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Chapter 1 Purchasing and Supply Management 7
Profit-Leverage Effect The profit-leverage effect of supply savings is measured by the increase in profit obtained by a decrease in purchase spend. For example, for an organization with revenue of $100 million, purchases of $60 million, and profit of $8 million before tax, a 10 percent reduction in purchase spend would result in an increase in profit of 75 percent, giving a leverage of 7.5. To achieve a $6,000,000 increase in profit by increasing sales, assuming the same percentage hold, might well require an increase of $75 million in sales, or 75 percent! Which of these two options—an increase in sales of 75 percent or a decrease in purchase spend of 10 percent—is more likely to be achieved? This is not to suggest that it would be easy to reduce overall purchase costs by 10 percent. In a firm that has given major attention to the supply function over the years, it would be difficult, and perhaps impossible, to do. But, in a firm that has neglected supply, it would be a realistic objective. Because of the profit-leverage effect of supply, large savings are possible relative to the effort that would be needed to increase sales by the much-larger percentage necessary to generate the same effect on the profit and loss (P&L) statement. Since, in many firms, sales already has received much more attention, supply may be the last untapped “profit producer.”
Return-on-Assets Effect Financial experts are increasingly interested in return on assets (ROA) as a measure of corporate performance. Figure 1–1 shows the standard ROA model, using the same ratio of figures as in the previous example, and assuming that inventory accounts for 30 percent of total assets. If purchase costs were reduced by 10 percent, that would cause an extra benefit of a 10 percent reduction in the inventory asset base. The numbers in the boxes show the initial figures used in arriving at the 10 percent ROA performance. FIGURE 1–1
Sales $1 million
Return-onAssets Factors
Divided by *
Inventory $150,000
Total assets $500,000
($135,000)
($485,000)
Investment turnover 2 (2.06)
Multiplied by Sales $1 million Minus †
Total cost $950,000
†† ($900,000)
ROA 10% (20.6%)
Profit $50,000 ($100,000)
Divided by
Sales $1 million
Profit margin 5% (10%)
*Inventory is approximately 30 percent of total assets. † Purchases account for half of total sales, or $500,000. †† Figures in parentheses assume a 10 percent reduction in purchase costs.
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The numbers below each box are the figures resulting from a 10 percent overall purchase price reduction, and the end product is a new ROA of 20.6 percent or about an 100 percent increase in return on assets.
Reduction in Inventory Investment Charles Dehelly, senior executive vice president at Thomson Multimedia, headquartered in Paris, France, said: “It came as quite a surprise to some supply people that I expected them to worry about the balance sheet by insisting on measuring their return on capital employed performance.”4 Mr. Dehelly was pushing for reductions in inventory investment, not only by lowering purchase price, as shown in the example in Figure 1–1, but also by getting suppliers to take over inventory responsibility and ownership, thereby removing asset dollars in the ROA calculations, but also taking on the risk of obsolescence and inventory carrying and disposal costs. Since accountants value inventory items at the purchaser at purchased cost, including transportation, but inventory at the supplier at manufacturing cost, the same items stored at the supplier typically have a lower inventory investment and carrying cost. Thus, it is a prime responsibility of supply to manage the supply process with the lowest reasonable levels of inventory attainable. Inventory turnover and level are two major measures of supply chain performance. Evidently, the financial impact of supply is on the balance sheet and the income statement, the two key indicators of corporate financial health used by managers, analysts, financial institutions, and investors. While the financial impact of the supply spend is obviously significant, it is by no means the only impact of supply on an organization’s ability to compete and be successful.
SUPPLY CONTRIBUTION Although supply’s financial impact is major, supply contributes to organizational goals and strategies in a variety of other ways. The three major perspectives on supply are shown in Figure 1–2: 1. Operational versus strategic. 2. Direct and indirect. 3. Negative, neutral, and positive.
The Operational versus Strategic Contribution of Supply First, supply can be viewed in two contexts: operational, which is characterized as trouble avoidance, and strategic, which is characterized as opportunistic. The operational context is the most familiar. Many people inside the organization are inconvenienced to varying degrees when supply does not meet minimum expectations. Improper quality, wrong quantities, and late delivery may make life miserable for the ultimate user of the product or service. This is so basic and apparent that “no complaints” is 4 M. R. Leenders and P. F. Johnson, Major Changes in Supply Chain Responsibilities (Tempe, AZ: CAPS Research, March 2002), p. 104.
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FIGURE 1–2 Purchasing’s Operational and Strategic Contributions Source: Michiel R. Leenders and Anna E. Flynn, ValueDriven Purchasing: Managing the Key Steps in the Acquisition Process (Burr Ridge, IL: Richard D. Irwin, 1995), p. 7.
1. Supply contribution
Operational
Strategic
Trouble prevention
Opportunity maximization
2. Supply contribution
Direct
Indirect
Bottom-line impact
Enhancing performance of others
3. Supply contribution
Negative
Neutral
Positive
Operationally deficient Strategically deficient Directly deficient Indirectly deficient
Operationally acceptable Strategically deficient Directly acceptable Indirectly deficient
Operationally acceptable Strategically acceptable Directly acceptable Indirectly acceptable
assumed to be an indicator of good supply performance. The difficulty is that many users never expect anything more and hence may not receive anything more. The operational side of supply concerns itself with the transactional, day-to-day operations traditionally associated with purchasing. The operational side can be streamlined and organized in ways designed to routinize and automate many of the transactions, thus freeing up time for the supply manager to focus on the strategic contribution. The strategic side of supply is future oriented and searches for opportunities to provide competitive advantage. Whereas on the operational side the focus is on executing current tasks as designed, the strategic side focuses on new and better solutions to organizational and supply challenges. (Chapter 2 discusses the strategic side in detail.)
The Direct and Indirect Contribution of Supply The second perspective is that of supply’s potential direct or indirect contribution to organizational objectives. Supply savings, the profit-leverage effect, and the return-on-assets effect demonstrate the direct contribution supply can make to the company’s financial statements. Although the argument that supply savings flow directly to the bottom line appears self-evident, experience shows that savings do not always get that far. Budget heads, when presented with savings, may choose to spend this unexpected windfall on other requirements. To combat this phenomenon, some supply organizations have hired financial controllers to assure that supply savings do reach the bottom line. Such was the case at Praxair, a global supplier of specialty gases and technologies. The chief supply officer and the
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CFO agreed that a financial controller position was needed in the supply organization to support financial analysis and budgeting. Validating cost savings and linking cost savings to the business unit operating budgets were an important part of this person’s responsibilities.5 The appeal of the direct contribution of supply is that both inventory reduction and purchasing savings are measurable and tangible evidence of supply contribution. The supply function also contributes indirectly by enhancing the performance of other departments or individuals in the organization. This perspective puts supply on the management team of the organization. Just as in sports, the team’s objective is to win. Who scores is less important than the total team’s performance. For example, better quality may reduce rework, lower warranty costs, increase customer satisfaction, and /or increase the ability to sell more or at a higher price. Ideas from suppliers may result in improved design, lower manufacturing costs, and/or a faster idea-to-design-to-product-completionto-customer-delivery cycle. Each would improve the organization’s competitiveness. Indirect contributions come from supply’s role as an information source; its effect on efficiency, competitive position, risk, and company image; the management training provided by assignments in the supply area; and its role in developing management strategy and social policy. The benefits of the indirect contribution may outweigh the direct contribution, but measuring the indirect benefits is difficult since it involves many “soft” or intangible contributions that are difficult to quantify.
Information Source The contacts of the supply function in the marketplace provide a useful source of information for various functions within the organization. Primary examples include information about prices, availability of goods, new sources of supply, new products, and new technology, all of interest to many other parts of the organization. New marketing techniques and distribution systems used by suppliers may be of interest to the marketing group. News about major investments, mergers, acquisition candidates, international political and economic developments, pending bankruptcies, major promotions and appointments, and current and potential customers may be relevant to marketing, finance, research, and top management. Supply’s unique position vis-à-vis the marketplace should provide a comprehensive listening post.
Effect on Efficiency The efficiency with which supply processes are performed will show up in other operating results. While the firm’s accounting system may not be sophisticated enough to identify poor efficiency as having been caused by poor purchase decisions, that could be the case. If supply selects a supplier who fails to deliver raw materials or parts that measure up to the agreed-on quality standards, this may result in a higher scrap rate or costly rework, requiring excessive direct labor expenditures. If the supplier does not meet the agreed-on delivery schedule, this may require a costly rescheduling of production, decreasing overall production efficiency, or, in the worst case, a shutdown of the production line—and fixed costs continue even though there is no output. Many supply managers refer to user departments 5
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Leenders and Johnson, Major Changes in Supply Chain Responsibilities, p. 89.
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as internal customers or clients and focus on improving the efficiency and effectiveness of the function with a goal of providing outstanding internal customer service.
Effect on Competitive Position/Customer Satisfaction A firm cannot be competitive unless it can deliver end products or services to its customers when they are wanted, of the quality desired, and at a price the customer feels is fair. If supply doesn’t do its job, the firm will not have the required materials or services when needed, of desired quality, and at a price that will keep end-product costs competitive and under control. The ability of the supply organization to secure requirements of better quality, faster at a better price than competitors, will not only improve the organization’s competitive position, but also improve customer satisfaction. The same can be said for greater flexibility to adjust to customers’ changing needs. Thus, a demonstrably better-performing supply organization is a major asset on any corporate team. A major chemical producer was able to develop a significantly lower-cost option for a key raw material that proved to be environmentally superior as well as better quality. By selling its better end product at somewhat lower prices, the chemical producer was able to double its market share, significantly improving its financial health and competitive position as well as the satisfaction of its customers.
Effect on Organizational Risk Risk management is becoming an ever-increasing concern. The supply function clearly impacts the risk level for the organization in terms of operational, financial, and reputation risk. Supply disruptions in terms of energy, service, or direct or indirect requirements can impact the ability of the organization to operate as planned and as expected by its customers, creating operational risks. Given that commodity and financial markets establish prices that may go up or down beyond the control of the individual purchaser, and that long-term supply agreements require price provisions, the supply area may represent a significant level of financial risk. Furthermore, unethical or questionable supply practices and suppliers may expose the organization to significant reputation risk.
Effect on Image The actions of supply personnel influence directly the public relations and image of a company. If actual and potential suppliers are not treated in a businesslike manner, they will form a poor opinion of the entire organization and will communicate this to other firms. This poor image will adversely affect the purchaser’s ability to get new business and to find new and better suppliers. Public confidence can be boosted by evidence of sound and ethical policies and fair implementation of them. The large spend of any organization draws attention in terms of supplier chosen, the process used to choose suppliers, the ethics surrounding the supply process, and conformance to regulatory requirements. Are the suppliers chosen “clean” in terms of child labor, environmental behavior, and reputation? Is the acquisition process transparent and legally, ethically, strategically, and operationally defensible as sound practice? Do supply’s actions take fully into account environmental, financial, and other regulatory requirements such as national security?
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Maintaining a proper corporate image is the responsibility of every team member and supply is no exception.
Training Ground The supply area also is an excellent training ground for new managers. The needs of the organization may be quickly grasped. Exposure to the pressure of decision making under uncertainty with potentially serious consequences allows for evaluation of the individual’s ability and willingness to make sound decisions and assume responsibility. Contacts with many people at various levels and a variety of functions may assist the individual in learning about how the organization works. Many organizations find it useful to include the supply area as part of a formal job rotation system for highpotential employees. Examples of senior corporate executives with significant supply experience include Thomas T. Stallkamp, vice chairman and CEO of MSX International, Inc., and former Chrysler president; Willie A. Deese, executive vice president and president, Merck Manufacturing Division; Richard B. Jacobs, general manager of Eaton Corporation’s Fluid Power Group’s Filtration Division.
Management Strategy Supply also can be used as a tool of management strategy and social policy. Does management wish to introduce and stimulate competition? Does it favor geographical representation, minority interest, and environmental and social concerns? For example, are domestic sources preferred? Will resources be spent on assisting minority suppliers? As part of an overall organization strategy, the supply function can contribute a great deal. Assurance of supply of vital materials or services in a time of general shortages can be a major competitive advantage. Similarly, access to a better-quality or a lower-priced product or service may represent a substantial gain. These strategic positions in the marketplace may be gained through active exploration of international and domestic markets, technology, innovative management systems, and the imaginative use of corporate resources. Vertical integration and its companion decisions of make or buy (insource or outsource) are everpresent considerations in the management of supply. The potential contribution of supply to strategy is obvious. Achievement depends on both top executive awareness of this potential and the ability to marshal corporate resources to this end. At the same time, it is the responsibility of those charged with the management of the supply function to seek strategic opportunities in the environment and to draw top executive attention to them. This requires a thorough familiarity with organizational objectives, strategy, and long-term plans and the ability to influence these in the light of new information. Chapter 2 discusses both potential supply contributions to business strategy and the major strategy areas within the supply function. Progressive managers have recognized the potential contributions of the supply management area and have taken the necessary steps to ensure results. One important step in successful organizations has been the elevation to top executive status of the supply manager. Although titles are not always consistent with status and value in an organization, they still make a statement within and outside of most organizations. Currently, the most common title of the chief supply officer is vice president, followed by director and manager.
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The elevation of the chief supply officer to executive status, coupled with high-caliber staff and the appropriate authority and responsibility, has resulted in an exciting and fruitful realization of the potential of the supply function in many companies.
THE NATURE OF THE ORGANIZATION The nature of the organization will determine how it will structure and manage its supply function. Whether the organization is public or private and produces goods or services or both, its mission, vision, and strategies, its size, number of sites, location, financial strength, and reputation will all be factors influencing its supply options and decisions. These will be addressed broadly in this first chapter and will be added to subsequently in this text.
Public or Private Organization Public institutions, including all levels of government from municipal to state or provincial to federal, tend to be service providers but are not exclusively so, and are subject to strict regulatory requirements regarding acquisition processes and policies. The public sector in many countries also includes education, health, utilities, and a host of agencies, boards, institutes, and so forth. The Southeastern University case at the end of this chapter provides an example of supply in a public-sector context at a state university. This case illustrates how many purchases in the public sector can be for capital and indirect supplies, which creates challenges for supply to influence purchasing decisions that ensure best value. A large segment of the acquisition needs of public institutions is concerned with the support of the organization’s mission and maintenance of facilities and offices. Concerns over public spending deal with transparency and fairness of access to all eligible suppliers, social aims such as support of minority and disadvantaged groups, and national security. Need definition and specification are often part of the supply manager’s responsibilities and are often geared to allow for multiple bidders. That not all public organizations are alike is evident from Figure 1–3 which shows just some of the differences among public bodies. Nongovernmental organizations (NGOs) and other nonprofit organizations would have a breakdown similar to those listed for public organizations, but might also operate internationally.
Private Organizations Private organizations, which include companies with publicly traded stocks, tend to have fewer constraints on need definition, specification, and supplier selection. The laws of the FIGURE 1–3 Differentiations for Supply Management in Public Organizations
joh77899_ch01_001-025.indd 13
Level:
Municipal
Mission:
Social Aims
Revenue Generation:
Limited
Size:
Small
Medium
Large
Number of Sites:
Single
Few
Many
State or Provincial Other or Combination Combination
Federal Economic Substantial
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14 Purchasing and Supply Management
FIGURE 1–4 Differentiations for Supply Management in Private Organizations Goods or Services:
Manufacturer
Combination
Services
Strategy:
Low cost
Combination
Differentiation
Size:
Small
Medium
Large
Number of Sites:
Single
Few
Many
Location:
Domestic
Financial Strength:
Weak
Medium
Strong
Reputation:
Poor
Medium
Outstanding
Few International
Many International
land (covered in Chapter 14) will establish the main ground rules for commerce. Transparency of commitments with suppliers has recently become more relevant to ensure that longterm commitments are properly disclosed in the company’s financial statements. Whereas in public institutions standardization is seen as a means of fairness to suppliers, in private companies, custom specifications are seen as a means of securing competitive advantage. Figure 1–4 shows some of the influencers that will affect supply management in private organizations. It is clear that for both public and private organizations these differences will affect supply significantly and some generalizations on supply impact follow.
Goods or Service Producers Another major supply influence is whether the organization produces goods or services or both. Goods producers, often called manufacturers, may produce a wide range of products, both in the industrial goods category and in consumer goods. For goods producers, normally the largest percentage of total spend of the organization is on materials, purchased parts, packaging, and transportation for the goods produced. For service providers (and the range of possible services is huge), normally the largest percent of spend is focused on services and the process enabling the delivery of the services. The Erica Carson case in this chapter describes a supply decision in a large services organization, a financial institution. This case illustrates the opportunities for supply to contribute to the customer value proposition. The following table identifies what the impact on organizational requirements is likely to be depending on whether the organization is primarily focused on manufacturing or providing a service: Manufacturer
Service Provider
• The largest portion of needs is generated by customer needs. • The largest portion of spend with suppliers will be on direct requirements which comprise products sold to customers.
• The largest portion of needs is generated by capital, services, and other requirements enabling employees to provide the service. • In retailing the largest spend is focused on resale requirements.
Very few organizations are pure manufacturers or service providers. Most represent a mixture of both. A restaurant provides meals and drinks as well as service and a place to eat.
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Chapter 1 Purchasing and Supply Management 15
An insurance company provides insurance policies and claim service as well as peace of mind. An R&D organization performs research, as well as research reports, models, and prototypes. A manufacturer may supply capital goods as well as repair service and availability of replacement parts. Wholesalers, distributors, and retailers provide resale products in smaller quantities and in more convenient locations at more convenient times than the manufacturers can provide. For these resellers the ability to buy well is critical for success. Resource and mining organizations explore for natural resources and find ways and means of bringing these to commodity markets. Educational institutions attempt to transform students into educated persons, frequently providing them with meals, residences, classrooms, parking facilities, and, hopefully, diplomas or degrees. Health organizations provide diagnostic and repair services using a very large variety of professionals, equipment, facilities, medicines, and parts to keep their clients healthy and functioning. It is no surprise that the nature of the organization in terms of the goods and services it provides will significantly affect the requirements of its supply chain.
The Mission, Vision, and Strategy of the Organization Supply strategy has to be congruent with organizational strategy. Therefore, the mission, vision, and strategy of the organization are the key drivers for how the supply function will be managed and how supply decisions are made and executed. A nonprofit organization with social aims may acquire its office needs totally differently from one that competes on cost in a tough commercial or consumer marketplace. An innovation-focused organization may define flexibility quite differently from one that depends largely on the acquisition and transformation or distribution of commodities. In the past, the supply manager was largely focused on the traditional value determinants of quality, quantity, delivery, price, and service as the five key drivers of sound supply decisions. Today’s supply managers face a host of additional concerns, as corporate mission, vision, and strategies require concerns over risk, the environment, social responsibility, transparency, regulation, and innovation as well. Thus, the old adage of value for money, a guiding principle for supply managers for centuries, has become a lot tougher over the last few decades and continues to evolve. The text and cases in this book are focused on major supply decisions appropriate for the unique organization in which the supply professional is employed.
The Size of the Organization The larger the organization, the greater the absolute amount of spend with suppliers. And the amount of the spend will be a major determinant of how many resources can be allocated to the acquisition process. Given a cost of acquisition of 1 to 2 percent of what is acquired, for a $100,000 purchase, up to $2,000 can be spent on acquisition. However, a $100 million acquisition can afford up to $2 million and a $1 billion spend up to $20 million. Therefore, the larger the amount of spend, the greater the time and care that can and should be allocated to acquisition. Therefore, in very small organizations, the responsibility for acquisition may be a part-time allocation to one or more individuals who probably wear multiple hats. In very large organizations, supply professionals may be completely dedicated to one category of requirements on a full-time basis. And a supply group may count hundreds of professionals. Military acquisition in the United States occupies over 40,000 people, a very large supply chain operation.
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Single or Multiple Sites An additional influence is whether the organization operates out of a single or multiple sites. The simplest situation is the single site. The supply situation becomes more complex as the number of sites increases. Transportation and storage issues multiply with multiple sites along with communication and control challenges. This is especially true for multinationals supplying multiple sites in a large variety of countries.
Financial Strength Supply management stripped to its bare essentials deals with the exchange of money for goods and services. With the acquiring company responsible for the money and the supplier for the goods and services, the ability of the buying organization to pay will be a very important issue in the supplier’s eyes. And the ability to pay and flexibility on when to pay depend on the financial strength of the organization. The stronger the buying organization is financially, the more attractive it becomes as a potential customer. A supplier will be more anxious to offer an exceptionally good value proposition to an attractive customer. And the ability and willingness to pay quickly after receipt of goods or services add valuable bargaining chips to any purchaser.
Reputation Corporate reputation in the trade is another important factor in building a positive corporate image both for suppliers and purchasers. If supply management is defined as the fight for superior suppliers, then a strong corporate image and reputation are valuable contributors. Superior suppliers can pick and choose their customers. Superior suppliers prefer to deal with superior customers. Superior customers enhance a superior supplier’s reputation. “You are known by the company you keep” applies in the corporate world just like it does in personal life. And supply managers can significantly affect their company’s image by their actions and relations with suppliers. For a long time the reputation of Fisher & Paykel (F&P) in New Zealand and Australia was such that any F&P supplier could use this as a persuasive argument for gaining additional customers in that area of the world. “If you are good enough to supply F&P, you are good enough for us” was the implication. A good buyer–supplier relationship is built on the rock of impeccable performance to contract agreements. Pay the right amount on time without hassle and deliver the right quality and quantity of goods or services on time and charge the correct price without hassle. These commitments are not as simple as they sound. Moreover, superior customers and superior suppliers add ethical treatment; advance communications on future developments in technology, markets, and opportunities for improvements as additional expectations; and are continually striving to do better. Corporate reputations are built on actions and results, not on noble intentions. It takes time to build a superior reputation, but not much time to harm a reputation.
SUPPLY QUALIFICATIONS AND ASSOCIATIONS In recognition that the talent in supply has to match the challenges of the profession, public and private organizations as well as supply associations have taken the initiative to ensure well-qualified supply professionals are available to staff the function.
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Education Although there are no universal educational requirements for entry-level supply jobs, most large organizations require a college degree in business administration or management. Several major educational institutions, such as Arizona State University, Bowling Green State University, George Washington University, Miami University, Michigan State University, and Western Michigan University, now offer an undergraduate degree major in Purchasing/Supply/Supply Chain/Logistics Management as part of the bachelor in business administration degree. In addition, many schools offer certificate programs or some courses in supply, for either full- or part-time students. A number of schools, including Arizona State, Michigan State, and Howard University, also offer a specialization in supply chain management as part of a master of business administration degree program. In Canada, the Richard Ivey School of Business has offered for over 60 years a purchasing and supply course as part of its undergraduate and graduate degree offerings. Other universities such as HEC, Laval, York, Queens, University of British Columbia, and Victoria have followed suit; academic interest in supply chain management is at an all-time high. While, obviously, a university degree is not a guarantee of individual performance and success, the supply professional with one or more degrees is perceived on an educational par with professionals in other disciplines such as engineering, accounting, marketing, information technology (IT), human resources (HR), or finance. That perception is important in the role that supply professionals are invited to play on the organizational team.
Professional Associations As any profession matures, its professional associations emerge as focal points for efforts to advance professional practice and conduct. In the United States, the major professional association is the Institute for Supply Management (ISM), founded in 1915 as the National Association of Purchasing Agents. The ISM is an educational and research association with over 40,000 members who belong to ISM through its network of domestic and international affiliated associations. In addition to regional and national conferences, ISM sponsors seminars for supply people. It publishes a variety of books and monographs and the leading scholarly journal in the field, The Journal of Supply Chain Management, which it began in 1965. Additionally, ISM and its Canadian counterpart, the Purchasing Management Association of Canada (PMAC), work with colleges and universities to encourage and support the teaching of purchasing and supply management and related subjects and provide financial grants to support doctoral student research. ISM launched the Certified Professional in Supply Management (CPSM) program in May 2008. The CPSM program focuses skill development in areas such as supplier relationship management, commodity management, risk and compliance issues, and social responsibility. Since the early 1930s, ISM has conducted the monthly “ISM Report on Business,” which is one of the best-recognized current barometers of business activity in the manufacturing sector. In 1998, the association initiated the Nonmanufacturing ISM Report on Business. The survey results are normally released on the second business day of each month. The Ivey Purchasing Managers Index (Ivey PMI), jointly sponsored by PMAC and the Richard Ivey School of Business, is the Canadian equivalent of ISM’s Report on Business, but covers the complete Canadian economy.
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In 1986, CAPS Research (formally the Center for Advanced Purchasing Studies) was established as a national affiliation agreement between ISM and the College of Business at Arizona State University. CAPS is dedicated to the discovery and dissemination of strategic supply management knowledge and best practices. It conducts industry wide purchasing benchmarking studies, publishes a good practices publication called Practix, runs the annual Purchasing Executives’ Roundtables, and conducts and publishes focused purchasing research in areas of interest to industry. In Canada, the professional association is the PMAC, formed in 1919. Its membership of approximately 6,000 is organized in 10 provincial and territorial institutes from coast to coast. Its primary objective is education, and in addition to sponsoring national conferences and publishing a magazine, it offers an accreditation program leading to the CPP (Certified Professional Purchaser) designation. PMAC’s accreditation program was started in 1963. In addition to ISM and PMAC, there are other professional purchasing associations, such as the National Institute of Governmental Purchasing (NIGP), the National Association of State Purchasing Officials (NASPO), the National Association of Educational Buyers (NAEB), and the American Society for Health Care Materials Management. Several of these associations offer their own certification programs. Most industrialized countries have their own professional purchasing associations: for example, Institute of Purchasing and Supply Management (Australia), Chartered Institute of Purchasing and Supply (Great Britain), Indian Institute of Materials Management, and Japan Materials Management Association. These national associations are loosely organized into the International Federation of Purchasing and Supply Management (IFPSM), which has as its objective the fostering of cooperation, education, and research in purchasing on a worldwide basis among the more than 40 member national associations representing approximately 200,000 supply professionals.
CHALLENGES AHEAD There are at least six major challenges facing the supply profession over the next decade: supply chain management, measurement, risk management, sustainability, growth and influence, and effective contribution to corporate success.
Supply Chain Management The success of firms like Walmart and Zara in exploiting supply chain opportunities has helped popularize the whole field of supply chain management. Nevertheless, significant challenges remain: While the giant firms in automotive, electronics, and retailing can force the various members of the supply chain to do their bidding, smaller companies do not have that luxury. Thus, each organization has to determine for itself how far it can extend its sphere of influence within the supply chain and how to respond to supply chain initiatives by others. Clearly, opportunities to reduce inventories, shorten lead times and distances, plan operations better, remove uncertainties, and squeeze waste out of the supply chain are still abundant. Thus, the search for extra value in the supply chain will continue for a considerable period of time.
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Measurement There is significant interest in better measurement of supply not only to provide senior management with better information regarding supply’s contribution, but also to be able to assess the benefits of various supply experiments. No one set of measurements is likely to suffice for all supply organizations. Therefore, finding the set of measures most appropriate for a particular organization’s circumstances is part of the measurement challenge.
Risk Management A recent study at Michigan State University found that supply chain disruptions and supply chain risk are among the most critical issues facing supply chain managers.6 Supply chains have become increasingly global and, therefore, face risks of supply interruptions, financial and exchange rate fluctuations, lead time variability, and security and protection of intellectual property rights, to name only a few. The trend to single sourcing has also created the increased risks for supply disruptions. Supply managers need to continually assess risks in the supply chain and balance risk/ reward opportunities when making supply decisions. For example, the attraction of lower prices from an offshore supplier may create longer-term high costs as a result of the need to carry additional safety stock inventories or lost sales from stock-outs. The Russel Wisselink case in Chapter 12 describes how one organization ran into problems in a low cost country sourcing program. Risk management will be covered in more detail in Chapter 2.
Sustainability Responsibility for reverse logistics and disposal has traditionally fallen under the supply organization umbrella (see Chapters 16 and 17). These activities include the effective and efficient capture and disposition of downstream products from customers. More recently, however, pressures from government and consumer groups are motivating organizations to reduce the impact of their supply chains on the natural environment. For example, the European Union (EU) has set aggressive targets for greenhouse gas reductions and cuts to overall energy consumption, and has implemented new legislation as a result. Supply will be at the forefront of sustainability initiatives. Senior management will expect supply to work with suppliers to identify solutions for the environmental and sustainability challenges they face.
Growth and Influence Growth and influence in terms of the role of supply and its responsibilities inside an organization can be represented in four areas as identified in a recent CAPS study.7 In the first place, supply can grow in the percentage of the organization’s total spend for which it is meaningfully involved. Thus, categories of spend traditionally not involving purchasing, such as real estate, insurance, energy, benefit programs, part-time help, relocation services, consulting, marketing spend with advertising and media agencies, travel and facilities management, IT, and telecommunications and logistics, have become part of procurement’s responsibility in more progressive corporations. 6
S. A. Melnyk et al., Supply Chain Management 2010 and Beyond: Mapping the Future of the Strategic Supply Chain (The Eli Broad College of Business at Michigan State University, 2006). 7 Leenders and Johnson, Major Changes in Supply Chain Responsibilities.
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20 Purchasing and Supply Management
Second, the growth of supply responsibilities can be seen in the span of supply chain activities under purchasing or supply leadership. Recent additions include accounts payable, legal, training and recruiting, programs and customer bid support, and involvement with new business development. Third, growth can occur in the type of involvement of supply in what is acquired and supply chain responsibilities. Clearly, on the lowest level, there is no supply involvement at all. The next step up is a transactionary or documentary role. Next, professional involvement implies that supply personnel have the opportunity to exercise their expertise in important acquisition process stages. At the highest level, meaningful involvement, a term first coined by Dr. Ian Stuart, represents true team member status for supply at the executive table. Thus, in any major decision taken in the organization, the question “What are the supply implications of this decision?” is as natural and standard as “What are the financial implications of this decision?” Fourth, supply can grow by its involvement in corporate activities from which it might have been previously excluded. While involvement in make-or-buy decisions, economic forecasts, countertrade, in- and outsourcing, and supplier conferences might be expected, other activities such as strategic planning, mergers and acquisitions, visionary task forces, and initial project planning might be good examples of broader corporate strategic integration. Each of these four areas of opportunity for growth allows for supply to spread its wings and influence creation in organization and increase the value of its contributions.
Effective Contribution to Organizational Success Ultimately, supply’s measure of its contribution needs to be seen in the success of the organization as a whole. Contributing operationally and strategically, directly and indirectly, and in a positive mode, the challenge for supply is to be an effective team member. Meaningful involvement of supply can be demonstrated by the recognition accorded supply by all members of the organization. How happy are other corporate team members to have supply on their team? Do they see supply’s role as critical to the team’s success? Thus, to gain not only senior management recognition but also the proper appreciation of peer managers in other functions is a continuing challenge for both supply professionals and academics.
THE ORGANIZATION OF THIS TEXT In this first chapter are listed the more common influences for all organizations. In subsequent chapters, we will cover various decisions regarding organizational and supply strategies, organization supply processes, make or buy, the variety of organizational needs, and how to translate these into commercial equivalents. These will be followed by decisions on quality, quantity, delivery, price, and service—the traditional five value criteria— culminating in supplier selection. Suppliers are located domestically and internationally and their location will affect how supply should be managed. The legal and ethical framework for supply establishes the framework for the contract between these two parties. How to evaluate supplier performance and how to relate to suppliers is followed by a section on supply chain associated responsibilities which may or may not be part of the supply
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manager’s assignment. This text concludes with the evaluation of the supply function, its performance reporting, and current trends in the field.
Conclusion
If the chief executive officer and all members of the management team can say, “Because of the kinds of suppliers we have and the way we relate to them, we can outperform our competition and provide greater customer satisfaction,” then the supply function is contributing to its full potential. This is the ambitious goal of this text: to provide insights for those who wish to understand the supply function better, whether or not they are or will be employed in supply directly.
Questions for Review and Discussion
1. What is the profit-leverage effect of supply? Is it the same in all organizations? 2. “Supply is not profit making; instead, it is profit taking since it spends organizational resources.” Do you agree? 3. What kinds of decisions does a typical supply manager make? 4. “In the long term, the success of any organization depends on its ability to create and maintain a customer.” Do you agree? What does this have to do with purchasing and supply management? 5. Is purchasing a profession? If not, why not? If yes, how will the profession, and the people practicing it, change over the next decade? 6. Differentiate between purchasing, procurement, materials management, logistics, supply management, and supply chain management. 7. In what ways might e-commerce influence the role of supply managers in their own organizations? In managing supply chains or networks? 8. In the petroleum and coal products industry, the total purchase/sales ratio is 80 percent, while in the food industry it is about 60 percent. Explain what these numbers mean. Of what significance is this number for a supply manager in a company in each of these industries? 9. How does supply management affect return on assets (ROA)? In what specific ways could you improve ROA through supply management? 10. How can the expectations of supply differ for private versus public organizations? Services versus goods producers?
References
Cavinato, J. L.; A. E. Flynn; and R. G. Kauffman. The Supply Management Handbook. 7th ed. Burr Ridge, IL: McGraw-Hill/Irwin, 2007. Lambert, D. M. Supply Chain Management: Processes, Partnerships and Performance, Sarasota, Florida: Supply Chain Management Institute, 2004. Leenders, M. R., and H. E. Fearon. “Developing Purchasing’s Foundation,” The Journal of Supply Chain Management 44, no. 2 (2008), pp. 17–27. Leenders, M. R., and A. E. Flynn. Value-Driven Purchasing: Managing the Key Steps in the Acquisition Process. Burr Ridge, IL: Irwin Professional Publishing, 1995.
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Nelson, Dave; Patricia E. Moody; and Jonathan Stegner. The Purchasing Machine. New York: The Free Press, 2001. Rozemeijer, Frank. Creating Corporate Advantage in Purchasing. Eindhoven, The Netherlands: Technische Universiteit Eindhoven, 2000. Zheng, J.; L. Knight; C. Hartland; S. Humby; and K. James. “An Analysis of Research into the Future of Purchasing and Supply Management.” Journal of Purchasing and Supply Management 13, no. 1 (2007), pp. 69–83.
Case 1–1
Qmont Mining Alice Winter, working on a summer internship at Qmont Mining, was trying to determine how the supply systems for remote locations could be improved.
QMONT MINING Qmont Mining, a major metals producer with headquarters in Vancouver, British Columbia, had extensive holdings all over the Canadian North. Supply management had been completely decentralized until very recently. A consulting study had recommended a move to more centralized supply management, including purchasing and logistics. The purchasing and stores manager at Qmont’s largest mine in British Columbia, Harry Davidson, had been asked to pursue this idea and to make recommendations on potential improvements. Harry had hired Alice Winter, a college student in logistics, to work as a summer intern to assist him. Harry had said to Alice: “A good project for you to work on is the way we handle supply for remote locations. I suspect that we could do substantially better, but I really don’t have any hard data.”
REMOTE LOCATIONS Alice found out that Qmont had 17 remote locations, ranging from three small mines that had a buyer/storekeeper on site to two mine start-ups, nine exploration sites, and three development projects with a distance of 5,000 km between the farthest ones and 300 km between the closest ones. Qmont made a distinction between exploration sites where the potential for ore was totally unproven to
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development sites where the possibility of mineralization had been proved, but where the extent of mineralization had to be determined. Qmont used its own drilling crews at these two types of sites, although most mining companies preferred to use contract drillers. Qmont managers believed that for security, availability, and cost reasons they needed full control and in-house crews. Typically, at both exploration and development sites an engineer or geologist would be in charge. All supplies for these sites would be flown in by bush planes on floats or by helicopters.
ACCOUNTING INFORMATION Alice Winter decided to visit the accounting department at Vancouver headquarters first to see what she could learn about supply in remote locations. She found out that accounting paid all invoices from suppliers who claimed to have supplied a remote location even when no confirmation of orders, deliveries, or receipts was available. This occurred in about one-third of all invoices. The accountant explained: “Getting suppliers to provide odd requirements in a hurry and to get bush pilots to fly them in is a constant hassle. The last thing we want to do is lose the goodwill of these suppliers because we don’t have our records straight and delay payments.”
DEVELOPMENT AND EXPLORATION SITE DATA Alice did get the chance to review the previous year’s actual supplier invoices for three different sites (one development and two exploration) over a four-month
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summer period. Communication between actual sites and suppliers occurred in two main ways. Since site leaders were in regular contact via satellite with head office personnel in exploration or engineering, they frequently asked the head office contacts to place specific orders for them. In addition, it was common for remote site personnel to contact suppliers directly and place orders. Moreover, when a drill needed a quick replacement part, apparently it was not unusual to place orders with several suppliers at the same time in the hope that at least one would deliver quickly. Drill and crew downtime was seen as very expensive. The site accounting records showed that the total supply spend for these three sites totaled about $850,000. Of this total, approximately: • $220,000 was for drilling equipment including drill bits and rods. • $120,000 for MRO suppliers. • $420,000 for air transport covering seven different suppliers, of which air transport of personnel in and out of sites cost about $170,000.
• $180,000 for fuel. • $80,000 for food. Alice uncovered 22 instances of multiple deliveries of the same item within days to the same site from different suppliers and 12 instances of multiple deliveries of the same item from the same supplier within a few days. There were 14 instances where the airfreight bill was at least 10 times higher than the value of the item transported.
NEXT STEPS After several weeks of gathering this information, Alice wondered what her next steps should be. One option would be to gather similar information for all remote sites to get a more complete picture and to extend the time period. Another would be to get more specific about the details of each order and each supplier. She knew that she would be meeting with Harry Davidson in a few days to discuss her progress and findings to date. She also expected Harry to ask her what she believed she should do next.
Case 1–2
Erica Carson “We will do it for 10 percent less than what you are paying right now.” Erica Carson, purchasing manager at Wesbank, a large western financial institution, had agreed to meet with Art Evans, a sales representative from D.Killoran Inc., a printing supplier from which Wesbank currently was not buying anything. Art Evans’s impromptu and unsolicited price quote concerned the printing and mailing of checks from Wesbank. Wesbank, well known for its active promotional efforts to attract consumer deposits, provided standard personalized consumer checks free of charge. Despite the increasing popularity of Internet banking, the printing of free checks and mailing to customers cost Wesbank $8 million in the past year. Erica Carson was purchasing manager in charge of all printing for Wesbank and reported directly to the vice president of supply. It had been Erica’s decision to split the printing and mailing of checks equally between two suppliers. During
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the last five years, both suppliers had provided quick and quality service, a vital concern of the bank. Almost all checks were mailed directly to the consumer’s home or business address by the suppliers. Because of the importance of check printing, Erica had requested a special cost analysis study a year ago, with the cooperation of both suppliers. The conclusion of this study had been that both suppliers were receiving an adequate profit margin and were efficient and cost-conscious and that the price structure was fair. Each supplier was on a two-year contract. One supplier’s contract had been renewed eight months ago; the other’s expired in another four months. Erica believed that Killoran was underbidding to gain part of the check-printing business. This in turn would give Killoran access to Wesbank’s customers’ names. Erica suspected that Killoran might then try to pursue these customers more actively than the current two suppliers to sell special “scenic checks” that customers paid for themselves.
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Case 1–3
Southeastern University Heather Sloman, buyer in the purchasing department of Southeastern University, was preparing for a meeting with her boss, Glen Meredith, for later that day. Two days earlier, on April 6, Glen had received a phone call from Walter Charbonneau, manager of the university registrar’s office. Heather was surprised to learn from Glen that Walter had just bought a new piece of equipment for his department without following standard university purchasing policies. Glen asked Heather to look into the situation and get back to him with recommendations.
PURCHASING DEPARTMENT Southeastern University was one of the largest universities in the state, with total enrollment of more than 25,000 graduate and undergraduate students and approximately 3,500 staff. There were 12 faculties at the university, over 20 continuing education diploma and certificate programs, and three affiliated colleges. Purchasing was centralized, and the purchasing director, Blake Hyatt, reported to the university’s vice president of administration. The purchasing department was responsible for negotiating with suppliers, signing contracts with suppliers, and supervising the execution of contracts. Small-value purchases, those less than $100, could be handled out of petty cash. The purchasing department had also recently introduced a purchasing card, which could be used to acquire eligible goods and services with a value of less than $1,000. The purchasing process began when a purchase request was submitted to the purchasing department. A clerk would stamp the requisition with the date and time received and checked it for proper signing authority. In some cases, it was necessary to forward the requisition to the research accounting section in the department of finance for account approval. Other information also was added to the requisition, such as tax and duty status, product classification, and supplier status. Although the purchase requisition form provided an opportunity for the requisitioner to identify the preferred supplier, the policy was to solicit at least two written quotations for purchases in excess of $7,500 and a minimum of three quotations for purchases in excess of $15,000. One of the buyers would prepare a request for
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quotation form (RFQ) and contacted approved suppliers. The RFQ form specified details, such as product or service description, quantities, FOB point, and terms of payment. Recent government legislation required that any RFQs in excess of $100,000 had to be posted on the Internet. After all bids were received and evaluated, the buyer would select the supplier and issue a purchase order. The purchasing department maintained a list of approximately 1,200 approved suppliers, which was adjusted every three to five years. The selection criteria for becoming an approved vendor was based on the following weighted average evaluation system: • • • •
Price, 50 percent Compliance with specifications, 25 percent Service, 20 percent Partnership, 5 percent
The purchasing department had three buying groups, and each group handled approximately 20 requests each day. (See Exhibit 1 for the organization chart.) In addition, approximately 250 contracts were rebid each year for ongoing purchases, such as snow removal services and photocopier supplies. The total dollar volume of purchases amounted to $75 million of goods and services each year. According to Heather Sloman, the main objective of the purchasing department was to achieve the greatest cost savings. She commented on the role of purchasing at the university: “Our training in purchasing allows us to negotiate the best deals for the university and help avoid wasting university money.” Although it was university policy that approval from the purchasing department was required before commitments could be made to suppliers, it was not unusual that university personnel contacted suppliers directly. Every year there were about 275 cases where contracts were signed with suppliers without prior approval of purchasing. Heather described what happened in these situations: “Most of the time, the only thing we can do is to call them and ask them to provide the details of the purchase. Usually the purchase has already been made, and there isn’t much else that can be done.”
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EXHIBIT 1 Organization Chart of the Purchasing Department Blake Hyatt Director Cindy Prosser Administrative Assistant
Joan Kada Senior Buyer Maintenance Equipment and Supplies
Edward Bell Senior Buyer Scientific Equipment
Glen Meredith Senior Buyer Computer and Business Products
Ken McKellar Buyer
Leslie Heyninck Buyer
Heather Sloman Buyer
Ray Sharen Manager Purchasing Systems
Elizabeth Robertson Purchasing Administrator
Barbara Hillman Clerk
James Pryor Central Supplies
THE FOLDING MACHINE ISSUE
HEATHER’S OPTIONS
The office of registrar handled about 160,000 pieces of mail a year. There were four major peaks of mailings each year: fees, admissions, records, and scholarships. As many as 50 to 60 people could be occupied manually stuffing envelopes two days a month. A combination of full-time employees and temporary staff was used to perform this activity. Walter Charbonneau had seen an advertisement in a flyer for an automatic folding machine, which could be used to eliminate some of the manual work in dealing with mass mailings. He later contacted a representative of the company and placed an order for the machine, at a cost of $14,000. Glen was notified shortly after the machine had arrived because Walter needed to make arrangements for payment. As far as Heather knew, the machine had arrived only in the last few days and had not been installed. Heather found that the supplier of the folding machine was not on her approved supplier list. She then contacted three of her suppliers and received quotes of $10,000, $11,000, and $15,000 for similar equipment. The third quotation included one year of free service.
Heather recognized that some employees were going to ignore university policy from time to time and she had to be prepared to deal with such situations. However, if university staff failed to appreciate the benefits of sound purchasing practices, the university’s centralized purchasing system would be undermined. When she spoke to Glen Meredith about the situation two days earlier, he said: “Let me know what we should do about this machine in the registrar’s office. But also think about what else we can be doing to prevent these kinds of situations from happening again. These bad deals cost the university too much money each year. Besides, as a public institution, we must be extra careful to follow our procedures.” There were a number of alternatives Heather was considering regarding the equipment. One option was to simply keep the machine and pay the supplier. However, she felt the equipment could be returned, and if necessary she could negotiate a cancelation penalty with the supplier. Alternatively, Heather could go back to the supplier and use the quotations to negotiate a lower price. Heather had about four hours before her meeting with Glen. As she sat down to prepare for the meeting, Heather thought about what she might say to Glen regarding avoiding future problems of this kind.
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Chapter Two Supply Strategy Chapter Outline Levels of Strategic Planning Major Challenges in Setting Supply Objectives and Strategies Strategic Planning in Supply Management Risk Management Operational Risk: Supply Interruptions and Delays Financial Risk: Changes in Price Reputational Risk Managing Supply Risks The Corporate Context Strategic Components What? Quality?
How Much? Who? When? What Price? Where? How? Why? Conclusion Questions for Review and Discussion References Cases 2–1 Spartan Heat Exchangers Inc. 2–2 Sabor Inc. 2–3 Ford Motor Company: Aligned Business Framework
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Key Questions for the Supply Decision Maker Should we • Become more concerned about the balance sheet? • Develop a strategic plan for purchasing and supply management? • Spend a major part of our time on strategic, rather than operational, issues? How can we • Anticipate the professional changes we will face in the next 10 years? • Ensure supply is included as part of the organization’s overall strategy? • Generate the information needed to do strategic planning?
In strategic supply, the key question is: How can supply and the supply chain contribute effectively to organizational objectives and strategy? The accompanying question is: How can the organizational objectives and strategy properly reflect the contribution and opportunities offered in the supply chain? A strategy is an action plan designed to achieve specific long-term goals and objectives. The strategy should concentrate on the key factors necessary for success and the major actions that should be taken now to ensure the future. It is the process of determining the relationship of the organization to its environment, establishing long-term objectives, and achieving the desired relationship(s) through efficient and effective allocation of resources.
LEVELS OF STRATEGIC PLANNING To be successful, an organization must approach strategic planning on three levels: 1. Corporate. These are the decisions and plans that answer the questions of What business are we in? and How will we allocate our resources among these businesses? For example, is a railroad in the business of running trains? Or is its business the movement (creating time and space utility) of things and people? 2. Business Unit. These decisions mold the plans of a particular business unit, as necessary, to contribute to the corporate strategy. 3. Function. These plans concern the how of each functional area’s contribution to the business strategy and involve the allocation of internal resources. Several studies by CAPS Research reinforced the notion that linking supply strategy to corporate strategy is essential, but many firms do not yet have mechanisms in place to link the two.1 1
R. M. Monczka and K. J. Petersen, Supply Strategy Implementation: Current State and Future Opportunities (Tempe, AZ: CAPS Research, 2008). Carter et al., Succeeding in a Dynamic World: Supply Management in the Decade Ahead (Tempe, AZ: CAPS Research, 2007). P. F. Johnson and M. R. Leenders, Supply’s Organizational Roles and Responsibilities (Tempe, AZ: CAPS Research, 2004).
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FIGURE 2–1 Supply Strategy Congruent with Organizational Strategy
FIGURE 2–2 Supply Strategy Links Current and Future Markets to Current and Future Needs
Supply objectives
Organizational objectives
Supply strategy
Organizational strategy
Current needs
Future needs
Current markets
Future markets
Effective contribution connotes more than just a response to a directive from top management. It also implies inputs to the strategic planning process so that organizational objectives and strategies include supply opportunities and problems. This is graphically shown in Figure 2–1 by the use of double arrows between supply objectives and strategy and organizational objectives and strategy. A different look at supply strategy is given in Figure 2–2. This shows an effective supply strategy linking both current needs and current markets to future needs and future markets. One of the significant obstacles to the development of an effective supply strategy lies in the difficulties inherent in translating organizational objectives into supply objectives. For example, Tony Brown, senior vice-president of global sourcing at Ford Motor Company, was implementing a new supply strategy that he believed would improve performance in the areas of quality, technology, delivery, cost, and speed to market. However, the company chairman and CEO William Clay Ford Jr. will be interested in issues such as how the new supply strategy will improve earnings per share and create shareholder value. (See the Ford Motor Company case at the end of the chapter.). Normally, most organizational objectives can be summarized under four categories: survival, growth, financial, and environmental. Survival is the most basic need of any organization. Growth can be expressed in a variety of ways. For example, growth could be in size of the organization in terms of number of employees or assets or number of operating units, or number of countries in which the organization operates, or in market share.
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Financial objectives could include total size of budget, surplus or profit, total revenue, return on investment, return on assets, share price, earnings per share, or increases in each of these or any combination. Environmental objectives include not only traditional environmental concerns like clean air, water, and earth but also objectives such as the contribution to and fit with values and ideals of the organization’s employees and customers, and the laws and aspirations of the countries in which the organization operates. The notion of good citizenship is embodied in this fourth objective. Unfortunately, typical supply objectives normally are expressed in a totally different language, such as quality and function, delivery, quantity, price, terms and conditions, service, and so on.
MAJOR CHALLENGES IN SETTING SUPPLY OBJECTIVES AND STRATEGIES The first major challenge facing the supply manager is the effective interpretation of corporate objectives and supply objectives. For example, given the organization’s desire to expand rapidly, is supply assurance more important than obtaining “rock bottom” prices? The second challenge deals with the choice of the appropriate action plan or strategy to achieve the desired objectives. For example, if supply assurance is vital, is it best accomplished by single or dual sourcing, or by making in-house? The third challenge deals with the identification and feedback of supply issues to be integrated into organizational objectives and strategies. For example, because a new technology can be accessed early through supply efforts, how can this be exploited? The Spartan Heat Exchangers case at the end of this chapter provides an illustration of how supply should be integrated to corporate strategy. The changes in corporate strategy and objectives at Spartan necessitate changes in supply strategy. The development of a supply strategy requires that the supply manager be in tune with the organization’s key objectives and strategies and also be capable of recognizing and grasping opportunities. All three challenges require managerial and strategic skills of the highest order, and the difficulties in meeting these challenges should not be minimized.
STRATEGIC PLANNING IN SUPPLY MANAGEMENT Today, firms face the challenge of prospering in the face of highly competitive world markets. The ability to relate effectively to outside environments—social, economic, political, legal, and technological—to anticipate changes, to adjust to changes, and to capitalize on opportunities by formulating and executing strategic plans is a major factor in generating future earnings and is critical to survival. Supply must be forward looking. A supply strategy is a supply action plan designed to permit the achievement of selected goals and objectives. If well developed, the strategy will link the firm to the environment as part of the long-term planning process. An overall supply strategy is made up of substrategies that can be grouped together into six major categories: 1. Assurance-of-supply strategies. Designed to ensure that future supply needs are met with emphasis on quality and quantity. Assurance-of-supply strategies must consider
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2.
3.
4.
5.
6.
changes in both demand and supply. (Much of the work in purchasing research [see Chapter 13] is focused on providing the relevant information.) Cost-reduction strategies. Designed to reduce the laid-down cost of what is acquired or the total cost of acquisition and use—life-cycle cost. With changes in the environment and technology, alternatives may be available to reduce an organization’s overall operating costs through changes in materials, sources, methods, and buyer–supplier relationships. Supply chain support strategies. Designed to maximize the likelihood that the considerable knowledge and capabilities of supply chain members are available to the buying organization. For example, better communication systems are needed between buyers and sellers to facilitate the timely notification of changes and to ensure that supply inventories and production goals are consistent with the needs. Supply chain members also need better relations for the communication needed to ensure higher quality and better design. Environmental-change strategies. Designed to anticipate and recognize shifts in the total environment (economic, organizational, people, legal, governmental regulations and controls, and systems availability) so that it can turn them to the long-term advantage of the buying organization. Competitive-edge strategies. Designed to exploit market opportunities and organizational strengths to give the buying organization a significant competitive edge. In the public sector, the term competitive edge usually may be interpreted to mean strong performance in achieving program objectives. Risk-management strategies. Whereas the various aspects of the previous five types of strategies have been covered earlier in this text, the issue of risk management has not yet been discussed. Therefore, this section will be expanded here, not to imply greater importance, but to assure adequate coverage.
RISK MANAGEMENT Every business decision involves risk, and supply is no exception. In financial instruments a higher rate of return is supposed to compensate the investor or lender for the higher risk exposure. Risks in the supply chain can be classified into three main categories: (1) operational: the risk of interruption of the flow of goods or services, (2) financial: the risk that the price of the goods or services acquired will change significantly, and (3) reputational risk. All three risks affect the survival, competitiveness, and bottom line of the organization and may occur simultaneously.
Operational Risk: Supply Interruptions and Delays Every business continuity plan recognizes that supply interruptions and delays may occur. Catastrophic events such as earthquakes, tornadoes, hurricanes, war, floods, or fire may totally disable a vital supplier. Strikes may vary in length, and even short-term interruptions related to weather, accidents on key roads, or any other short-term factor affecting the supply and/or transport of requirements may affect a buying organization’s capability to provide good customer service.
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A distinction can be drawn between factors beyond the purchaser’s or supplier’s control, such as weather, and those that deal directly with the supplier’s capability of selecting its own suppliers, managing internally, and its distribution so as to prevent the potential of physical supply interruption. Careful supplier evaluation before committing to purchase can mitigate against the latter type of supply interruption. In situations of ongoing supply relationships, communication with key suppliers is essential. Such is the situation in the Sabor case at the end of the chapter. Ray Soles is concerned about the potential shortage of a key raw material and must come to an agreement with his suppliers to avoid possible supply disruptions. Unfortunately, supply interruptions increase costs. If last-minute substitutions need to be made, these are likely to be expensive. Idle labor and equipment, missed customer delivery promises, and scrambling—all have increased costs associated with them.
Financial Risk: Changes in Price Quite different from supply interruptions are those risks directly associated with changes in the price of the good or service purchased. A simple example comes from the commodity markets. Increases in the price of oil affect prices paid for fuel, energy, and those products or services that require oil as a key ingredient or raw material. A purchaser who has committed to a fixed-price contract may find a competitor able to compete because commodity prices have dropped. Currency exchange rate changes and the threat of shortages or supply interruption also will affect prices, as will arbitrary supplier pricing decisions. Changes in taxation, tolls, fees, duties, and tariffs also will affect cost of ownership. Given that both supply interruption and price/cost risks directly impact any organization’s ability to meet its own goals and execute its strategies, supply chain risks—whether they are on the supply side, internal to the organization, or on the customer side—need to be managed properly.
Reputational Risk Reputational risk may be even more serious than operational or price risks, because the loss of reputation may be catastrophic for a company. Both legal and ethical supply issues may affect the company’s reputation. “You are known by the company you keep” applies not only to one’s personal life, but also to corporate life. Thus, the reputation of a company’s supply chain members will affect its own image. The internal and external communications decisions and behavior of supply personnel can have both negative and positive impacts. Therefore, the content of the legal issues and ethics (Chapter 15) is highly relevant to reputational risk. Adverse publicity with respect to bribery, kickbacks, improper quality, improper disposal and environmental practices, dealings with unethical suppliers, and so on, can be extremely damaging.
Managing Supply Risks Managing supply risks requires (1) identification and classification of the risks, (2) impact assessment, and (3) a risk strategy. Given that supply is becoming more and more global and supply networks more complex, risk identification is also becoming more difficult. The preceding discussion identifying supply interruption and price/cost changes as two categories has been highly
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simplified. Technology, social, political, and environmental factors have not even been mentioned yet. Technology has the potential of interrupting supply through the failure of systems and through obsoleting existing equipment, products, or services, or drastically changing the existing cost/price realities. A purchaser committed to a long-term, fixedprice contract for a particular requirement may find a competitor can gain a significant advantage through a technology-driven, lower-cost substitute. Environmental legislative changes can drastically offset a supplier’s capability to deliver at the expected price or to deliver at all. Because the well-informed supply manager is probably in the best position to identify the various supply risks his or her organization faces, such risk identification should be a standard requirement of the job, including the estimation of the probability of event occurrence. Impact assessment requires the ability to assess the consequences of supply interruption and/or price/cost exposure. Correct impact assessment is likely to require the input of others in the organization, such as operations, marketing, accounting, and finance, to name just a few. Assessed potential impact from identified risk may be low, medium, or high. Combining potential impact assessment with the probability of event exposure creates a table of risks with low probability and low impact on one extreme and high probability with high impact on the other. Obviously, high-impact, high-probability risks need to be addressed or, better yet, avoided, if at all possible. Managing supply risks should be started at the supply level, but may escalate to the overall corporate level. Relatively simple actions such as avoiding high-risk suppliers or high-risk geographical locations, dual or triple sourcing, carrying safety stock, hedging, and using longer-term and/or fixed- or declining-price contracts and protective contract clauses have been a standard part of the procurement arsenal for a long time. If most purchasers had their way, they would like to transfer all risk to their suppliers! However, the assumption of risk carries a price tag, and a supplier should be asked to shoulder the risk if it is advantageous to both the supplier and purchaser to do so.
The Corporate Context Supply risk is only one of the various risks to which any organization is exposed. Traditionally, financial risks have been the responsibility of finance, property insurance part of real estate, and so on. The emergence of a corporate risk management group headed by a risk manager or chief risk officer (CRO) allows companies as a whole to assess their total risk exposure and seek the best ways of managing all risks. A supply manager’s decision not to source in a politically unstable country because of his or her fear of supply interruption may also miss an opportunity to source at a highly advantageous price. A corporate perspective might show that the trade-off between a higher price elsewhere and the risk of nonsupply favors the apparently riskier option. Mergers and acquisitions as well as insourcing and outsourcing represent phenomena full of opportunities and risks in which supply input is vital to effective corporate risk resolution. The decision about how much risk any organization should be willing to bear and whether it should self-insure or seek third-party protection is well beyond the scope of this text. Nevertheless, it is clear that risk management is going to be an area of growing concern for supply managers.
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FIGURE 2–3 Strategic Supply Planning Process
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Restate organizational goals Identify and analyze alternatives
Determine supply objectives to contribute to organizational goals
Isolate factors affecting achievement of supply objectives
Determine supply strategy
Review implementation factors
Gain commitment and implement
Evaluate
Figure 2–3 is a conceptual flow diagram of the strategic supply planning process. It is important to recognize that the planning process normally focuses on long-run opportunities and not primarily on immediate problems.
STRATEGIC COMPONENTS The number of specific strategic opportunities that might be addressed in formulating an overall supply strategy is limited only by the imagination of the supply manager. Any strategy chosen should include a determination of what, quality, how much, who, when, what price, where, how, and why. Each of these will be discussed further. (See Figure 2–4.)
What? Probably the most fundamental question facing an organization under the “what” category is the issue of make or buy, insourcing, and outsourcing. Presumably, strong acquisition strengths would favor a buy strategy. (See Chapter 5.) Also included under the heading of what is to be acquired is the issue of whether the organization will acquire standard items and materials readily available in the market, as opposed to special, custom-specified requirements. Standard items may be readily acquired in the marketplace, but they may not afford the organization the competitive edge that special requirements might provide.
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FIGURE 2–4 Supply Strategy Questions
1. What? Make or buy Standard versus special 2. Quality? Quality versus cost Supplier involvement 3. How Much? Large versus small quantities (inventory) 4. Who? Centralize or decentralize Quality of staff Top management involvement 5. When? Now versus later Blank check system Forward buy 6. What Price? Premium Standard Lower Cost-based Market-based Lease/make/buy 7. Where? Local, regional Domestic, international Large versus small
Single versus multiple source High versus low supplier turnover Supplier relations Supplier certification Supplier ownership 8. How? Systems and procedures Computerization Negotiations Competitive bids Fixed bids Blanket orders/open orders Systems contracting Blank check system Group buying Materials requirements planning Long-term contracts Ethics Aggressive or passive Purchasing research Value analysis 9. Why? Objectives congruent Market reasons Internal reasons 1. Outside supply 2. Inside supply
Quality? Part of the “what” question deals with the quality of the items or services to be acquired. Chapter 5 addresses the various trade-offs possible under quality. The intent is to achieve continuous process and product or service improvement.
Supplier Quality Assurance Programs Many firms have concluded that a more consistent quality of end-product output is absolutely essential to the maintenance of, or growth in, market share. Suppliers must deliver consistent quality materials, parts, and components; this also will effect a marked reduction in production costs and in-house quality control administrative costs. Therefore, a strategy of developing suppliers’ knowledge of quality requirements and assisting them in implementation of programs to achieve desired results may be needed. Three of the programs that might be used are: 1. Zero defect (ZD) plans. “Do it right the first time” is far more cost effective than making corrections after the fact. 2. Process quality control programs. These use statistical control charts to monitor various production processes to isolate developing problems and make needed adjustments
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(corrections) before bad product is produced. The buying firm may need to assist the supplier with the introduction of the needed statistical techniques. 3. Quality certification programs. Here the supplier agrees to perform the agreed-upon quality tests and supply the test data, with the shipment, to the buying firm. If the seller does the requisite outgoing quality checks and can be depended on to do them correctly, the buying firm then can eliminate its incoming inspection procedures and attendant costs. This approach almost always is a key element in any just-in-time purchasing system, as discussed in the following section.
How Much? Another major component of any supply strategy deals with the question of how much is to be acquired in total and per delivery. Chapter 8 discussed a number of trade-offs possible under quantity. In JIT and MRP, the trend has been toward smaller quantities to be delivered as needed, as opposed to the former stance of buying large quantities at a time to ensure better prices. Ideally, buyers and suppliers try to identify and eliminate the causes of uncertainty in the supply chain that drive the need for inventory, thus reducing the amount of inventory in the total system. One option available under the how much question may involve the shifting of inventory ownership. The supplier maintains finished goods inventory because the supplier may be supplying a common item to several customers. The safety stock required to service a group of customers may be much less than the combined total of the safety stocks if the several customers were to manage their own inventories separately. This concept is integral to the successful implementation of systems contracting (discussed in Chapter 4). From a strategic standpoint, supply may wish to analyze its inventory position on all of its major items, with a view to working out an arrangement with key suppliers whereby they agree to maintain the inventory, physically and financially, with delivery as required. Ideally, of course, the intent of both buyer and supplier should be to take inventory out of the system. An area in the buyer’s facility may even be placed under the supplier’s control. Dell is one example of a company that has successfully used its supply relationships to create a competitive advantage. Critical to Dell’s success is that it carries almost no inventories, either finished products or materials, and everything that Dell buys from its suppliers is immediately assembled into a computer and sold.2 Other options are to switch to JIT purchasing or to consignment buying. If a supplier can be depended on to deliver needed purchased items, of the agreed-upon quality, in small quantities, and at the specified time, the buying firm can substantially reduce its investment in purchased inventories, enjoy needed continuity of supply, and reduce its receiving and incoming inspection costs. To accomplish this requires a long-term plan and substantial cooperation and understanding between buyer and seller. In consignment buying, a supplier owns inventory in the buyer’s facility under the buyer’s control. The buyer assumes responsibility for accounting for withdrawals of stock from that consignment inventory, payment for quantities used, and notification to the supplier of the need to replenish inventory. Verification of quantities remaining in inventory 2
B. S. Fugate and J. T. Mentzer, “Dell’s Supply Chain DNA,” Supply Chain Management Review 8, no. 7 (2004), pp. 20–24.
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then would be done jointly, at periodic intervals. This strategy has advantages for both supplier (assured volume) and buyer (reduced inventory investment) and is often used in the distribution industry.
Who? The whole question of who should do the buying and how to organize the supply function has been addressed in Chapter 3. The key decisions are whether the supply function should be centralized or not, what the quality of staff should be, and to what extent top management and other functions will be involved in the total acquisition process. To what extent will teams be used to arrive at supply strategies?
When? The question of when to buy is tied very closely to the one of how much. The obvious choices are now versus later. The key strategy issue really lies with the question of forward buying and inventory policy. In the area of commodities, the opportunity exists to go into the futures market and use hedging. The organized commodity exchanges present an opportunity to offset transactions in the spot and future markets to avoid some of the risk of substantial price fluctuation as discussed in Chapter 10.
What Price? It is possible for any organization to follow some specific price strategies. This topic already has been extensively discussed in Chapter 11. Key trade-offs may be whether the organization intends to pursue paying a premium price in return for exceptional service and other commitments from the supplier, a standard price target in line with the rest of the market, or a low price intended to give a cost advantage. Furthermore, the pursuit of a cost-based strategy as opposed to a market-based strategy may require extensive use of tools such as value analysis, cost analysis, and negotiation. For capital assets, the choice of lease or own presents strategic alternatives, as discussed in Chapter 16.
Where? Several possibilities present themselves under the question of where to buy. Many of these are discussed in Chapter 12 under “Source Selection.” Obvious trade-offs include local, regional, domestic, or international sourcing; buying from small versus large suppliers; single versus multiple sourcing; and low versus high supplier turnover, as well as supplier certification and supplier ownership. Lastly, through reverse marketing or supplier development, the purchaser may create rather than select suppliers.
How? A large array of options exists under the heading of “how to buy.” These include, but certainly are not limited to, supply chain management integration systems and procedures; choice of technology; e-commerce applications; use of various types of teams; use of negotiations, auctions, competitive bids, blanket orders, and open order systems; systems contracting; group buying; long-term contracts; the ethics of acquisition; aggressive or passive buying; the use of purchasing research and value analysis; quality assurance programs; and reduction of the supply base. Most of these will be discussed in Chapters 3 through 12 in this text.
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Why? Every strategy needs to be examined not only for its various optional components, but also for the reason why it should be pursued. The normal reason for a strategy in supply is to make supply objectives congruent with overall organizational objectives and strategies at both an operational and strategic level. Other reasons may include market conditions, both current and future. Furthermore, there may be reasons internal to the organization, both outside of supply and inside supply, to pursue certain strategies. For example, a strong engineering department may afford an opportunity to pursue a strategy based on specially engineered requirements. The availability of excess funds may afford an opportunity to acquire a supplier through backward/vertical integration. The reasons inside supply may be related to the capability and availability of supply personnel. A highly trained and effective supply group can pursue much more aggressive strategies than one less qualified. Other reasons may include the environment. For example, government regulations and controls in product liability and environmental protection may require the pursuit of certain strategies. What makes supply strategy such an exciting area for exploration is the combination of the multitude of strategic options coupled with the size of potential impact on corporate success. The combination of sound supply expertise with creative thinking and full understanding of corporate objectives and strategies can uncover strategic opportunities of a size and impact not available elsewhere in the organization.
Conclusion
The increasing interest in supply strategies and their potential contribution to organizational objectives and strategies is one of the exciting developments in the whole field of supply. Fortunately, as this chapter indicates, the number of strategic options open to any supply manager is almost endless. A significant difficulty may exist in making these strategies congruent with those of the organization as a whole. The long-term perspective required for effective supply strategy development will force supply managers to concentrate more on the future. The coming decade should be a highly rewarding one for those supply managers willing to accept the challenge of realizing the full potential of supply’s contribution to organizational success.
Questions for Review and Discussion
1. What role can (should) supply play in determining a firm’s strategy in the area of social issues and trends? 2. How can the supply manager determine which cost-reduction strategies to pursue? 3. Can you have a supply strategy in public procurement? Why or why not? 4. Why should a supply manager consider hiring (or obtaining internally) an employee without any supply background? 5. What can supply do to assist in minimizing a firm’s risk of product liability lawsuits? 6. What factors have caused the current interest in, and attention to, strategic purchasing and supply planning?
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7. What type of data would supply need to contribute to an organization’s strategic growth? How might supply obtain such data? 8. How can supply sell itself more effectively internally? 9. What do you believe to be the most difficult obstacles to making a supply function strategic? 10. Why should supply be concerned about the balance sheet?
References
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Carter, P. L.; R. M. Monczka; G. L. Ragatz; and P. L. Jennings. Supply Chain Integration: Challenges and Good Practices. Tempe, AZ: CAPS Research, 2009. Carter, P. L. et al. Succeeding in a Dynamic World: Supply Management in the Decade Ahead. Tempe, AZ: CAPS Research, 2007. Cavinato, J. L. “Supply Chain Logistics Risks: From the Back Room to the Board Room.” International Journal of Physical Distribution & Logistics Management 34, no. 5 (2004), pp. 383–387. Christopher, M.; H. Peck; and D. Towill. “A Taxonomy for Selecting Global Supply Chain Strategies.” International Journal of Logistics Management 17, no. 2 (2006), pp. 277–287. Cox, A. Strategic Sourcing. Warwickshire, UK: Earlsgate Press, 2008. Fawcett, S. E.; G. M. Magnan; and J. Ogden. Achieving World-Class Supply Chain Collaboration: Managing the Transformation. Tempe, AZ: CAPS Research, 2007. Fine, C. H. Clock Speed. Reading, MA: Perseus Books, 1998. Hunt, S. D., and D. F. Davis, “Grounding Supply Chain Management in ResourceAdvantage Theory.” The Journal of Supply Chain Management 44, no. 1, pp. 10–21. Johnson, P. F., and M. R. Leenders. Supply’s Organizational Roles and Responsibilities. Tempe, AZ: CAPS Research, 2004. Johnson, P. F., and M. R. Leenders. “Minding the Supply Savings Gaps.” MIT Sloan Management Review 51, no. 2 (2010), pp. 25–31. Johnson, P. F., and M. R. Leenders. Supply Leadership Changes. Tempe, AZ: CAPS Research, March 2007, 106 pages. Lambert, D. M. Supply Chain Management: Processes, Partnerships and Performance. Sarasota, Florida: Supply Chain Management Institute, 2004. Mol, M. J. “Purchasing’s Strategic Relevance.” Journal of Purchasing & Supply Management 9, no. 1 (2003), pp. 43–50. Monczka, R. M. and K. J. Petersen. Supply Strategy Implementation: Current State and Future Opportunities. Tempe, AZ: CAPS Research, 2008. Zsidisin, G. A.; G. L. Ragatz; and S. A. Melnyk. “The Dark Side of Supply Chain Management.” Supply Chain Management Review 9, no. 2 (2005), pp. 46–52.
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Case 2–1
Spartan Heat Exchangers Inc. On June 10, Rick Coyne, materials manager at Spartan Heat Exchangers Inc. (Spartan), in Springfield, Missouri, received a call from Max Brisco, vice president of manufacturing: “What can the materials department do to facilitate Spartan’s new business strategy? I’ll need your plan next week.”
SPARTAN HEAT EXCHANGERS Spartan was a leading designer and manufacturer of specialized industrial heat transfer equipment. Its customers operated in a number of industries, such as steel, aluminum smelting, hydro electricity generation, pulp and paper, refining, and petrochemical. The company’s primary products included transformer coolers, motor and generator coolers, hydro generator coolers, air-cooled heat exchangers, and transformer oil coolers. Spartan’s combination of fin-tube and time-proven heat exchanger designs had gained wide recognition both in North America and internationally. Sales revenues were $25 million and Spartan operated in a 125,000-square-foot plant. Spartan was owned by Krimmer Industries, a large privately held corporation with more than 10,000 employees worldwide, headquartered in Denver. Rick Coyne summarized the business strategy of Spartan during the past 10 years: “We were willing to do anything for every customer with respect to their heat transfer requirements. We were willing to do trial and error on the shop floor and provide a customer with his or her own unique heat transfer products.” He added, “Our design and manufacturing people derived greatest satisfaction making new customized heat transfer products. Designing and research capabilities gave us the edge in developing and manufacturing any kind of heat transfer product required by the customer. Ten years ago, we were one of the very few companies in our industry offering customized services in design and manufacturing and this strategy made business sense, as the customers were willing to pay a premium for customized products.”
MANUFACTURING PROCESS The customized nature of Spartan’s product line was supported by a job shop manufacturing operation with several departments, each of which produced particular component
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parts, feeding a final assembly area. Each job moved from work center to work center, accompanied by a bill of material and engineering drawing. The first process involved fitting a liner tube (in which the fluid to be cooled passed) into a base tube. This base tube, made of aluminum, was then pressure bonded to the inner liner tube through a rotary extrusion process that formed spiral fins on the base tube. The depth of the fins and the distance between them determined the amount of airflow across the tubes, and thus the cooling efficiency and power of the unit. After the tubes were formed, cabinet and end plate fabrication began. The tubes were welded to the cabinet and the end plates. Flanges were then welded to pairs of tubes on the other side of the end plates to create a looped system. The unit was then painted and fans and motors were installed. Finally, the unit was tested for leaks and performance, crated, and shipped to the job site for installation.
MATERIALS DEPARTMENT Spartan’s buyers sourced all raw material and components required by manufacturing and were responsible for planning, procurement, and management of inventories. Rick managed an in-house warehouse used for housing the raw material inventories, maintained adequate buffer inventories, and executed purchase contracts with vendors, ensuring specifications were met while achieving the best possible price. Rick’s department included two buyers, a material control clerk, an expediter, and two shippers-receivers. It was common for Spartan to have multiple vendors for raw material supply, and the materials group used more than 350 vendors for its raw materials, with current lead times ranging from a few days to six weeks. This wide supplier base was necessitated by the customization strategy adopted by the company. Rick noted that approximately 35 percent of Spartan’s purchases were for aluminum products, mainly tubes and sheets. On average the plant had $3.5 million worth of inventory, in the form of both raw and work in process. Raw material inventory constituted approximately 40 percent of the total. Rick estimated that Spartan had inventory turns of four times per year, which he believed was comparable to the competition. Manufacturing operations regularly complained about material shortages and stockouts, and regular inventory audits
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indicated significant discrepancies with inventory records on the company’s computer system. Furthermore, a significant amount of stock was written off each year due to obsolescence. Rick suspected that production staff regularly removed stock without proper documentation and that workers frequently deviated from established bills of material.
NEW BUSINESS STRATEGY Competition in the heat exchanger industry had increased dramatically over the past decade, with much of the new competition coming from Korea and Europe. Korean firms, with their low cost base, competed primarily on price, while European firms focused on standardizing their product lines to a few high-volume products and competed on delivery lead time and price. Spartan’s competitors in Europe used assembly-line manufacturing processes, rather than batch or job shop operations. Senior management viewed the competition from Europe and Korea as an imminent threat. Many of Spartan’s customers had recently developed aggressive expectations regarding pricing and delivery lead times, and some key customers had decided to opt for standard product design, sacrificing custom design for lower cost and faster delivery. The changing nature of the industry forced senior management to reexamine their business strategy. As a result, in January, a multidiscipline task force representing engineering, manufacturing, and sales was formed with the mandate to formulate a new five-year business strategy.
The new corporate strategy was finalized in May and reviewed with the management group on June 1st in an all-day staff meeting. The central theme of the new strategy was standardization of all product lines, in terms of both design and manufacturing, reducing variety to three or four basic lines for each product category. The sales department would no longer accept orders for specialized designs. The aim of the new strategy was to reduce the delivery lead time from 14 weeks to 6 weeks and to lower production costs dramatically.
NEW CHALLENGES FOR MATERIAL DEPARTMENT Max Brisco indicated that he expected the materials group to play a major role in support of the new corporate strategy and needed to know by next week the specifics of Rick’s plan. The task force had set a number of ambitious targets. First, customer lead times for finished products were to be reduced to six weeks from the current average of 14 weeks. Second, the new objective for inventory turns was 20 times. Meanwhile, raw material stockouts were to be eliminated. Third, Max believed that product standardization also would provide opportunities to reduce costs for purchased goods. He expected that costs for raw materials and components could be cut by 10 percent over the next 12 months. Rick fully supported the new direction that the company was taking and saw this as an opportunity to make major changes. He knew that Max would want the specifics of his plan during the meeting in a week’s time.
Case 2–2
Sabor Inc. In mid-April, Ray Soles, vice president of supply chain management at Sabor Inc., had become increasingly concerned about the potential shortage of supply of marconil, a new high-tech raw material for air filtration. Sabor Inc.’s three suppliers, during the last two weeks, had advised Ray Soles to sign long-term contracts and he was trying to assess the advisability of such commitments.
SABOR INC. Sabor Inc. of Cleveland, Ohio, produced high-quality consumer and industrial air-conditioning and heating units. An extensive network of independent and company-owned installation and sales centers serviced
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customers throughout the North American market. Total company sales last year totaled $800 million.
AIR FILTRATION AND MARCONIL Sabor Inc. for decades had sold air humidification and air filtration units along with its prime units in air heating and cooling. Until three years ago, air filtration had accounted for about 7 percent of total corporate sales and had been sold primarily as add-ons to a new air cooling/ heating system. However, with the advent of marconil, air filtration had started to increase significantly as a percentage of total sales. Marconil, a new high-tech product developed as part of the U.S. space effort, had a range of
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unique properties of high interest to a variety of industries. In the case of air filtration, when processed by a Sabor Inc. developed and patented process, marconil could be transformed into a thin, very light, and extremely fine meshlike sponge material capable of filtering extremely small particles. Given the population’s sensitivity to air quality and the increasing number of people with asthma and allergies, the new Sabor filters became popular, not only with new Sabor air system installations but also as retrofits in older air conditioning and heating systems. Moreover, compared to electronic air cleaners that cost about three times as much to install and required monthly cleaning, marconil filters had to be replaced every six months, guaranteeing a continued sales volume of filters for years to come. When combined with an ultraviolet light unit, which killed airborne bacteria, a marconil air cleaning system was considered a huge leap forward in air treatment. The manufacturing cost of a marconil filter accounted for about 28 percent of its selling price.
AIR FILTRATION SALES Along with the marconil filtration system introduction three years ago, Sabor’s marketing department had initiated a significant promotional campaign directed at both the industrial and consumer sectors. Marketing’s ability to forecast sales accurately had not been impressive, according to Ray Soles. For the first year, marketing had forecast marconil filter sales at $1 million, when in reality they sold $11 million. In the second year, the forecast was for $15 million and actual sales were $29 million, and, in the third year, a forecast of $40 million turned into actual sales of $72 million. The marketing department expected sales growth to level off over the next three years to a rate of 20 percent per year.
EXHIBIT 1 Sabor Marconil Purchases and Prices
Company
Bilt Chemical Warton Inc. G. K. Specialties Prices
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MARCONIL SUPPLY Sabor’s first marconil supplier was Bilt Chemical, a longtime supplier of paints and adhesives to Sabor and a large, diversified, innovative chemical producer that held the patent on marconil. Ray Soles did not like the idea of single sourcing and, therefore, when marconil requirements rose significantly in the second year, he brought in a second supplier, Warton Inc., which not only produced the marconil raw materials (under license from Bilt Chemical), but also manufactured a variety of marconil products in the textile and automotive fields. In the third year, Ray had secured a third supplier, G. K. Specialties, a much smaller company than Bilt Chemical and Warton Inc., which also produced marconil under license for its own applications in aerospace and the military, but which had some excess capacity that it sold on the open market. All three suppliers sold marconil at identical prices, which had increased over the past three years. Actual volumes purchased by Sabor Inc. from each of the three suppliers were as shown in Exhibit 1. The current price of marconil from all three suppliers was $50.00.
SUPPLIER PROPOSALS FOR LONGTERM CONTRACTS During the first two weeks of April, Ray Soles was visited by each of his current three marconil suppliers with Bilt Chemical first. Each warned that a shortage of marconil supply was looming and that unless Ray was willing to sign a long-term contract, they would not be in a position to guarantee supply. However, each proposal was different. Bilt Chemical proposed a five-year contract with takeor-pay commitments of 25,000 pounds for the current year and 20 percent annual increases in volume for each of the following years. Prices were subject to escalation
Capacity (in pounds)
80,000 40,000 20,000
41
Purchases (in pounds) Year 1
Year 2
Year 3
5,000 0 0 $39.00
10,000 3,000
20,000 8,000 4,000 $44.00
$42.00
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42 Purchasing and Supply Management
for energy, raw material, and labor every quarter based on the current $50.00 price per pound. Warton Inc. proposed a two-year contract for 10,000 pounds each year with similar price provisions to those of Bilt Chemical. G. K. Specialties suggested an agreement for 12.5 percent of Sabor’s annual requirements, which could be dropped at any time by either party, but which proposed a price of $56.00 for the current year, to be adjusted semiannually, thereafter based on inflation, energy, labor, and material. Although Ray Soles did not know much about the actual manufacturing process for marconil, he had heard that increases in capacity were expensive. He also understood that two of the three component raw materials for marconil were by-products from industrial processes that were reasonably stable.
Since Ray Soles had been able to buy almost all of Sabor’s needs on quarterly, semiannual, or annual contracts, he was not particularly keen on departing from his current supply practice. He had heard some rumors that in a few years a much lower-cost substitute for marconil might be developed. He suspected that, therefore, his current suppliers were anxious to tie Sabor to a long-term commitment.
APRIL 15 On April 15, the Bilt Chemical sales representative sent an e-mail to Ray Soles requesting a meeting on April 22. The e-mail concluded, “I would like to bring my sales manager so that we may discuss our proposal for the marconil with you. We will not be able to guarantee you supply after August 1, if you are unable to commit.”
Case 2–3
Ford Motor Company: Aligned Business Framework3 Tony Brown, senior vice president of global sourcing at Ford Motor Company (Ford), was putting the finishing touches on his plan for the company’s new supply chain strategy—“Aligned Business Framework” (ABF). ABF was a bold step that would significantly change in the relationships between Ford and its suppliers. Tony described his motivation: “We want to operate a supply chain management system that delivers on the dimensions of quality, technology, delivery and cost, while executing programs in a disciplined fashion with faster time-to-market.”4 It was August 10, 2005, and Tony was expected to review the final details of his proposal with company chairman and CEO William Clay (Bill) Ford Jr. before making a formal public announcement the following month. ABF would substantially reduce the number of suppliers and give those that remained long-term contracts and early involvement in new product development programs. Tony expected that the strategy would provide benefits to Ford through overall lower costs, while suppliers would benefit from
long-term financial stability and profitability. The question remained, however, how he would convince Ford’s supplier community to commit to the principles of ABF.
FORD MOTOR COMPANY Founded in 1903, Ford was the no. 2 U.S. automaker with global sales of approximately $177 billion. In 2005, its global brands included Ford, Lincoln, Mercury, Jaguar, Land Rover, Aston Martin, and Volvo.5 In recent years all of the “Detroit 3” (General Motors, Ford, and Chrysler) automakers were struggling under intense global competition, rising fuel prices, and steep product discounts and rebates. In the most recent quarter, Ford reported a $1.1 billion operating loss and the company’s debt had recently been downgraded to junk-bond status. To turn around company performance, Ford had announced plans to cut its salaried workforce, reduce capacity by closing plants and selling the Hertz rental car division, and ramp up production of hybrid vehicles.6
3
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Ford Motor Company or any of its employees. 4 Tom Stundza, “Ford Has a Better Idea,” Purchasing 135, no. 12 (2006), p. 49. 5 Ford Motor Company 2005 annual report. 6 Jeffrey McCracken, “Ford Retools: Seeks Big Savings by Shaking Up Parts Supply System,” The Globe & Mail, September 29, 2005, p. B19.
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ALIGNED BUSINESS FRAMEWORK (ABF) The Ford global supply chain included approximately 2,500 production and 9,000 nonproduction suppliers, with operations in more than 60 countries, supporting 107 Ford manufacturing sites. Total purchases in 2005 were more than $90 billion for roughly 250 production commodities (e.g., seats, heating and cooling systems, advanced electronics and steering systems) and 500 nonproduction commodities (e.g., health care, software, logistics, and marketing and advertising services). The more than 130,000 active production parts accounted for approximately $70 billion of total annual purchases.7 Historically Ford leaned heavily on suppliers for annual across-the-board price reductions that averaged approximately 3 percent, although requests for more substantial reductions were commonplace. This environment had created contemptuous relationships between Ford and its suppliers, which were reinforced through annual performance evaluations and bonuses for buyers based on achieving year-over-year price reduction objectives. The foundation of the new ABF strategy was a cultural shift from confrontational to collaborative
43
supplier relationships. Tony commented on his assessment of Ford’s current supply chain strategy: “We have a problem with the business model in this industry. It is not working effectively for our suppliers. It is not working effectively for us. When my day is dominated by issues related to financially distressed suppliers, commodity price shocks, quality problems and costs issues, it’s clear to me that there must be a better approach.”8 ABF targeted companywide cost reductions of 10 percent of Ford’s annual spend of production parts by 2010—$7 billion per year—by adopting what Tony considered best practices approach to supply chain management and supplier partnerships: “It’s an environment between Ford and a select family of suppliers where innovative ideas can emerge, and then be incubated, evaluated and incorporated into our products.”9 Under the new system, preferred suppliers would be matched with Ford purchasing and engineering managers to work on projects to achieve quality, cost, and delivery goals. The 20 key elements of the ABF that Tony planned to propose are provided in Exhibit 1, which Brown described as “a kinder, gentler era of cooperation from global suppliers that can be implemented beyond North America.”10
EXHIBIT 1 Key Elements of ABF11 Ford Commitments • Up-front reimbursement of supplier engineering, design, and testing • Long-term sourcing • Improved commonality and reuse • Improved product, cycle plan, and forecast volume stability • Sharing of forecast volumes and product plans (beyond 3 years) • More disciplined program execution through Ford Global Product Development system
Bilateral Commitments • • • • •
•
• •
Achieve best-in-class quality Data transparency Agree on detailed cost models Focus on total costs, included elimination of emphasis on bins Competitive cost at Job no. 1, with less emphasis on yearover-year price reductions Open collaboration on global manufacturing, engineering footprint Ongoing senior leadership communication Data exchange remains confidential
Supplier Commitments • Share current financial data to demonstrate health • Backstop other commodity suppliers • Manage and assure proper working conditions in their facilities and in the facilities of sub-tiers • Sourcing of minority- and women-owned suppliers • Use mutually agreeable multiparty agreement in directed tier 2 sourcing scenarios • Technological innovations will be provided to Ford
7
www.ford.com/aboutford/microsites/sustainability-report-2006-07. Stundza, “Ford Has a Better Idea, p. 49. 9 Ibid. 10 Ibid. 11 Presentation by Tony Brown, October 7, 2005, www.oesa.org/cmspages/getAttch.php?id=180. 8
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Tony was proposing that in the first phase of the ABF implementation his supply organization would focus on 20 high-impact commodity groups, such as seats, tires, and bumpers, where the automaker sent approximately $35 billion per year with 200 suppliers. The plan was to reduce the number of suppliers for these commodities to 100 by the 2009 model year. In the long term, Tony’s objective was to shrink the production supply base from 2,500 to 1,000.12
FINALIZING THE PLAN Tony recognized that there would be a great many questions from other Ford executives, members of his purchasing organization and suppliers regarding how ABF would be implemented. There were obviously going to be winners and losers from the existing Ford supplier community under ABF and many of Ford’s existing suppliers would have to be told that they would not be participating in future programs. The preferred suppliers would have many questions regarding how their relationships would function with Ford in the future. For example, it was expected that suppliers would benefit from higher capacity utilization as a result of the increased production volumes. Furthermore, additional benefits were anticipated
from greater collaboration, early supplier involvement in new product development, and supplier innovation. How would the associated costs and benefits be measured and shared among Ford and its suppliers? Ford had a decades-long tradition of confrontational relationships with its supplier community. A recent survey of North American automotive tier 1 suppliers ranked Ford second to last with a score of 157 versus top-ranked Toyota at 415 and Honda at 375 (scale: 500 ⫽ very good, 0 ⫽ very poor).13 Turning around relationships with suppliers could take years. Given the difficult times in the industry and at Ford, Tony knew that Bill Ford would have questions about supplier skepticism regarding the company’s motivations behind ABF and how quickly the plan would start to show results. Tony Brown believed that it was necessary to make major changes to Ford’s supply chain if the company was going to survive. As he got ready for his meeting with Mr. Ford, Tony pondered how he should proceed with implementation, and specifically how suppliers could be convinced to buy into the principles of ABF. Tony commented on the challenges that ABF presented: “This is not business as usual. We’re not only asking our suppliers to step up. We’re also asking ourselves to step up.”14
12
Jeffrey McCracken, “Ford Retools: Seeks Big Savings by Shaking Up Parts Supply System,” The Globe & Mail, September 29, 2005, p. B19. 13 John Henke, Planning Perspectives, Birmingham, Michigan, 2008. 14 “ Ford Key Suppliers Roll Out Innovative Business Model,” Ford Motor Company press release, http://media.ford.com .newsroom/release, September 29, 2005.
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Chapter Three Supply Organization Chapter Outline Objectives of Supply Management Organizational Structures for Supply Management Small and Medium-Sized Organizations Large Organizations Centralized and Decentralized Supply Structures Hybrid Supply Structure Specialization within the Supply Function Structure for Direct and Indirect Spend Managing Organizational Change in Supply Organizing the Supply Group The Chief Purchasing Officer (CPO) Reporting Relationship
Supply Activities and Responsibilities What Is Acquired Supply Chain Activities Type of Involvement Involvement in Corporate Activities Influence of the Industry Sector on Supply Activities Supply Teams Leading and Managing Teams Cross-Functional Supply Teams Other Types of Supply Teams Consortia Conclusion Questions for Review and Discussion References Cases 3–1 Iowa Elevators 3–2 Roger Haskett
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46 Purchasing and Supply Management
Key Questions for the Supply Decision Maker Should we • Separate sourcing and commodity management responsibilities? • Use cross-functional sourcing teams to make better supply decisions? • Move towards greater centralization? How can we • Fit supply’s organizational structure better with the structure of the corporate organizational structure? • Gain the maximum benefits from our organizational structure? • Structure and manage teams for effectiveness and efficiency?
Every organization in both the public and private sector is in varying degrees dependent on materials and services supplied by other organizations. No organization is self-sufficient. Even the smallest office needs space, heat, light, power, communication and office equipment, furniture, stationery, and miscellaneous supplies to carry on its activities. Purchasing and supply management is, therefore, one of the key business processes in every organization. Almost every company has a separate supply function as part of its organizational structure. One important management challenge is ensuring effective use of the resources and capabilities of the supply organization and the supply chain or network to maximize supply’s contribution to organizational objectives. Managing the balance between the competitive environment, corporate strategy, and organizational structure is an ongoing process for every company. Senior management selects strategies designed to address competitive challenges and adopts an appropriate corporate organizational structure to complement the company’s strategy. The structure of supply has to be congruent with this organizationwide structure. The challenge for the chief purchasing officer (CPO) is to manage the supply organization to deliver the maximum benefits within the predefined structure. For example, a chief executive might decide that a decentralized organizational structure is appropriate in order to allow flexibility in responding to customer requirements. The supply organization also would be decentralized to the various business units to fit the corporate organizational model. The organizational structure of the supply function influences how supply executes its responsibilities, how it works with other areas of the firm, and the skills and capabilities needed by supply personnel. Regardless of the structure adopted, work must be assigned to ensure the efficient and effective delivery of goods and services to the organization. This requires managing personnel and delegating responsibilities. Managing the people in the supply organization to their full potential is a significant challenge. In this chapter, three questions are addressed: (1) What are the objectives of supply? (2) How might supply be organized to achieve these objectives effectively and efficiently? (3) What are the activities and responsibilities of supply management?
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Supply Organization 47
OBJECTIVES OF SUPPLY MANAGEMENT The standard statement of the objectives of the supply function is that it should obtain the right materials (meeting quality requirements), in the right quantity, for delivery at the right time and right place, from the right source (a supplier who is reliable and will meet its commitments in a timely fashion), with the right service (both before and after the sale), and at the right price in the short and long term. The supply decision maker might be likened to a juggler, attempting to keep several balls in the air at the same time, for he or she must achieve these seven rights simultaneously. It is not acceptable to buy at the lowest price if the goods delivered are unsatisfactory from a quality/performance standpoint, or if they arrive two weeks behind schedule. On the other hand, the right price may be higher than normal if the item in question is an emergency requirement where adherence to normal lead time would result in a higher total cost of ownership. The right price is one aspect of lowest total cost of ownership. The supply decision maker attempts to balance the often conflicting objectives and makes trade-offs to obtain the optimum mix of these seven rights. Obtaining this balance with an eye to both the short term and the long term requires supply managers to have both a tactical and strategic perspective. A more encompassing statement of the overall goals of supply would include the following nine goals: 1. Improve the organization’s competitive position. As a strategic player, the activities of supply management must be focused on contributing to overall organizational strategy, goals, and objectives. Supply managers must identify and exploit opportunities in the supply chain to contribute to revenue enhancement, asset management, and cost reduction. Supply can secure the lowest total cost source of supply, provide access to new technologies, and design flexible delivery arrangements, fast response times, access to high-quality products or services, and product design and engineering assistance. Companies that are successful in the long run must constantly look for opportunities in the supply chain to provide a superior value proposition for their customers, and supply represents a key area for such opportunities. Strategic supply is concerned with the long-term survival and prosperity of the organization. It focuses on bottom-line impact, the income statement, and the balance sheet. Chapter 2 discusses the potential contributions of purchasing and supply management to the overall strategy of the organization and specific internal supply strategies for strengthening the organization’s competitive position. 2. Provide an uninterrupted flow of materials, supplies, and services required to operate the organization. Stockouts or late deliveries of materials, components, and services can be extremely costly in terms of lost production, lower revenues and profits, and diminished customer goodwill. For example (1) an automobile producer cannot complete the car without the purchased tires, (2) an airline cannot keep its planes flying on schedule without purchased fuel, (3) a hospital cannot perform surgery without purchased surgical tools, and (4) an office cannot be used without purchased maintenance services. 3. Keep inventory investment and loss at a minimum. One way to ensure an uninterrupted material flow is to hold large inventories. But inventory assets require use of capital that cannot be invested elsewhere, and the cost of carrying inventory may be
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20 to 50 percent of its value per year. For example, if supply can support operations with an inventory investment of $10 million instead of $20 million, at an annual inventory carrying cost of 30 percent, the $10 million reduction in inventory represents a savings of $3 million in addition to freeing $10 million in working capital. 4. Maintain and improve quality. A certain quality level is required for each material or service input; otherwise the end product or service will not meet expectations or will result in higher-than-acceptable costs. The cost to correct a substandard quality input could be huge. For example, a spring assembled into the braking system of a diesel locomotive can cost less than $5.00. However, if the spring turns out to be defective when the locomotive is in service, the replacement cost is in the thousands of dollars, caused by the teardown required to replace the spring, the lost revenue to the railroad because the locomotive is not in service, and the possible loss of locomotive reorders. Continuous improvement in supplier quality is directly linked to an organization’s ability to compete effectively on a worldwide basis. 5. Find or develop best-in-class suppliers. The success of supply depends on its ability to link supply base decisions to organization strategy and its skill in locating or developing suppliers, analyzing supplier capabilities, selecting the appropriate supplier, and then working with that supplier to obtain continuous improvements. Only if the final selection results in suppliers who are both responsive and responsible will the firm obtain the items and services it needs. 6. Standardize, where possible, the items bought and the processes used to procure them. Standardization refers to the process of agreeing on a common specification or process. Specifications and processes may be standardized across an organization, an industry, a nation, or the world. Supply should constantly strive to standardize its capital equipment, materials, MRO, and services purchases wherever and whenever possible. For materials, standardization often leads to lower risk in the marketplace, lower prices through volume purchase agreements, and lower inventory and tracking costs while maintaining service levels. In the case of capital equipment, standardization results in reduction in MRO inventories and reduced costs for training staff on equipment operation and maintenance. In the case of services, standardization leads to supply base reduction, lower operating costs, more consistent service levels, and lower prices. Supply management process standardization also can result in shortened cycle time, lower transaction costs, and greater opportunities to share knowledge across functional and organizational boundaries. Because standardization touches on multiple stakeholders, it usually requires cross-functional and sometimes cross-organizational teamwork. 7. Purchase required items and services at lowest total cost of ownership. Purchased goods and services in the typical organization represent the largest share of that organization’s total costs. Consequently, the profit-leverage effect discussed in Chapter 1 can be significant. Price is the most convenient method to compare competing proposals from suppliers. However, supply’s responsibility is to obtain the needed goods and services at the lowest total cost of ownership, which necessitates consideration of other factors—such as quality levels, after-sales service, warranty costs, inventory and spare parts requirements, downtime, and so forth—that in the long term might have a greater cost impact on the organization than the original purchase price.
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Supply Organization 49
8. Achieve harmonious, productive internal relationships. Supply managers cannot effectively accomplish their goals and objectives without effective cooperation with the appropriate individuals in other functions. Therefore, it is useful to examine relationships between supply and key internal business partners: Supply and design engineering. Close to 70 percent of the value of any given requirement is established during the first few phases of the standard acquisition process: recognition and description of need. Therefore, close cooperation between design engineering and supply to assure proper specifications is essential. The design must be driven by final customer requirements for value and satisfaction, and be designed for manufacturability and procurability. It is obvious that such close liaison also needs proper involvement of marketing, operations, and finance/accounting to recognize these opportunities and constraints. It is during the design phase that all of these varied interests need to be appropriately incorporated, something that is unlikely to happen unless the various functional experts can represent their points of view well and are able to work effectively as a team. Too frequently, the failure to include supply considerations properly at the design stages results in inadequate product or service performance, costly delays, rework, and end user dissatisfaction. Supply and operations. In most organizations, close supply–operations coordination is essential to operational excellence. In manufacturing companies especially, the total task of integrated logistics, meeting end-customer demands on the one side and using the supply networks on the other, while managing material and information flow, equipment, people, and space effectively, represents an incredible challenge. Meeting quality, delivery, quantity, cost, flexibility, and continuity objectives profitably and competitively requires strategic as well as tactical skills of both operations and supply managers. Supply and marketing/sales. Since supply and marketing are mirror images of each other, with negotiation and customer service in common, there are benefits from greater integration of the two functions. Although research indicates that supply is not typically included in marketing planning, supply and marketing often serve on new product development teams in organizations. Supply can offer information on current and future market conditions and negotiation expertise; and marketing can keep supply up to date on marketing campaigns, special promotions, and sales forecasts and involve supply in meetings with end customers to help supply better understand customer needs. In many organizations, there is an effort to use a strategic sourcing process for spend categories such as advertising and media. This effort requires close cooperation of supply and marketing. Supply and accounting/finance. Supply and accounting/finance interact in the areas of accounts payable, planning, and budgeting. Lack of horizontal goal alignment often leads to behavior in one area that conflicts with behavior in the other area. For example, finance/accounting may adopt a payment policy that is at odds with the payment terms of the contract. From the finance perspective, holding onto cash as long as possible is a good way to contribute to the organization’s financial goals. From the supply perspective, building sound, mutually beneficial relationships with key suppliers contributes to financial performance. Supply managers often argue that accounting focuses too much on short-term gains from holding cash rather than the
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50 Purchasing and Supply Management
longer-term benefits of a strong buyer–supplier relationship that is influenced by paying according to contractual payment terms. Improved communication between supply and accounting/finance and greater goal congruence can help to alleviate some of the problems. Supply can help finance by providing funds flow forecasts, focusing on inventory minimization, and providing market information. 9. Accomplish supply objectives at the lowest possible operating costs. It takes resources to operate supply: salaries, communications expense, supplies, travel costs, computer costs, and accompanying overhead. The objectives of supply should be achieved as efficiently and economically as possible. Process inefficiencies represent waste and lead to excessive operating costs and unnecessarily high total cost of ownership. Supply managers should be continually alert to improvements possible in purchasing and supply processes, methods, procedures, and techniques. For example, opportunities to reduce transaction costs include e-procurement systems that automate the process from requisition to payment and purchasing cards and e-catalogs for small-value purchases. Companies with efficient supply processes can create competitive advantage through reduced costs, improved flexibility, faster time to market, and greater compliance, while allowing supply personnel to concentrate on value-added activities. The objectives of supply must ultimately contribute to the attainment of short- and longterm organizational strategy, goals, and objectives. The process and function can be organized in a number of different ways to maximize supply’s contribution effectively and efficiently.
ORGANIZATIONAL STRUCTURES FOR SUPPLY MANAGEMENT Ultimately the supply organization structure must be aligned with the corporate structure and strategy. In addition, organizational size and the need for specialization with supply also need to be taken into account.
Small and Medium-Sized Organizations In practice it has been proven that assigning the supply function to supply professionals, properly trained and charged with the appropriate responsibilities and authorities, contributes more efficiently and effectively to organizational goals and strategies than assigning supply responsibilities to those for whom supply is a secondary responsibility. Nevertheless, in single business unit organizations, particularly small enterprises, it is not unusual to see supply responsibilities shared by a variety of individuals who have no supply expertise and purchase their own requirements from local retailers or wholesalers. As the size of the business unit increases, the idea of assigning a professional the responsibility of supply emerges and a separate function is created. The size and activities of the supply function in a single business unit organization will depend on a number of factors, such as the size of the company and the nature of its business. Figure 3–1 provides an example of a supply organization in a typical mediumsized, single business unit enterprise. Obviously in small companies where the supply staff consists of only one or two individuals, the staff is expected to be flexible in terms of their
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Chapter 3
FIGURE 3–1 Example of a Typical Supply Organization in a SingleLocation, Medium-Sized Company
Supply Organization 51
Director of Supply
Commodity Manager
Commodity Manager
Manager Administration and Processes
Buyer
Buyer
Manager e-Purchasing
Buyer
Buyer
Manager p-cards
Manager Purchasing Research
Materials Manager
Stores/ Warehouse Manager Receiving Inspection Manager Manager Transportation
capabilities and skills. Specialization will occur as the organization gets larger and the company can afford to hire additional supply personnel.
Large Organizations In large companies the centralization–decentralization issue is of key importance for the supply structure. The overall corporate structure sets the framework for the supply structure. Structural options can be viewed as a continuum ranging from centralized at one extreme to decentralized at the other. Centralization refers to where spending decisions are made, not where the purchasing and supply staff are located geographically. Therefore, the degree of centralization is reflected by the amount of spend managed or controlled by corporate supply. Three common organizational models are: 1. Centralized, where the authority and responsibility for most supply-related functions are assigned to a central organization. 2. Hybrid, where authority and responsibility are shared between a central supply organization and business units, divisions, or operating plants. Hybrid structures may lean more heavily toward centralized or decentralized depending on how decision-making authority is divided. One type of hybrid supply structure is a “center-led” organization in which strategic direction is centralized and execution is decentralized. 3. Decentralized, where the authority and responsibility for supply-related functions are dispersed throughout the organization. CAPS Research conducts Purchasing Performance Benchmarking Studies for a wide range of industries. One of the benchmarks is whether the participating companies use a centralized, decentralized, or hybrid structure. To read about the type of structure common in different industries, visit the CAPS Web site at http://www.capsresearch.org.
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Centralized and Decentralized Supply Structures There are advantages and disadvantages to centralization and to decentralization. Table 3–1 summarizes the advantages and disadvantages of a centralized supply structure and Table 3–2 summarizes the advantages and disadvantages of a decentralized supply structure.1
Hybrid Supply Structure In an organization with multiple business units, different divisions or business units often sell different products or services requiring a different mix of purchased items. Often the division or business unit is operated as a profit center where the division manager is given total responsibility for running the division, acts as president of an independent firm, and is judged by profits made by the division. Since purchases are the largest single controllable cost of running the division and have a direct effect on its efficiency and competitive position, the profit-center manager may insist on having direct authority over supply. This has led firms to adopt decentralized–centralized supply, or a hybrid organizational structure, in which the supply function is partially centralized at the corporate or head office and partially decentralized to the business units. Often the corporate supply organization works with the business unit supply departments in those tasks that are more effectively handled on a corporate basis: (1) establishment
TABLE 3–1
Advantages
Potential Advantages and Disadvantages of Centralization
• Strategic focus • Greater buying specialization • Ability to pay for talent • Consolidation of requirements—clout • Coordination and control of policies and procedures • Effective planning and research
• Common suppliers • Proximity to major organizational decision makers • Critical mass • Firm brand recognition and stature • Reporting line—power • Cost of purchasing low
Disadvantages • • • • • • • • • •
Lack of business unit focus Narrow specialization and job boredom Cost of central unit highly visible Corporate staff appears excessive Tendency to minimize legitimate differences in requirements Lack of recognition of unique business unit needs Focus on corporate requirements, not on business unit strategic requirements Most knowledge sharing one-way Even common suppliers behave differently in geographic and market segments Distance from users
• Tendency to create organizational silos • Customer segments require adaptability to unique situations • Top management not able to spend time on suppliers • High visibility of purchasing operating costs
1
M. R. Leenders and P. F. Johnson, Major Structural Changes in Supply Organizations ( Tempe, AZ: CAPS Research, 2000).
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TABLE 3–2 Potential Advantages and Disadvantages of Decentralization
Advantages • Easier coordination/communication with operating department • Speed of response • Effective use of local sources
• Business unit autonomy
• Reporting line simplicity • Undivided authority and responsibility • Suits purchasing personnel preference • Broad job definition • Geographical, cultural, political, environmental, social, language, currency appropriateness • Hide the cost of supply
Supply Organization 53
Disadvantages • More difficult to communicate among business units • Encourages users not to plan ahead • Operational versus strategic focus • Too much focus on local sources—ignores better supply opportunities • No critical mass in organization for visibility/effectiveness—“whole person syndrome” • Lacks clout • Suboptimization • Business unit preferences not congruent with corporate preferences • Small differences get magnified • Reporting at low level in organization • Limits functional advancement opportunities • Ignores larger organization considerations • Limited expertise for requirements • Lack of standardization
• Cost of supply relatively high
of policies, procedures, controls, and systems; (2) recruiting and training of personnel; (3) coordination of the purchase of common-use items in which more “clout” is needed, (4) auditing of supply performance, and (5) development of corporatewide supply strategies. Therefore, hybrid organizational structures attempt to capture the benefits of both centralized and decentralized structures by creating an organizational structure that is neither completely centralized nor decentralized. (See Figure 3–2.) Structure affects processes, procedures, systems, and relationships. Whether supply is centralized, decentralized, or a hybrid, supply personnel must focus on maximizing the advantages of the structure and minimizing the disadvantages. Supply managers can develop and implement strategies to overcome the obstacles and fully exploit the opportunities of organizational and supply structure.
Specialization within the Supply Function If the supply organization is to contribute well to organizational goals and objectives, it needs to be staffed by professionals with clearly defined responsibilities. Specialization within the supply department allows staff to develop expertise in particular areas and may require the creation of specialized groups within the supply organizational structure. Most large supply organizations consist of four general areas of specialization: sourcing and commodity management, materials management, administration, and supply research.
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FIGURE 3–2 Potential Advantages of the Hybrid Structure
Centralized
Disadvantages
Decentralized
Advantages
Advantages
Disadvantages
Hybrid
Sourcing and Commodity Management These personnel develop commodity strategies, identify potential suppliers, analyze supplier capabilities, select suppliers, and determine prices, terms, and conditions of supplier agreements; they create contracts and purchase orders. This activity is normally further specialized by type of commodity to be purchased, such as raw materials (which may be further specialized); fuels; capital equipment; office equipment and supplies; and maintenance, repair, and operating (MRO) supplies. Figure 3–3 presents a job description for a commodity specialist at Deere & Company. A variation of commodity management is project buying, in which the specialization of buying and negotiation is based on specific end products or projects, requiring the buyer to be intimately familiar with all aspects of the project from beginning to end. Project buying might be used in the supply organization of a large general contractor, where the purchasing for each job is part of a self-contained, temporary organization. At the completion of the project, the buyer then would be reassigned to another project. The United States Defense Acquisition University trains special project managers who are responsible for the proper acquisition and development of new military equipment initiatives. Such projects may last as long as 20 years.
Materials Management This group manages the contract after it is signed, directs the flow of materials and services from the supplier, and keeps track of the supplier’s delivery and quality commitments to avoid any disruptive surprises. If problems develop, the materials management group pressures and assists the supplier to resolve them. Materials management activities are frequently handled at the local plant or office level and involve regular communication with suppliers concerning requirements, such as order quantities and delivery dates. Figure 3–4 presents a job description for a supply management planner.
Administration This group handles the physical preparation and routing of the formal purchase documents, manages the department budget, keeps the necessary data required to operate the department, and prepares reports needed by top management and supply. These personnel will likely manage operation of information systems, including e-procurement systems, B2B e-commerce, and EDI.
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FIGURE 3–3 Commodity Specialist Job Description for Deere & Company
Job Title: Department: Job Function:
Commodity Specialist Supply Management Locate sources for and procure materials, products, supplies or services to support the assigned commodity requirements of the enterprise. Manage the relationships with suppliers.
Primary Duties: 1. Manage source selection and development through a team process including the evaluation of cost, quality, and manufacturing systems. 2. Develop and manage internal and external supplier/customer relationships, including strategic alliances where appropriate. 3. Lead and/or participate on simultaneous engineering teams; facilitate the integration of suppliers into the product delivery process (PDP). 4. Evaluate the cost effectiveness of designs, procure tooling, and qualify processes to assure the product meets specifications. 5. Make recommendations for design change and/or influence design through personal or supplier involvement. 6. Develop and execute supply management strategies to manage cost, quality, and continuous improvement. 7. Develop material control and logistics objectives. 8. Act as a primary communications link between tactical and strategic purchasing functions and business units; participate in team activities.
Supply Research Supply researchers work on special projects relating to the collection, classification, and analysis of data needed to make better purchasing decisions. Activities include studies on use of alternate materials, long-range demand, price and supply forecasts, and analysis of what it should cost an efficient supplier to produce and deliver a product or service. This group is also responsible for performing benchmarking studies. For example, the global purchasing processes and systems group at Cable and Wireless plc, in the United Kingdom, benchmarks its purchasing processes to identify opportunities to improve its supply systems.2 2
M. R. Leenders and P. F. Johnson, Major Changes in Supply Chain Responsibilities ( Tempe, AZ: CAPS Research, 2002).
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FIGURE 3–4 Supply Management Planner Job Description for Deere & Company
Job Title: Department: Job Function:
Supply Management Planner Supply Management To expedite, schedule, and/or analyze requirements for purchased materials in accordance with established requirements and inventory control criteria. May interact with suppliers to establish procedural agreements, obtain delivery commitments, and resolve quality problems.
Primary Duties: 1. Manages specific supplier performance and feedback along with managing day-to-day business plan and relationships with supplier. 2. Plans and/or executes inventory goals by product/supplier and plans/develops delivery system to meet material control objectives (i.e., JIT delivery, P.O.U.D., EDI). 3. Schedules material based on requirements and expedites deliveries that are delinquent or expected to be delinquent. Tracks and resolves problems with inbound shipments. 4. Interprets systems output to determine items requiring follow-up to suppliers on materials ordered to assure on-time delivery. 5. Is involved with the day-to-day problem resolution/corrective action with suppliers: to scrap, return, reclaim, or replace rejected material. Is responsible for bringing products within specifications. 6. Acts as the primary communications link between tactical and strategic purchasing functions and business unit; participates in supply management team activities. 7. Costs and implements current part revisions, including tooling, as part of the decision processing activity. Also reads and reacts to engineering decisions. 8. Conducts price/economic order quantity analysis and compares multiple quotes, including piece price, freight, duty, performance systems, and supplier rating. Also investigates invoice price errors.
Structure for Direct and Indirect Spend Direct spend includes any goods that go into the end product; indirect spend is comprised of the goods and services that are needed to run the organization. Indirect spend includes purchases such as professional services, utilities, travel, employee benefits, and office supplies. In many organizations, the locus of control over direct spend is in a highly centralized supply group. This makes sense because anything that ultimately touches the final customer is worthy of expertise.
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Indirect spend, on the other hand, is often outside the loop of a structured sourcing process and supply authority and responsibility is often left in the hands of the internal user. For example, a marketing manager needing to hire temporary labor would conduct the purchasing process in his or her own way. This highly decentralized approach leads to a fragmented spend for temporary labor, including multiple suppliers, multiple rates, and varying contract terms and conditions. This is partly due to the belief that these types of purchases require a level of knowledge and expertise not found in a typical supply department. The increasing focus on strategic cost management has led many senior managers to turn their attention to indirect spend to realize cost savings, reductions, or avoidances. To better manage indirect spend, some organizations will pull indirect spend categories into the purchasing process. Others expect supply managers to convince internal users that there is value in following a structured sourcing process. In some cases, supply provides analysis and recommendations, but the budget owner makes the purchasing decision. Cross-functional teams consisting of internal users (often across business units) and buyers or commodity managers may be given responsibility for the category. Sourcing, evaluating, and selecting suppliers for indirect spend will be discussed in greater detail in Chapter 12. Any purchase dollars that are not managed through a structured sourcing process may represent a target for cost savings, reduction, or avoidance.
Managing Organizational Change in Supply Firms frequently make major changes to their supply organizational structure. CAPS conducted a study in 2000, in part to answer two questions: (1) Why are there so many structural changes in supply organizations at large companies? (2) If the hybrid organizational structure is theoretically so attractive, then why do so many large firms not use this structure and/or move out of it?3 First, the researchers found that organizational structure change was the result of a change in the overall corporate organizational structure. In none of the situations did the CPO have free choice to select the supply organizational structure that he or she deemed appropriate for the circumstances. Rather, the supply organizational structure was forced to be congruent with the overall corporate structure. The challenge for supply executives, therefore, was to maximize the benefits of the organizational structure while minimizing the disadvantages. Secondly, there are a number of implementation issues to consider when making a major organizational structure change in supply. Major changes affect the lives of many people and create an atmosphere of apprehension among the staff. Implementing change places significant pressures on the CPO, who not only has to worry about managing the day-to-day affairs of the supply department, but also has to successfully implement the organizational change. The challenges associated with these issues frequently contribute to the need to seek assistance from consultants when implementing a major structural change.
Changes toward Centralization When moving toward centralization, two concerns were sources of supply talent and information technology. During the transition, the source of supply talent at all levels of the supply function was a significant challenge. Experienced senior corporate-level supply 3 Leenders and Johnson, Major Structural Changes in Supply Organizations ( Tempe, AZ: CAPS Research, May 2000).
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personnel may not exist in-house. How and where to develop such organizational talent represented an important implementation issue. Some firms placed a greater priority on CPO credibility within the organization, as opposed to previous supply experience. Others identified new CPOs with previous supply experience to handle the change process. At the middle and junior levels, additional staff with specialized skills in areas such as contracting was required. Quite often, the existing supply talent in the decentralized organization was perceived to lack the required training or experience needed in the new centralized environment.
Changes toward Decentralization The CAPS research identified one implementation issue unique to the sites in the study moving toward decentralization: how to dismantle the centralized supply unit effectively. For example, Ontario Hydro created a shared services function that was responsible for negotiating corporatewide agreements and establishing and maintaining corporate purchasing policies, while the business units were responsible for materials management activities. The approach taken by Hoechst was to create a separate legal entity, Hoechst Procurement International, which would also offer purchasing services to other companies on a feefor-service basis. The key objective in both situations was to preserve at least some of the organization’s core supply capabilities and talent, while adapting to the new structural requirements of the company.
ORGANIZING THE SUPPLY GROUP Once the corporate organizational structure is set, no matter what organizational design is chosen, delegation takes place within it. Whether the organization structure is based on functions, products, or business processes is immaterial; what really matters is that work must be assigned and executed in accordance with strategic plans and organizational goals. It follows logically that organizational planning and delegation are important segments of the integration of strategic goals and organizational designs. The following sections describe the key aspects of supply organizational design, including the role of the chief purchasing officer, supply’s status in the organization, and its reporting relationship and internal relationships. Even though the focus is on large supply organizations, many of the comments are also relevant for smaller supply organizations.
The Chief Purchasing Officer (CPO) The chief purchasing officer (CPO) or chief supply officer (CSO) is defined as the “most senior” or “top level” executive in a “firm’s corporate (executive level) office or major division, such as a strategic business unit (SBU), who has formal authority and responsibility to manage his or her firm’s (or SBU’s) purchasing, buying or sourcing functions for the procurement of goods and services from external suppliers.”4 The CPO’s responsibilities may be divided and apportioned among managers and departments, but the functional responsibility and authority of the CPO should be definitely recognized. Moreover,
4
T. E. Hendrick, and J. A. Ogden, Chief Purchasing Officers’ Compensation Benchmarks and Demographics: A 2001 Study of Fortune 500 Firms ( Tempe, Arizona: CAPS Research, 2002).
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functionalization implies that all the responsibilities reasonably involved in the supply function must be given to the CPO, covering the relevant supply network links as well as the full range of organizational needs. The essential principle is that there are certain universally recognized duties pertinent to this function and that these duties should be placed in a separate group equal in status with the other major functions of the organization. The changes in supply management have affected everything from what the function is called to the titles of the people performing the tasks to the tasks that are performed. There is no common title for the individual who holds the top supply position in a large organization in North America. Depending on the role of supply in the organization, the reporting line, and where it is placed on the organization chart, the title may be chief purchasing officer, vice president, director, or manager. Attached to that may be purchasing, procurement, supply management, sourcing, strategic sourcing, logistics, or supply chain management. It is quite common to see CPO titles such as vice president, strategic sourcing and supply; vice president, purchasing; vice president, supply chain management; or director, global procurement. The titles in the cases used in this text provide a good range of titles in current use.
Profile of the CPO The following profile of the average CPO emerged from the CAPS study.5 The average CPO is a well-educated 49-year-old who has been at his or her organization for 14 years and CPO for a little over four years. While most CPOs have previous experience in supply, three-quarters of the CPOs in the study had worked in at least one other function. Approximately 60 percent of CPOs had the title of vice president and the title most likely included the word purchasing, procurement, or supply in it, such as vice president, global procurement or vice president of supply chain management. Typically there are one to two levels between the CPO and the CEO. The CPO was found to report to the CEO in 14 percent of the companies in the CAPS study. The most common reporting lines were to senior vice president/group vice president, vice president of finance/CFO, and executive vice president. The CPO may have overall management responsibility for nontraditional purchases such as corporate travel, food services, real estate, and printing. Additionally, the CPO might have responsibility for logistics (which includes inbound and outbound transportation, fleet management, warehousing, materials handling, order fulfillment, inventory management, supply/demand planning, and management of third-party logistics providers), quality, accounts payable, document/contract management, leadership of the supply process, materials, manufacturing, distribution, and facility management.
CPO Trends Several trends have emerged over at least the last 10 years:6 • Education levels are increasing. Almost all CPOs hold a bachelor’s degree; about half, a graduate degree, typically an MBA.
5
P. F. Johnson, and M. R. Leenders, Supply’s Organizational Roles and Responsibilities ( Tempe, AZ: CAPS Research, 2004). 6 P. F. Johnson, and M. R. Leenders, Supply Leadership Changes ( Tempe, AZ: CAPS Research, 2007).
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• Reporting lines are changing. CPOs tend to report higher in the organization than they did in the 1980s and 1990s. • CPOs are increasingly being hired from outside the organization rather than promoted from within. The 2004 CAPS study found that CPO tenure with their organization had declined to 14 years, from 18 years in 1995, and that approximately one-third of CPOs were hired into the position from another firm. • CPOs are increasingly being hired from functional areas other than supply. • When a new CPO replaces a current CPO, the current CPO is promoted or leaves the company for a similar position in another firm. • CPO reporting lines change every 2.5 years on average, which means that the typical CPO will have at least two different bosses during his or her tenure in the role. • The CPO role is still new in many organizations.
Reporting Relationship The executive to whom the CPO reports gives a good indication of the status of supply and the degree to which it is emphasized within the organization. If the chief purchasing officer has vice presidential status and reports to the CEO, this indicates that supply has been recognized as a top management function. The lower that supply reports in the organization, the less influence supply is likely to have on corporate strategy. When supply is not given the same status as other functions, it must be placed under another senior functional executive. In many cases, supply reports to the chief financial officer because of the immediate impact of supply decisions on cash flows, the size of the annual spend, and the amount of money tied up in inventory. Organizational focus on strategic cost management also supports the decision to place supply under finance. In organizations where a high percentage of annual spend is for production requirements, supply often reports to the top manufacturing executive. In a shared services model, supply along with legal, accounting, human resources, and other functions might report to an administrative vice president. In a heavily engineering-oriented firm, the reporting relationship might be to the chief of engineering to get closer communication and coordination on product specification and quality control. Factors that influence the level at which the supply function is placed in the organizational structure cover a broad spectrum. Among the major ones are: 1. The amount of purchased material and outside services costs as a percentage of either total costs or total income of the organization. A high ratio emphasizes the importance of effective performance of the supply function. 2. The nature of the products or services acquired. The acquisition of complex components or extensive use of subcontracting represents a difficult supply problem. 3. The extent to which supply and suppliers can provide competitive advantage. The important consideration in determining to whom supply should report relates to where it will be most effective in realizing its contribution to the organization’s objectives. Supply should report at a level high enough in the organization so that the key supply aspects of strategic managerial decisions will receive proper consideration.
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SUPPLY ACTIVITIES AND RESPONSIBILITIES Supply management can be described as a series of activities that must be managed effectively for the organization to deliver best value to the final customer. According to a CAPS Research report, Major Changes in Supply Chain Responsibilities,7 roles and responsibilities of supply fall into four general categories: (1) what is acquired, (2) supply chain activities, (3) type of involvement in categories 1 and 2, and (4) involvement in corporate activities.
What Is Acquired The items acquired by the supply group vary from organization to organization and items are added or deleted depending on circumstances in the buying organization. The acquisition segments include raw materials, standard and special direct purchases, MRO, capital, services, and resale. Nontraditional purchases are spend categories that have typically been managed outside of the purchasing and supply management process. In some organizations, purchasing activities are limited to production-related materials and services, leaving responsibility for nonproduction or indirect materials and services in the hands of users. The amount of annual spend that falls outside the management or control of supply ranges from a low of about 2 percent to a high of about 40 percent. This often includes large amounts for capital equipment, utilities, insurance, computers and software, travel, real estate, and construction services. Senior management in many organizations has recognized the significant opportunities from applying the skills of their supply group and the benefits of a structured sourcing process in the acquisition of nontraditional materials and services. The Iowa Elevators case demonstrates the opportunities for supply to capture cost reductions in a large service organization. Exhibit 2 in the case provides a list of spend categories that include direct (e.g., farm supplies) and indirect (e.g., travel) purchases. In contrast to Iowa Elevators, the Roger Haskett case describes capital equipment purchasing. How to finance and manage capital expenditure purchases is also covered in Chapter 6.
Supply Chain Activities Supply has assumed greater responsibilities in a wide range of areas, including those not seen as traditional, as companies strive to leverage profit opportunities and create competitive advantage through their supply practices. Today’s supply management organization has more responsibilities than the traditional “buying” activities once associated with the function. The activities handled by the supply function vary from firm to firm, even within the same industry. However, regardless of company size, there are a number of activities common to most supply organizations (see Table 3–3). The addition or deletion of activities in any organization can be categorized as internally or externally focused. Internally focused activities include accounts payable, centralized coordination of purchasing, cost management, legal, materials management and logistics, production planning, quality, and supply budget and financial management. Externally focused 7
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Leenders and Johnson, Major Changes in Supply Chain Responsibilities ( Tempe, AZ: CAPS Research, 2002).
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TABLE 3–3 Supply Activities
Area of Responsibility Purchasing/buying
Purchasing research
Inventory control
Transportation Environmental and investment recovery/disposal
Forecasting and planning Outsourcing and subcontracting
Nonproduction/nontraditional purchases
Supply chain management
Activities • Creating contracts and supply agreements for materials, services, and capital items • Managing key purchasing processes related to supplier selection, supplier evaluation, negotiation, and contract management • Identifying better techniques and approaches to supply management, including benchmarking processes and systems • Identifying medium- and long-term changes in markets and developing appropriate commodity strategies to meet future needs • Identifying supply chain trends and opportunities for better materials and services • Managing inventories and expediting material delivery • Establishing and monitoring vendor-managed inventory systems • Managing inbound and outbound transportation services, including carrier selection • Managing supply chain–related activities to assure compliance with legal and regulatory requirements and with company environmental policies • Managing disposal of surplus materials and equipment • Planning production and forecasting short-, medium-, and long-term requirements • Evaluating potential suppliers and negotiating contracts • Supporting the transition from internal production to external supply and vice versa • Managing cost-effective delivery of nonproduction and nontraditional purchases, such as office supplies, security services, janitorial services, advertising, and insurance • Implementing and managing key supplier relationships and supplier partnerships, including supplier development and participation on crossfunctional and cross-organizational teams • Developing strategies that use the supply network to provide value to end customers and contribute to organizational goals
activities may have either a supplier focus or a customer focus. Supplier-focused activities include inbound logistics, supplier development, raw material procurement for suppliers, supplier evaluation and communication, e-procurement, and outsourcing or subcontracting. Customer-focused activities include outbound logistics, involvement with new business development and new product development, and programs and customer bid support.
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Type of Involvement Supply can have no involvement or documentary, professional, or meaningful involvement in what is acquired and in supply chain activities. No involvement means supply is excluded completely. Documentary involvement requires the supply function to act as a recorder, a sender of purchase orders, or a receiver of bids, but important supply decisions are made outside supply. Professional involvement implies that supply professionals have the opportunity to exercise their expertise in important acquisition process stages. Meaningful involvement means that parties outside the supply group are willing and able to take supply considerations into account in managing their own areas of responsibility. They routinely and actively request input and assistance from supply personnel and, in turn, also are involved in supply decisions traditionally considered the prerogative of supply. One measure of meaningful involvement is the extent to which supply is expected to take part in major corporate activities.
Involvement in Corporate Activities Major strategic corporate initiatives include mergers and acquisitions, new facility planning, new product development, outsourcing, revenue enhancement, technology planning, corporate e-commerce initiative, and corporate cost reduction initiative.
Influence of the Industry Sector on Supply Activities The industry sector influences supply responsibilities. Firms that manufacture discrete goods such as cars, consumer electronics, apparel, and furniture face a significant number of dynamic, product-related pressures that affect the supply function and that are less likely to occur in commodity-oriented process industries. These pressures include changing consumer preferences, product innovation, and relatively short product life cycles. Purchased materials and services also represent a high percentage of the cost of sales for firms in discrete goods industries. For example, purchased materials and services can represent 80 percent of the average cost of an automobile. Consequently, firms in discrete goods industries are likely to have supply departments that play a key role in each step in the materials cycle, from product design to production. The role of supply in process industry firms, such as oil and gas, chemicals, glass, and steel industries, is typically different compared to firms in discrete goods industries. Many process industry firms have two supply organizations: a specialized supply group, such as a commodity trading department, that frequently handles purchasing for important raw materials and a purchasing group responsible for the acquisition of materials, supplies, and services that support the operation of facilities. For example, it is common practice for crude oil acquisition in most large integrated oil companies to be handled by a commodity trading group, while other purchases are handled by the supply organization. As a result, although the cost of purchased materials and services might represent a substantial portion of the total cost of sales, the supply function for firms within processing industries is frequently excluded from the acquisition of the single most important raw material. In the public not-for-profit sector and service sectors, most purchases are for end use within the organization itself, with the exception of purchases for resale, such as in distribution and retail. In fast-growing organizations, capital purchases may represent a large percentage of total acquisition expenditures.
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SUPPLY TEAMS Corporate organization structures are leaner, flatter, more adaptive, and more flexible than in the past. Rigid functional structures have been replaced by a greater dependence on cross-functional teams that overlay the functional organization to push decisions lower in the organizational hierarchy. Teams bring together a number of people, often from different functional areas, to work on a common task. It is believed that teams provide superior results compared to individual efforts as a result of the range of skills, knowledge, and capabilities of team members. They also promote cross-functional cooperation and communication and may facilitate consensus building in the organization. Teams are used by a number of functions for a variety of purposes, such as improvements in quality, cost, or delivery; product development; process engineering; and technology management. They can be project oriented or ongoing. Project teams are brought together for a limited time to achieve a specific goal or outcome, such as completion of a capital project or an e-commerce initiative. Ongoing teams continue indefinitely, such as a commodity-sourcing team that manages the process and the supplier relationship.
Leading and Managing Teams Many teams fail to meet performance expectations. Changing to a team-based workplace requires a significant level of commitment and training of management and individual team members. Critical success factors include: • • • • • • • •
Supportive organizational culture, structure, and systems. A common compelling purpose, measurable goals, and feedback for individual and team. Organized for customer satisfaction rather than individual functional success. All functional areas involved in up-front planning, shared leadership roles, and role flexibility. The right people (right qualifications), in the right place (on a team that needed their skills), at the right time (when those skills were needed). A common, agreed-upon work approach and investment in a high level of communication. Dedication to performance and implementation with decisions delegated to the appropriate level. Integration of all relevant functional areas and various teams throughout the project life cycle.
Senior management often tries to combine the flexibility of decentralized supply management and the buying power and information sharing of centralized supply through the use of teams. Various types of purchasing and supply management teams may be used, including cross-functional teams, teams with suppliers, teams with customers, teams with both suppliers and customers, supplier councils (key suppliers), purchasing councils (purchasing personnel only), commodity management teams (purchasing personnel only), and consortia (pool buying with other firms).
Cross-Functional Supply Teams Cross-functional teams consist of personnel from multiple functions focused on a supplyrelated task. It is generally believed that high-performing, cross-functional teams will get
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better results on the task, with greater benefit to the organization as a whole, at lower costs, in less time, with greater stakeholder buy-in. Effective cross-functional teams save time by allowing a simultaneous, rather than a sequential, approach. For example, if key stakeholder groups are involved in the development of a new process from concept through design, development, and rollout, the process may be better to start with, more widely accepted, and adopted quickly. The cycle time may be less than the nonteam approach but more of the work is concentrated at the beginning of the process. Three important cross-functional supply teams are sourcing, new product development, and commodity management.
Sourcing Teams A cross-functional sourcing team includes supply and representatives from other relevant functional areas. The team can focus on a wide range of projects including developing cost-reduction strategies; developing local, business unit, or organizationwide sourcing strategies; evaluating and selecting suppliers; performing value analysis; analyzing spend; and identifying consolidation opportunities. For example, to foster internal strategic business alignment, the CPO at General Mills created a position called director of sourcing operations (DSO). The prime focus of the DSO was to work with cross-functional business unit teams comprised of marketing, R&D, manufacturing, distribution, and accounting on important strategic initiatives. The DSO brought a sourcing perspective and provided a leadership role and alignment between sourcing strategies and business unit strategies. Specific initiatives were proposed as part of the annual business plan and DSO performance was evaluated considering team results.8
New Product/Service Development Teams Effective new product or service development processes can improve an organization’s competitive position. Cross-functional teams can shorten development cycle times, improve quality, and reduce development costs by operating concurrently rather than sequentially. Rather than each functional area performing its task and passing the project off to the next functional area, the key functional groups—usually design, engineering, manufacturing, quality assurance, purchasing, and marketing—work on the new product development simultaneously. Because a large percentage of a product’s cost is purchased materials, early supplier involvement is often needed. When surveyed, many supply managers report greater involvement in new product/service design and development.
Commodity Management Teams Commodity management teams are formed when expenditures are high and the commodity is complex and important to success. These are generally permanent teams that provide increased expertise, more cross-functional coordination and communication, better control over standardization programs, and increased communication with suppliers. They develop and implement commodity strategies aimed at achieving the lowest total cost of ownership. They engage in a number of activities, including supply base reduction, consolidation of requirements, supplier quality certification, management of deliveries and lead times, cost savings projects, and management of supplier relationships. 8
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Johnson and Leenders, Supply Leadership Changes ( Tempe, AZ: CAPS Research, 2007, p. 59).
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The Delphi Corporation case in Chapter 15 describes how the company used approximately 30 commodity teams, across four categories—chemical, electrical, metallic, and technological—to manage its approximately 80 percent of its spend.
Other Types of Supply Teams In addition to the three common forms of cross-functional teams, there are at least six additional approaches to supply teams: supplier participation, customer participation, colocation of supply, co-location of suppliers, supplier councils, and supply councils.
Teams with Supplier Participation Supplier participation in cross-functional sourcing teams depends on the nature of the assignment. For example, it makes sense to include suppliers in teams assigned to develop supplier capabilities or improve supplier responsiveness, but not on teams assigned to evaluate and select new suppliers. Involving suppliers at the product design stage can produce substantial benefits and is common in discrete goods manufacturing industries, such as automotive and consumer electronics. The development of the Boeing 777 commercial aircraft made extensive use of supplier participation on cross-functional teams, enabling successful design and production in record time. Automotive manufacturers periodically give suppliers primary responsibility for designing major components, such as seating systems. The Ford Motor Company case in Chapter 2 provides an example of a company that engages suppliers early in the product-development process to identify opportunities for cost and quality improvements and supplier innovation. Intellectual property issues and confidentiality are perhaps the biggest obstacles to supplier participation, particularly when new product design is involved. Some firms ask suppliers to sign confidentiality agreements to minimize the potential effect of this obstacle on the team’s effectiveness.
Teams with Customer Participation In an effort to be truly customer driven, some organizations include end customers on their teams. For example, when a commercial airframe maker designs a new passenger aircraft, it makes sense to have potential airline customers participate in the design team. They know best the characteristics a new aircraft must have from the airline perspective, given its anticipated passenger loads, route structures, maintenance plans, and passenger service strategies. If supply is also included in teams with end customers, there is a greater opportunity to deliver the greatest value in the shortest cycle time.
Co-location of Supply with Internal Customers Locating buyers with internal customers (e.g., engineering) can help to break down barriers between functions as individuals get to know, and learn to work with, each other. Close proximity fosters greater awareness that leads to better understanding of the goals, strategies, and challenges of each group. Also, internal customers are more likely to involve supply in decisions if the buyer is readily accessible when questions arise. Buyers can “sell” other departments on their worth by providing market intelligence including information on availability, suppliers, and specific commodities. The best selling point is a measurable outcome such as cost reduction, improved quality, or a better specification.
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Co-location of Suppliers in the Buying Organization As organizations look for ways to do more work with fewer people and achieve the productivity and competitiveness goals of the firm, they are increasingly looking to suppliers for expertise and assistance. Having key supplier personnel located in the buying organization who can function as buyers, planners, and salespeople can improve buyer–seller communications and processes, absorb work typically done by the firm’s employees, and reduce administrative and sales costs.
Supplier Councils A number of large firms, such as General Motors and Boeing, use supplier councils to manage supplier relationships. Supplier councils usually consist of 10 to 15 senior executives from the company’s preferred supplier base, along with six to eight of the buying firm’s top management. Supplier councils usually meet two to four times per year and deal with supply policy issues at the buying firm with the objectives of developing relationships and improving communication with the supply base. Supplier councils allow suppliers to be proactive participants in the supply management activities at the buying firm and can be useful forums to communicate strategies to key suppliers, identify problems with the supply base early on, and agree upon competitive targets in areas such as cost, quality, and delivery.
Supply Councils Supply councils are generally comprised of senior supply staff and are established to facilitate coordination among the business units, divisions, or plants. Many firms use supply councils as a means of sharing information among decentralized units, or coordinating activities focused on a specific problem that might involve several supply groups. The goals of the council are to manage buyer–supplier relationships properly and to encourage continuous improvement. For example, Wellman, a manufacturer and distributor of polyester fibers and PET resins, had a decentralized supply organization, where plant purchasing reported to the local manager at each site. The corporate purchasing council consisted of site purchasing leadership. It concentrated on standardizing purchasing processes, standardizing goods and services across sites, aggregating requirements and leveraging volume for lower prices, and simplifying and streamlining the materials process. The council also formulated annual business plans and objectives for purchasing.9
CONSORTIA Purchasing consortia are a form of collaborative purchasing that is used by both public and private-sector organizations as a means of delivering a wider range of services at a lower total cost. Purchasing consortia can take one of several forms, ranging from informal groups that meet regularly to discuss purchasing issues, to the creation of formal centralized consortia for the purpose of managing members’ supply activities. Consortia are quite common in not-for-profit organizations, particularly educational institutions and health care organizations. Interest in the concept in the for-profit sector was sparked by the ability 9
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Leenders and Johnson, Major Changes in Supply Chain Responsibilities ( Tempe, AZ: CAPS Research, 2002).
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to run an Internet-based consortium, called an electronic exchange or marketplace, and the lack of antitrust obstacles (see Chapter 14). Savings through price reductions are a primary motivation for the creation and participation in purchasing consortia. Other benefits are opportunities for staff reductions, product and service standardization, improved supplier management capabilities, specialization of staff, and better customer service. Despite the benefits, hesitation to participate in consortia may be due to concerns about:10 • Antitrust issues. Collaboration might be viewed as anticompetitive by the U.S. Department of Justice’s Antitrust Division and/or the Federal Trade Commission. • Bureaucracy. The consortium may become bureaucratic, difficult to manage, and costly to coordinate. • Complexity. Fear that “open enrollment” will bring together buyers with widely diverse needs and philosophies toward buyer–seller relations, resulting in untenable complexity and dysfunction. • Competitors. Fear that the competition might be allowed to join. • Confidentiality. Disclosure of sensitive information. Therefore, most items purchased through consortia are nonstrategic, such as MRO components and routine services. • Supplier resistance. Strong suppliers may resist participating in consortium arrangements. • Distribution channels. Some believe existing distributors provide adequate pricing and services. • Equality. A firm currently has preferred relationships with suppliers/free riding. The unequal size of member organizations can create difficulties with respect to the allocation of benefits. • Uncertainty. Some were concerned costs would not decline and service levels would. • Standardization and compliance. The degree of uniqueness of requirements and the costs of standardizing products and services. • Governance. Loss of control and reporting relationships were concerns. Successful consortia are able to address these hurdles by achieving the following six objectives:11 1. Reducing total costs for the members through lower prices, higher quality, and better services. 2. Eliminating and avoiding all real and perceived violations of antitrust regulations. 3. Installing sufficient safeguards to avoid real and perceived threats concerning disclosure of confidential and proprietary information. 4. Mutual and equitable sharing of risks, costs, and benefits to all stakeholders, including buying firms/members, suppliers, and customers. 10 T. E. Hendrick, Purchasing Consortiums: Horizontal Alliances among Buying Firms Buying Common Goods and Services ( Tempe, AZ: Center for Advanced Purchasing Studies, 1997); P. F. Johnson, “The Pattern of Evolution in Public Sector Purchasing Consortia,” International Journal of Logistics: Research & Applications 2, no. 1(1999), pp. 57–73. 11 T. E. Hendrick, Purchasing Consortiums: Horizontal Alliances among Buying Firms Buying Common Goods and Services ( Tempe, AZ: Center for Advanced Purchasing Studies, 1997).
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5. Maintaining a high degree of trust and professionalism of the consortium stakeholders. 6. Maintaining a strong similarity among consortium members and compatibility of needs, capabilities, philosophies, and corporate cultures.
Conclusion
There is no one perfect organizational structure for supply. Its organizational structure will mirror the overall corporate structure. The challenge for supply executives is to maximize the benefits of their organizational structure, whether it is centralized, decentralized, or hybrid. Major research into organizational issues over the last decade has provided useful insights into innovative attempts to integrate the supply function and suppliers more effectively into organizational goals and strategies. No matter where the supply function is situated on the organization chart, each individual member of the supply organization has the opportunity to improve relations with internal customers and suppliers in an effort to make a greater contribution to organizational objectives.
Questions for Review and Discussion
1. Relate the objectives of supply to (1) a company producing automobiles, (2) a large fast-food restaurant chain, and (3) a financial institution. 2. What are the challenges faced by a supply manager working in a highly centralized structure? In a highly decentralized structure? 3. How does specialization within supply differ in small and large organizations? 4. What are the reasons for giving the CPO a title and reporting line equal to marketing, engineering, or other key business functions? 5. What are indicators that supply is “meaningfully involved”? 6. What are the challenges in expanding the role of the CPO? 7. What implementation factors would you consider when asked to change the supply organization from a centralized to a hybrid structure? What factors would you consider if moving from decentralized to centralized? 8. How is team buying likely to affect the purchasing/supply function over the next decade? 9. Why and how would you go about setting up a consortium for the purchase of fuel oil, furniture, corrugated cartons, or office supplies?
References
Fearon, Harold E., and Michiel R. Leenders. Purchasing’s Organizational Roles and Responsibilities. Tempe, AZ: Center for Advanced Purchasing Studies, 1995. Giunipero, Larry C.; Robert B. Handfield; and Reham Eltantawy. “Supply Management’s Evolution: Key Skill Sets for the Supply Manager of the Future.” International Journal of Operations and Production Management 26, no. 7, pp. 822–844. Hendrick, Thomas E. Purchasing Consortiums: Horizontal Alliances among Firms Buying Common Goods and Services. Tempe, AZ: Center for Advanced Purchasing Studies, 1997. Hendrick, Thomas E., and Jeffrey Ogden. Chief Purchasing Officers’ Compensation Benchmarks and Demographics: A 2001 Study of Fortune 500 Firms. Tempe, AZ: Center for Advanced Purchasing Studies, 2002.
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Johnson, P. Fraser. “Supply Organizational Structures.” Critical Issues Report, CAPS Research, August 2003. Johnson, P. Fraser. “The Pattern of Evolution in Public Sector Purchasing Consortia.” International Journal of Logistics: Research and Applications 2, no. 1 (1999), pp. 57–73. Johnson, P. F., and M. R. Leenders. Supply’s Organizational Roles and Responsibilities. Tempe, AZ: CAPS Research, 2004. Johnson, P. F., and M. R. Leenders, Supply Leadership Changes. Tempe, AZ: CAPS Research, 2007. Leenders, Michiel R., and P. Fraser Johnson. Major Structural Changes in Supply Organizations. Tempe, AZ: Center for Advanced Purchasing Studies, 2000. Leenders, Michiel R., and P. Fraser Johnson. Major Changes in Supply Chain Responsibilities. Tempe AZ: Center for Advanced Purchasing Studies, 2002. McCue, Cliff, and Eric Prier. “Using Agency Theory to Model Cooperative Public Purchasing.” Journal of Public Procurement 8, no. 1, 2008, pp. 1–35. Murphy, David J., and Michael E. Heberling. “A Framework for Purchasing and Integrated Product Teams.” International Journal of Purchasing and Materials Management, Summer 1996, pp. 11–19. Nollet, Jean, and Martin Beaulieu, “Should an Organization Join a Purchasing Group?” Supply Chain Management 10, no. 1 (2005), pp. 11–17.
Case 3–1
Iowa Elevators Scott McBride, director of purchasing at Iowa Elevators, was reviewing information collected by his analyst, Cathy Ritchie, as he prepared for a meeting with the executive management team scheduled for Wednesday, June 11. Scott had been asked by Walter Lettridge, Iowa, Elevator’s CEO, to present a five-year plan for the purchasing department at the meeting. In preparation for the meeting, Scott asked Cathy to prepare a report analyzing all expenditures made by the company with outside suppliers over the previous year. It was now June 3, and Scott knew there was still a lot of work that had to be completed to get ready for the meeting the following week.
IOWA ELEVATORS Iowa Elevators was one of the largest grain-handling companies in the United States. Headquartered in Des Moines, Iowa, the company had annual revenues of $2.3 billion
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and employed more than 2,500 people. Its two business units were the grain-handling and marketing division and the farm supplies division. The grain-handling and marketing division operated approximately 300 grain elevators in the Midwest. This division represented approximately 75 percent of total company revenues, although total revenues had declined by 20 percent from the previous year due to drought conditions that had affected farm crop production. Over the previous five years, the company had invested heavily in upgrading its elevator system to improve throughput and increase capacity in key regions. The farm supplies division sold crop-protection products, equipment and supplies, fertilizer, and seed through its network of country elevators and approximately 30 marketing centers. Revenues for this division had doubled over the previous five years as part of a strategy to tap the company’s country elevator network to diversify its revenue base.
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Iowa Elevators had a past reputation for steady financial performance and profitability. However, the company had seen a steady decline in profitability over the previous three years. In the most recent fiscal year, it experienced a loss of $11 million after taxes and a sharp decline in working capital. Management attributed its disappointing results to lower volumes in its grain-handling and marketing division and increased competition. Despite its rising market share, operating margins at the farm supplies division had remained flat. Concern over the financial performance of the company led to a decision by the board of directors to make changes to the executive team. In February, Walter Lettridge, a veteran of the grain-handling industry, was brought in as the new president and CEO. Shortly afterward, Jose Sousa joined Iowa Elevators as the new chief financial officer. Both Walter and Jose had worked together at a competitor of Iowa Elevators. Immediately after joining the company, Walter went to work creating a major cost-cutting initiative, which would include reductions in headcounts, capital expenditure budgets, and overhead expenses. As part of this process, Scott McBride was asked to present a five-year plan to the executive management team, including annual cost reduction targets.
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PURCHASING AND SUPPLY MANAGEMENT Scott supervised a group of 11 people (see Exhibit 1) who were responsible for the acquisition of requirements for head office and some regional sales and administrative offices. Its major purchases were information technology (hardware and software); printing for forms, brochures, and advertising; office supplies; and company automobile leases. The only change in the purchasing organization within the last year had been the addition of a travel coordinator as a result of a contract for air travel and car rentals. The purchasing organization was part of the corporate services organization, which also included the human resources and information technology groups, and reported to the CFO. Iowa Elevators had a history of decentralized management, with individual divisions held accountable for their own operations and bottom-line performance. As a result, local elevator managers acted autonomously but were responsible for local market share and profitability. In addition, the elevator managers also made decisions concerning the amount and variety of crop-protection products, fertilizer, and seed stock to handle in their retail
EXHIBIT 1 Iowa Elevators Purchasing Department Jose Sousa CFO
Scott McBride Director
Manager Other Purchases & Fleet
Supervisor
Analyst
Manager IT Purchasing
Asset Management Clerk
Travel Coordinator
Cathy Ritchie Analyst
Buyer
Assistant Buyer Expediting Clerk Invoice Clerk
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operation. Purchases for elevator operations were handled locally and monitored based on spending limits set in annual operating budgets. The farm supplies division had a group of four product managers who were responsible for the three main product segments (crop-protection products, equipment and supplies, and fertilizer and seed). These individuals were responsible for supplier selection, product mix, branding, and promotion and assisted elevator and marketing center managers in the areas of promotion, new product development, and inventory planning.
ANALYSIS OF CORPORATE SPEND In a meeting in early May, Scott was asked by Walter Lettridge and Jose Sousa to present his five-year plan for the purchasing department at an executive management team meeting on June 11. Walter had scheduled time for a number of senior managers to present their plans and ideas aimed at returning the company to profitability. During the meeting, Walter commented to Scott: “I expect purchasing to deliver cost savings and your group needs to play a more significant role in the company. You need to explain what you can deliver and explain how you intend to accomplish your objectives. As far as I am concerned,
EXHIBIT 2 Total Purchases by Category ($000)
everything is on the table right now. We need to return the company to profitability and I am not afraid to make some major changes in terms of how we run this business.” Recognizing the need to present a thorough plan, Scott enlisted the support of his analyst, Cathy Ritchie, to help him collect and organize data. The data collection focused on two questions: (1) How much money did Iowa Elevators spend with its outside suppliers? and (2) How much inventory did the company carry? The data collection process had been complicated by the variety of management systems at different levels and at different locations. Scott believed that, if more time had been available, Cathy might have been able to capture more spend and inventory data. Cathy’s analysis identified a total corporate spend of $728 million. Although the company dealt with more than 1,500 suppliers, 20 suppliers accounted for approximately 45 percent of the total spend and the top five represented 35 percent. (The top five suppliers consisted of two railway companies and three suppliers to the farm supplies division for crop protection and fertilizer.) She estimated that average annual inventories in the farm supplies division were nearly $120 million with annual purchases of $310 million. A summary of Cathy’s key findings is reported in Exhibits 2 and 3.
Spend Category
Annual Spend*
Farm supplies Information technology and telecommunications Fees, levies, memberships Energy Financial services and interest expense Fleet Insurance Packaging Professional services MRO & construction Transportation services Travel and entertainment Other Miscellaneous and unclassified
$ 254,406 17,187 26,301 8,602 24,461 4,229 5,239 10,551 7,708 127,829 208,927 3,557 17,350 11,926
Total
$ 728,273
* Data for the most recent fiscal year.
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EXHIBIT 3 Farm Supplies Division Inventory ($000)
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Category
Average Inventory
Annual Purchases
Crop protection products Equipment and supplies Fertilizer Seed
$ 65,098 22,388 20,938 10,389
$ 124,696 13,743 130,557 41,787
$ 118,813
$ 310,783
Total
THE MIS PROPOSAL Scott was aware that the MIS Group had been asked to make a similar presentation to the executive management team. The MIS director had informed Scott that he would be requesting $10 million in additional spending beyond standard upgrades over the next five years with anticipated cost savings of about $500,000 per year.
PREPARATION FOR THE MEETING Scott viewed the upcoming meeting as an opportunity to redefine the role of purchasing at Iowa Elevators. His session with executive management was expected to last approximately 90 minutes, and he wanted to prepare a five-year plan with specific objectives for each year, including cost reduction targets. In particular, his plan for the coming year had to be very specific and include
identifiable projects and initiatives, schedules, project plans, and expected costs and benefits. As part of his proposal, Scott also wanted to establish a budget and human resource requirements that would be needed to support his recommendations. While he regarded his staff as competent, Scott recognized that he would require new managerial resources if the role of corporate purchasing was to be expanded. Consequently, he also planned on proposing a new organization structure and establishing a headcount plan and budget for the purchasing department. As Scott reviewed Cathy’s report, he began considering where he was going to start and what could be accomplished. His major concern would be resistance from the divisions and field elevator managers, and he wondered what, if anything, could be done to address any organizational resistance to his recommendations.
Case 3–2
Roger Haskett On June 26, 2004, Roger Haskett, director of purchasing for Morrow University in San Antonio, Texas, was evaluating a proposal negotiated by Professor Kahsay from the engineering faculty to upgrade computer equipment in his engineering lab. Roger was concerned that the proposal involved a capital lease arrangement, and even though there was no policy to prevent capital leases from being arranged, the university did not typically enter into such agreements.
MORROW UNIVERSITY With more than 1,100 faculty members and almost 30,000 undergraduate and graduate students, Morrow University was recognized as a national leader in teaching as well as
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research. Through its 12 faculties and schools and four affiliated colleges, the university offered more than 60 different degree and diploma programs. The purchasing department’s mandate was to maximize the value of funds spent on supplies, equipment, and services; ensure ethical buying practices; maintain good supplier relations; and ensure compliance with the regulations governing taxes, accounting procedures, and other related university policies. The purchasing department was responsible for the acquisition of all goods and services for the university except for construction contracts, reading material offered by the library system, items offered for resale by the campus bookstore, and purchases for the food services department.
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EXHIBIT 1 Capital and Operating Leases
Capital Leases If any of the following criteria are met, a lease must by classified as a capital lease: 1. 2. 3. 4.
Ownership of the property is transferred to the lessee at the end of the term, or The lease contains an option to purchase the property for less than fair market value, or The lease term is greater than 75 percent of the property’s estimated economic life, or The present value of the lease payments exceeds 90 percent of the fair market value of the property.
Operating Leases Any lease that is not a capital lease is an operating lease.
Most faculty and staff tended to handle their own purchasing needs for low-value purchases, which had been made easier with online purchasing applications. For purchases greater than $100,000, the purchasing department assigned a senior buyer to monitor and assist throughout the acquisition process. Senior buyers were available from three functional areas: business items, scientific items, and furniture/building items. University procedures tried to maximize purchasing value and minimize vendor relations issues. Prior to acquiring goods or services with a value in excess of $7,500, two written quotes were required. Three quotes were required for acquisitions in excess of $10,000, and state policies required all acquisitions over $100,000 to be posted electronically to allow all potential vendors an opportunity to quote.
THE EQUIPMENT LEASE PROPOSAL On June 22 the purchasing department received a proposal from Professor Kahsay to lease eight new Curtis processors for his engineering laboratory from Menard Leasing (Menard). The payment schedule called for an initial payment of $115,000 due on September 1, 2004; three annual payments of $90,000 due on March 1st of each of the subsequent three years; and a purchase option of $90,000 due on February 28, 2008. The total cost of the equipment would be $475,000, including interest. Given the nature and size of this request, Roger decided to deal with this request personally. Even though there was no policy to prevent capital leases from being arranged, the university did not typi-
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cally enter into capital leases. In general, the purchasing department considered capital leases an expensive and problematic purchase arrangement that should seldom be undertaken. Exhibit 1 describes the differences between capital and operating leases. In a subsequent discussion with Professor Kahsay, Roger found out that Professor Kahsay had arranged a capital lease because he did not have sufficient funds within his annual operating budget to cover the cost of purchasing the equipment outright. Roger requested that Professor Kahsay change the lease to a purchase agreement with the equipment supplier. Roger wanted to pay cash for the net present value of the lease—approximately $425,000. However, Professor Kahsay was adamant that he should handle the acquisition out of his own budget and that any delays would jeopardize several important research projects. He said: “This is the only way we can stay within my budget and have the equipment arrive on time. Several of my doctoral candidates and I have important papers due for a worldwide conference and you are just blocking academic progress.”
DECISION As of June 26, Roger had not yet signed the lease and both Professor Kahsay and Pamela Switzer, from Menard, were pressing for Roger to approve the contract (see Exhibit 2). However, Roger felt uncomfortable with the arrangement and wondered what action he should take.
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EXHIBIT 2 Conditional Sales Contract
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MENARD LEASING Attn: Roger Haskett We are pleased to present the following proposal as a basis for further discussion concerning the financing by Menard Leasing of your planned equipment acquisitions. We appreciate the opportunity to make this proposal to you. Menard Leasing looks forward to working with you to complete this transaction. LESSEE: EQUIPMENT:
Morrow University (2) Curtis SV1 Module with (4) 2.1 FJLOP Processors & Full Care Warranty until February 28, 2008 (as described in attached quotations). TERM: 42 months, commencing September 1, 2004, or 15 days after delivery of processors. ESTIMATED PAYMENT: $115,000.00 due September 1, 2004, followed by 3 annual payments of $90,000.00 commencing March 1, 2005, payable in U.S. funds, with all applicable taxes. ACTUAL PAYMENT: The Estimated Monthly Payment is based on Menard’s cost of funds on the date of this letter and, to arrive at the Actual Monthly Payment, it will be adjusted upward or downward to reflect changes in interest rates. END OF LEASE 1) Purchase for $90,000.00 February, 28, 2008. CONDITIONS: 2) The absence of any material adverse changes in the Lessee’s financial health or creditworthiness prior to the Funding Date. 3) The completion and due execution and delivery of Menard’s standard form of Master Lease/Lease Arrangement, Delivery & Acceptance Certificate and other documents, as Menard may reasonably require, all such documents to be in form and substance satisfactory to Menard in all respects; such documents will supercede this letter once executed and delivered. 4) The acceptance of this proposal by the Lessee by June 28, 2004. 5) Lessee agrees to install and accept the Equipment set forth within ten (10) days of delivery or notify the Lessor of any problems with the Equipment within the ten days. Acceptance shall also be based on running the basic hardware and software diagnostics. In addition, Lessee agrees to accept partial shipment of the Equipment with the understanding that partial shipment shall include an operable system. ACCEPTED this ________ day of June, 2004. MENARD LEASING
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MORROW UNIVERSITY
Pamela Switzer
(signature)
Pamela Switzer
(name/title)
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Chapter Four Supply Processes and Technology Chapter Outline The Supply Management Process Strategy and Goal Alignment Ensuring Process Compliance Information Flows Steps in the Supply Process 1. Recognition of Need 2. Description of Need Purposes and Flow of a Requisition Types of Requisitions Early Supply and Supplier Involvement 3. Identification of Potential Sources Issue an RFx 4. Supplier Selection and Determination of Terms 5. Preparation and Placement of the Purchase Order 6. Follow-up and Expediting Assess Costs and Benefits
76
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Improving Process Efficiency and Effectiveness A Supply Process Flowchart Strategic Spend Nonstrategic Spend Information Systems and the Supply Process Benefits of Information Systems Technology Technology Options Types of Information Systems Intranets and Extranets Technology-Driven Efficiency and Effectiveness Electronic Procurement Systems Electronic or Online Catalogs Electronic Data Interchange (EDI) E-Marketplaces Online Reverse Auctions Radio Frequency Identification (RFID) Implications for Supply
7. Receipt and Inspection Eliminate or Reduce Inspection
Policy and Procedure Manual
8. Invoice Clearing and Payment Aligning Supply and Accounts Payable Cash Discounts and Late Invoices
Questions for Review and Discussion
9. Maintenance of Records and Relationships Linking Data to Decisions Manage Supplier Relationships
Conclusion References Cases 4–1 Bright Technology International 4–2 Hemingway College 4–3 Portland Bus Company
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Key Questions for the Supply Decision Maker Should we • Use an e-procurement system to improve the efficiency of the supply process? • Use online reverse auctions to buy nonstrategic goods and services? • Consider establishing a supplier-managed inventory program for MRO requirements? How can we • Handle lower-value purchases more efficiently? • Streamline the process so that supply managers are more involved in the earlier stages? • Communicate more effectively with our internal business partners?
Identifying and streamlining key business processes to reduce costs, grow revenues, and manage assets represents an opportunity in most organizations. Critical processes are embedded in all areas of the organization, including new product development, supply, operations, marketing, sales, and accounts payable. Managing these processes, understanding what makes each process efficient and effective, and clarifying how each process interacts with other processes and activities are critical to the success of the organization as a whole. Understanding how and when to apply information technology solutions to business processes is also an ongoing challenge. According to the CapGemini Global Chief Procurement Officer Survey, over 60 percent of total organizational spend was under the control of procurement in 65 percent of respondents.1 While this result indicates the importance of supply in procuring a significant portion of organizational resources, it also suggests the challenges of designing an efficient and effective process for a diverse spend. Ultimately, however, the simplest definition of supply is the exchange of money (the buyer’s responsibility) for goods and services (the supplier’s responsibility). The first key decision is: Which process or processes will be most effective and efficient to support this exchange? The options for managing the information flows of a supply process have expanded along with supply management’s range of responsibilities. The nature of the requirement will dictate the information exchanges between the purchaser and supplier. Is the purchase one-time or repetitive? How are volumes, specifications, and shipping schedules communicated? Are the purchases part of a short-term or long-term contract? How will prices be established and how will payment be made? The acquisition process is closely tied to almost all other business processes and also to the external environment, creating a need for complete information systems and crossfunctional cooperation. For example, supply must work with engineering to determine specifications, operations to determine production schedules, and finance to arrange payment. In the past 30 years, there have been remarkable advancements in information technology 1
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Global Chief Procurement Officer Survey 2009, CapGemini Consulting, www.capgemini.com/consulting.
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used in the recording, transmission, analysis, and reporting of information within organizations and their supply chain networks. Most people recognize the strategic importance of information and knowledge management. They also recognize that technology provides tools that can improve efficiency and effectiveness when applied appropriately to a business process. The Internet and the availability of integrated software packages have had a substantial impact on the acquisition process and its management. Supply managers need to stay abreast of technological developments and be able to assess the fit of each new tool with the organization’s goals and strategy. Thus, the second key decision is: What information systems might be used to support or enable efficient and effective processes? This chapter focuses, first, on the critical steps of a robust supply management process, one with structure and discipline. Once the basic supply process is understood, tools and techniques are addressed that might improve the efficiency and effectiveness of the entire process or specific categories of spend. If the process itself is flawed, then a process improvement program must be undertaken before the process is automated. Remember, process first and technology last.
THE SUPPLY MANAGEMENT PROCESS A process is a set of activities that has a beginning and an end, occurs in a specific sequence, and has inputs and outputs. The supply management process starts with need recognition and ends with monitoring suppliers and relationships. The steps include: recognize and describe need, identify potential sources, select source(s), determine price and terms, follow up and expedite, receive, pay invoice, and monitor. A process-oriented person considers the flow of information, materials, services, and capital throughout the process no matter how many functions or departments touch it. A functionally oriented person only considers the steps for which his or her department is responsible. If supply personnel are not involved until potential sources are identified, they and the internal business partner may miss the opportunity for supply and suppliers to add value in the need recognition and description stages. Waste is driven into the process in the forms of unnecessary costs, long cycle times, and missed opportunities because the buying organization, operating out of functional silos, manages the process sequentially rather than simultaneously. Five major reasons for developing a robust process are as follows: 1. 2. 3. 4. 5.
Large number of items. Large dollar volume involved. Need for an audit trail. Severe consequences of poor performance. Potential contribution to effective organizational operations inherent in the function.
Strategy and Goal Alignment The first step in optimizing the supply process is building internal consensus around the opportunities to add value to the organization. The focus is: “Where, when, and how can supply personnel contribute to short- and long-term goals and strategies of the organization?” Vertical and horizontal alignment of strategy and goals is required for supply to fully contribute to the organization. Vertically, if the supply strategy at the functional or business
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unit level is out of sync with organizational strategy, then supply decisions will hinder rather than assist with the achievement of organizational goals. Horizontal alignment between and among functional areas is also required. For example, to attain profitability targets, the finance group’s cash flow goals may lead to a payment policy that conflicts with the supply group’s goal to contribute to profitability through longterm partnerships with key suppliers in which payment terms were a key negotiating point. Personnel at all levels must work to align strategies and goals vertically and horizontally to maximize organizational opportunities. Individuals from many functions play valuable roles in a successful acquisition process. The users and specifiers of the good or service (supply’s internal customers or internal business partners) play a role in recognizing and describing the need. They are usually the budget owners and the primary information sources for technical descriptions, volume requirements, and quality, delivery, and service targets. How and when internal users communicate with supply varies. Sometimes internal customers hand off information to supply once they have clearly defined the requirement. Other times, supply personnel bring market intelligence such as supply availability, price trends, or new technology to the need recognition and description stages. When value can be created in the early stages of the process, the internal business partners and supply should interact early and often in cross-functional sourcing teams, new product or service design teams, and commodity management teams. Often, however, supply takes the lead role in analyzing and selecting the supplier(s) and determining price and other terms and conditions such as payment, delivery, quality and service. Other functional areas may step in as well. For example, expediting, shipping and receiving, legal, marketing, information systems, engineering, and accounts payable all play a role in the process, but are typically part of different functional areas with a different reporting line than supply. Each stakeholder has goals and objectives relative to the purchase. When these conflict, the total cost of owning, consuming, and disposing of a purchase may increase unnecessarily. Because of this risk, many senior managers foster a process orientation through cross-functional teams, and by creating shared or common goals, objectives, and metrics.
Ensuring Process Compliance Increasing the rate of internal compliance with the supply process can be challenging. Often nonsupply staff make unauthorized buying decisions (maverick buying) that lead to higher total cost of ownership and undermine supply’s credibility internally and externally. The root causes of noncompliance must be identified and eliminated. Organizational structure affects process compliance. In a highly decentralized organization where supply decisions are made at the business unit, plant, or division level, supply councils composed of site leaders may be beneficial. The council works to standardize goods, services, and processes across sites; aggregate requirements and leverage volume for lower prices; simplify and streamline the materials management process; formulate annual business plans; and establish objectives for supply. Without a supply council and willing participation by site supply leaders, the organization may have multiple suppliers of the same goods and services with disparate prices, terms and conditions and varying levels of quality and service. Even in a highly centralized organization there may be high levels of noncompliance. Process improvements and consistent delivery of results to internal business partners may increase compliance.
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Organizational culture also influences process compliance. A mandate from top management to use the supply process will stop maverick buying in some organizational cultures. In others, mandates mean little and supply personnel must persuade and convince users to comply. Information systems may compel compliance by eliminating alternative purchasing paths, reducing process cycle time, and instilling confidence in users that delays will be minimal.
Information Flows There are four basic information flows involving supply. Inward Flows (1) Information from within the organization is sent to supply, including statements of need for materials and services. (2) Information from external sources is sent to supply. This may come from suppliers (e.g., prices, and deliveries) or from other sources (e.g., general market conditions and import duties). Outward Flows (1) Information from within supply is sent to others within the organization. This includes supplier pricing, market conditions, and supply forecasts for cash flow budgeting. (2) Information, such as requests for quotes or proposals, is sent from supply to external sources (suppliers). Supply must be able to manage effectively information flows involving both internal and external partners in the supply chain. Information systems enable the efficient flow of information and support effective decision making. These tools are discussed later in this chapter.
Steps in the Supply Process The supply process is basically a communications process. Determining what needs to be communicated, to whom, and in what format and time frame is at the heart of an efficient and effective supply management process. It is essential for supply professionals to determine when, where, and how they can add value and when, where, and how they can extricate themselves from steps that are best left to other people or to technology. The essential steps in the supply process are: 1. 2. 3. 4. 5. 6. 7. 8. 9.
Recognition of need. Description of need. Identification and analysis of possible sources of supply. Supplier selection and determination of terms. Preparation and placement of purchase order. Follow-up and/or expediting the order. Receipt and inspection. Invoice clearing and payment. Maintenance of records and relationships.
1. RECOGNITION OF NEED A purchase originates when a person or a system identifies a definite need in the organization—what, how much, and when it is needed. The supply department helps anticipate the needs of using departments. Supply policy and practice may encourage or require the use of standardized items, provide procedures
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for special or unusual orders, and limit the use of rush orders. Also, since the supply department tracks price trends and general market conditions, placing forward orders may be essential to protect against shortage of supply or increased prices. Supply should inform users of the normal lead time and any major changes for all standard purchased items. Since the greatest opportunity to affect value is when needs are recognized and described (product conception and design), the supply manager and supplier can contribute more in these steps than later in the acquisition process. (See Chapter 6 for additional information on value creation.) Early supply and supplier involvement, often as members of new product development teams, provides information that may lead to cost avoidance or reduction, faster time to market, and greater competitiveness. As discussed in Chapter 3, many organizations are turning to cross-functional teams to bring different functional areas, and suppliers, into the process as early as possible.
2. DESCRIPTION OF NEED The purchaser must know exactly what the internal customers want. And internal requirements should be driven by a clear understanding of the external customer’s needs. It is essential to have an accurate description of the need, whether it is a tangible good, a service, or goods and services bundled together. Unclear or ambiguous descriptions, or overspecified materials, services, or quality levels will lead to unnecessary costs. Supply management and the user, or the cross-functional sourcing team, share responsibility for accurately describing the item or service needed.
Purposes and Flow of a Requisition A requisition is the document used to communicate needs internally between users/ specifiers and supply management according to established accounting controls. The flow of the requisition is determined by who needs access to the information to perform their duties, the need for an audit trail, and evidence of proper authorization. A requisition is a gatekeeping tool to manage the flow of information through three gates: (1) authority, (2) internal clarity, and (3) internal clearance. Gate 1: Authority Does the requisitioner have the authority to make the specified request—goods or services—and at the specified budget level? The supply department establishes who has the power to requisition, prevents unauthorized requisitions, and communicates to suppliers that a requisition is not an order. Gate 2: Internal Clarity Is the need described in a clear and unambiguous way? Uniform terms or standardized commodity or service codes should be used to describe required articles or services. The importance of proper nomenclature or commodity coding cannot be overemphasized. The most effective way to secure this uniformity is to maintain a database of common purchased items. A coding structure that standardizes purchases brings order and consistency and supports an efficient and effective process. A general catalog lists all the items used, and a stores catalog lists all items carried in stock. Depending on the technological sophistication of the organization, catalogs may be in an electronic file, on e-catalogs, in loose-leaf form, or in a card index. Difficulties arise when supplier codes
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(manufacturers or service providers), industry codes, and company codes are different. While software is available to cleanse data and apply standard coding schemas, these tools are not perfect. If adequately planned and properly maintained, coding schemas promote uniformity in description, reduce the number of odd sizes or grades of articles requisitioned, and facilitate accounting and inventory procedures. If poorly planned, maintained, or used, they may be confusing and expensive beyond their projected benefits. Convincing internal users that a standard item will suffice is an ongoing challenge for supply personnel. Typically only one item is included on a purchase requisition, particularly for standard items. For special items not regularly stocked, several items may be covered by one requisition if for the same delivery date. This simplifies recordkeeping, since specific items are secured from different suppliers, call for different delivery dates, and require separate purchase orders and treatment. Gate 3: Internal Clearance Descriptions should be reviewed before preparing documentation to communicate externally with potential suppliers. Quantity, based on anticipated needs, should be compared to economical quantities. The delivery date should allow time to secure quotations and samples, if necessary, and to execute the purchase order and obtain delivery. The requisitioner should be notified if there is a time or delivery constraint that drives in additional expense. Consistent lack of adequate lead time is an indicator of a process problem that must be analyzed and resolved. This review may be performed by a buyer or a team or it may be system generated. In an electronic or e-procurement system, preloaded data establish decision rules for requisitioning, order points, and suppliers and include triggers to send red flags for buyer review. It is management by exception. Humans are flagged when the system detects a problem based on thresholds set by decision makers. For lower-value and lower-risk purchases, the buyer should question a specification if a modification would deliver more value. For example, the buyer might recommend a substitute if there are market shortages or lower-priced or better alternatives. A high degree of interaction between the buyer and the user is required in the early stages of need definition because of the impact of future market conditions. At best, an inaccurate description may result in loss of time; at worst it may have serious financial consequences and cause disruption of supply, hard feelings internally, lost opportunity for a product or service improvement, and loss of supplier respect and trust.
Types of Requisitions There are several types of purchase requisitions, including standard requisitions, traveling requisitions, a bill of materials, and stores/inventory requisition. Standard Requisition requisition: 1. 2. 3. 4.
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The following information should be included on a standard
Date. Number (identification). Originating department. Account to be charged.
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5. 6. 7. 8.
Supply Processes and Technology 83
Complete description of material or service desired and quantity. Date material or service needed. Any special shipping or service-delivery instructions. Signature of authorized requisitioner.
Electronic requisitions typically have prefilled fields for standard or recurring information. Some organizations include fields for “suggested supplier” and “suggested price.” Traveling Requisition People have always adopted and adapted new technology to business processes. The traveling requisition was an innovation used for recurring requirements and standard parts to reduce operating expenses. In a manual system, the traveling requisition is a form on cardstock that contains a complete description of the item. The requisitioner sends the card to supply, indicating quantity and date needed. Supply enters the supplier, price, and purchase order (PO) number on the traveler and sends it back to the requisitioner, who files the card until the next reorder. The process of determining which items are appropriate for use on a traveling requisition and the flow of the information are useful when transitioning to an automated system. Bill of Materials A bill of materials (BOM) simplifies the requisitioning process for frequently needed line items in organizations that make a standard item over a relatively long period of time. A BOM includes all materials and parts, including allowance for scrap, to make one end unit: for example, a two-slice toaster. Production scheduling notifies supply of the quantity (e.g., 18,000) scheduled for production next month. Supply “explodes” the BOM by multiplying through by 18,000 to determine the total quantity of material needed for next month’s production. Comparison of these numbers with inventory yields the open-to-buy figures. A materials requirement planning (MRP) or enterprise resource planning (ERP) system is preloaded with pricing information on suppliers with longterm agreements, and order releases are generated to cover the open-to-buy amounts. (See Chapter 8.) Stores/Inventory Requisition Needs may be met by a material requisition from inventory or the transfer of surplus stock from another department or division.
Early Supply and Supplier Involvement For purchases that are of strategic or critical value to the buying organization, it is usually advisable to manage the process through a cross-functional sourcing team (see Chapter 3). For lower-value purchases, the buyer should question a specification if it appears that the organization might be served better through a modification. For example, the buyer might recommend a substitute if there are market shortages of the desired commodity or lowerpriced or better alternatives are available. Since future market conditions play such a vital role, it makes sense to have a high degree of interaction between the supply and specifying groups in the early stages of need definition. At best, an inaccurate description may result in some loss of time; at worst it may have serious financial consequences and cause disruption of supply, hard feelings internally, lost opportunity for a product or service improvement, and loss of supplier respect and trust.
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3. IDENTIFICATION OF POTENTIAL SOURCES Supplier selection constitutes an important part of the supply function. It involves (1) identifying potential qualified sources and (2) assessing the probability that a purchase agreement would result in on-time delivery of satisfactory product/service with appropriate before and after sale service at lowest total cost of ownership. Supplier selection is discussed in detail in Chapter 12, “Supplier Selection.” This section addresses the tools available to communicate with potential suppliers.
Issue an RFx When items are not covered by a contract, the buyer has four options for communicating with potential suppliers: (1) Issue a request for information (RFI)—an optional step that is not a solicitation for business. The three options for soliciting business are: (1) request for quotation (RFQ), (2) request for proposal (RFP), or (3) request or invitation for bid (RFB or IFB). There are no commonly accepted definitions of these terms, so it is important for buyers to communicate clearly to potential suppliers the analysis and selection process. Often each solicitation tool signifies a level of complexity of the purchase, dollar value, and degree of risk the supplier bears.
Request for Information (RFI) An RFI is issued to gather information about potential suppliers’ products and services. Even though the Internet enables fairly quick and easy searches, many supply organizations still prepare and send (electronically or by mail) RFIs to suppliers. An RFI is not a solicitation for business or an offer to do business. As the name suggests, an RFI is for information-gathering purposes only. Solicitations The three options for soliciting business from potential suppliers are: (1) request for quotation (RFQ), (2) request for proposal (RFP), or (3) request or invitation for bid (RFB or IFB).
Request for Quotation (RFQ ) Typically, an RFQ is issued when there is a clear and unambiguous description of the need: for example, a grade of material, a stock-keeping unit (SKU), or other commonly accepted terminology. An RFQ is basically a price comparison tool for commonly used commodities sold in an open and free market where quotations can be obtained at any time. The RFQ is a standard requisition form that includes a list of potential suppliers. It is prepared, checked, signed, and transmitted electronically (e-procurement system, e-mail, or fax) or mailed to potential suppliers. Quotations are recorded, the buyer selects a supplier(s), typically on the basis of price, and a purchase order is prepared and placed with the chosen supplier.
Request for Proposal (RFP) An RFP is used for more complex requirements in which price is only one of several key decision factors. Typically the buyer is planning to negotiate price and terms. An RFP includes a detailed description of the requirement and invites bidders to use their expertise to develop and propose one or more solutions.
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Request for Bid A request or invitation for bid is used in a competitive bid process with or without the opportunity to negotiate after bid receipt. A detailed bid specification package, similar to an RFP, is developed. It is important to communicate to suppliers how the final selection will take place. Will this be a sealed competitive bid in which the contract will be awarded based on the lowest bid? Will the bids be the starting point from which negotiations will take place?
4. SUPPLIER SELECTION AND DETERMINATION OF TERMS Analysis and selection of the supplier lead to order placement. Applicable tools range from a simple bid analysis form to complex negotiations. Supplier selection methods are discussed in Chapter 12, “Supplier Selection.” Determination of price and terms is discussed in Chapter 9, “Delivery,” Chapter 10, “Price,” Chapter 11, “Cost Management,” and Chapter 15, “Legal and Ethics.”
5. PREPARATION AND PLACEMENT OF THE PURCHASE ORDER A purchase order is used (see Figure 4–1) unless the supplier’s sales agreement or a release against a blanket order is used instead. Failure to use the proper contract form may result in serious legal complications or improper documentation. Even where an order is placed by telephone, a confirming written order should follow. In no instance—unless it is for minor purchases from petty cash—should materials be bought without documentation, written or computer generated. All companies have purchase order forms. In practice, however, all purchases are not governed by the conditions stipulated on the purchase order. Many are governed by the sales agreement submitted by the seller. Every company seeks to protect itself as completely as possible. Responsibilities that the purchase order form assigns to the supplier are often transferred to the buyer in the sales agreement. Therefore, management is anxious to use its own sales agreement when selling its products and its own purchase order form when buying. Chapter 15 discusses the legal implications.
Format Purchase order format and routing varies. The essential requirements are the serial number, date of issue, name and address of the supplier, the quantity and description, date of delivery, shipping directions, price, terms of payment, and conditions governing the order. The conditions might include: 1. Indemnification clause—to guard the buyer from damage suits caused by patent infringement. 2. Price provisions, such as “If the price is not stated on this order, material must not be billed at a price higher than last paid without notice to us and our acceptance thereof.” 3. A clause stating that no charges will be allowed for boxing, crating, or drayage. 4. Stipulation that the acceptance of the materials is contingent on inspection and quality.
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Purchasing and Supply Management
FIGURE 4–1 Purchase Order Source: Honeywell Flight Systems Division.
PURCHASE ORDER NO.
CO. NO.
T425671–03A
DATE
3–23–92
ITEM
QUANTITY
1
150
HONEYWELL INC. SPERRY COMMERCIAL FLIGHT SYSTEMS P.O. BOX 52006 PHOENIX, ARIZONA 85072-2006
TERMS
4682777
1
SHIP TO: ABOVE ADDRESS UNLESS OTHERWISE NOTED
DIVISION
CM CM
2. NONTAXABLE—SERVICES 3. NONTAXABLE—PRODUCTIVE EQUIP.
Quality Control Requirements of QCS 210 apply as well as codes noted. General Packaging and Shipping instructions GPSI100 apply as well as specific supplier packaging codes noted REVLIR
DESCRIPTION
B
PRICE
ACCELEROMETER
1214.00
UNIT OF MEASURE
4. TAXABLE—NONPRODUCTIVE GROUP 5. TAXABLE—RENTALS CONSUMABLES
DESTINATION
ACCOUNT CONT - - SUB
COMM CODE
PROD CODE
4232C
17412
450
562
J.O.
DEPT
A.O. NO.
3230
EACH
This Purchase Order or Change Order including all provisions set forth hereon and any continuation sheets and addendums and Buyer's then current Purchase Order General Terms will be deemed as being accepted by the Seller upon the initiation of performance hereunder. Unless specifically requested on the face hereof acknowledgement by the seller is not required.
PER REVISION LETTER SHOWN CONFIRMED ORDER 3/20/92 THIS ORDER PLACED IN ACCORDANCE WITH A PRICING AGREEMENT BETWEEN BUYER AND SELLER.
11132-200 (REV 1-88) HONEYWELL INC .
TAX PROJECT CODE CODE
ORIGIN
1. NONTAXABLE—FOR RESALE CERT NO. 07-001648
PLUS CODE 12 PLUS CODE 988 BUYER PART NUMBER
COMPLETE PURCHASE ORDER NUMBER BUYER PART NUMBER AND NUMBER OF CAPTIONS OF SHIPMENT MUST APPEAR ON ALL ADDRESS LABEL. PACKING SLIP MUST ACCOMPANY EACH SHIPMENT.
F.O.B.
2–10–30
ADMIRAL GEAR & INSTRUMENT 2287 W. 9TH STREET SAN MATEO, ARIZONA 85382
GPSI-100 CODES
MAIL INVOICE TO:
HONEYWELL INC. SPERRY COMMERCIAL FLIGHT SYSTEMS 21111 N. 19TH AVENUE PHOENIX, ARIZONA 85027-2708
PURCHASE ORDER
34624B–30–31
QCS 210 CODES
SHIP TO:
DESTINATION
ACCOUNT CONT - - SUB
COMM CODE
PROD CODE
J.O. A.O.
NO.
DEPT
By AUTHORIZED SIGNATURE
ADDRESS ALL INQUIRIES TO:
TOTAL PRICE $182,100.00 ITEM 1
REQUISITION NO. (S)
ITEM 1 DELIVERY REQUIRED AT DESTINATION ISSUER – – MAIL STATION
QTY.
WEEK
QTY.
WEEK
15 15
8925 8942
15 15
8930 8945
QTY.
WEEK
MISC. CODE AND SPECIAL CHARGES
21 ITEM 2
ATT.
WEEK
8920 8940
REQUISITION NO. (S)
55 WEEK
HONEYWELL INC., SPERRY COMMERCIAL FLIGHT SYSTEMS GROUP AIR TRANSPORT SYSTEMS DIVISION P.O. BOX 21111 PHOENIX, ARIZONA 85036-1111
QTY.
WEEK
QTY.
WEEK
QTY.
WEEK
15 15
8932 8950
15 15
8935
15
8937
PRIORITY OR ALLOTMENT NO.
QTY.
15
CONTRACT NO. ITEM 1
43 QTY.
WEEK
QTY.
WEEK
QTY.
WEEK
QTY.
WEEK
QTY.
ISSUER
ITEM 2 DELIVERY REQUIRED AT DESTINATION ISSUER
UNLESS NOTED OVERSHIPMENTS UNACCEPTABLE
MISC. CODE AND SPECIAL CHARGES
PRIORITY OR ALLOTMENT NO.
CONTRACT NO. ITEM 2
SPLIT
IF GOVERNMENT CONTRACT NUMBER IS SHOWN THIS IS A RATED ORDER CERTIFIED FOR NATIONAL DEFENSE USE, AND YOU ARE REQUIRED TO FOLLOW ALL THE PROVISIONS OF THE DEFENSE PRIORITIES AND ALLOCATIONS SYSTEM REGULATION (15 CFR PART 350)
5. A requirement, in case of rejection, that the seller receive a new order before replacement is made. 6. A precise description of quality requirements and the method of quality assurance/ control. 7. Provision for cancellation of the order if deliveries are not received on the date specified in the order. 8. A statement that the buyer refuses to accept drafts drawn against the buyer. 9. Quantity provisions for overshipments or undershipments. 10. Special interest provisions—for example, arbitration or the disposition of tools.
Routing While a discussion about routing may seem unnecessary in the age of electronic processes, it is important to understand the flow of information. Who needs access to
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Supply Processes and Technology 87
purchase order information, and why? How that information is made available, on paper documentation or electronic files, is a matter of process design and organizational capability. Externally, the supplier needs the information on a PO. Giving or sending a purchase order does not constitute a contract until it has been accepted. Typically, the supplier sends an acknowledgment to confirm acceptance of the order and to complete the contract. What constitutes mutual consent and the acceptance of an offer is primarily a legal question (See Chapter 15). Without an acknowledgement, the buyer can only assume that delivery will be made by the requested date. When delivery dates are uncertain, the buyer needs definite information in advance to plan operations effectively. Internally, the supply department requires access (electronically or hard copy), accounts payable (AP) for the payment process, and receiving and/or stores to plan for and confirm receipt and incoming inspection if required.
Blanket and Open-End Purchase Orders Blanket or open-end purchase orders reduce costs by reducing the number of purchase orders issued. A blanket order usually covers a variety of items. An open-end order allows for addition of items and/or extension of time. Blanket orders are used to buy maintenance, repair, and operations (MRO) items and production-line requirements used in volume and purchased repetitively over a period of months. The original purchase order contains all negotiated terms and conditions for estimated quantities over a period of time. Subsequently, releases (See Figure 4–2) of specific
FIGURE 4–2 Blanket Order Release
REQUISITION NO.
Source: Raytheon Company.
RAYTHEON COMPANY SORENSEN OPERATION SOUTH NORWALK, CONN.
RAYTHEON
REQUISITIONED BY
UNIT
TO
BLANKET ORDER RELEASE THIS NUMBER MUST APPEAR ON ALL DOCUMENTS AND PACKAGES
RELEASE DATE
PURCHASE ORDER NO.
RELEASE NO.
ACCOUNT NO.
SHIP VIA
UPS SHIP MATERIAL TO ABOVE ADDRESS UNLESS INDICATED OTHERWISE BELOW
DELIVER MATERIAL TO (INTERNAL)
SORENSEN DELIVERY AT DESTINATION
VENDOR CODE
MATERIAL CODE
620393 RECEIVED Date Quantity
Item
Quantity Ordered
x INDICATES CONFIRMING ORDER DATE
YOUR
TAXABLE
DESCRIPTION
BLANKET ORDER TERMS AND CONDITIONS APPLY
PROD. SHOP ORDER NO.
YES
NO
X Part Number
EXEMPTION NO.
5151175 Qty
Net Unit Price
TOTAL
RECEIVING DEPARTMENT USE ONLY
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quantities are made against the order. Releases may be executed by supply or, more efficiently, by production scheduling directly to the supplier. An open-end order may remain in effect for a year, or until changes in design, material specification, or conditions affecting price or delivery necessitate renegotiations. The Bright Technology International case at the end of this chapter illustrates a common problem faced by many supply professionals, large numbers of orders from suppliers for goods and services that are used regularly. An opportunity for supply in such a situation is to reduce transaction costs by setting appropriate processes for order placement.
Master Service Agreement (MSA) A master service agreement is an agreement wherein the supplier(s) provides predetermined services over a specified period of time with total costs not to exceed an amount previously agreed upon. The scope of work for each function or level of service is fully defined and agreed upon before the period of performance starts. Costs are generally fixed for the period of performance and usually have a “not to exceed” value. MSAs are usually awarded for periods of one year or longer.
6. FOLLOW-UP AND EXPEDITING After issuing a PO, the buyer may follow up and/or expedite the order. Follow-up is routine order tracking to ensure the supplier can meet delivery promises. An appropriate follow-up date is indicated with the order. Progress inquiries may be made by phone, e-mail, fax, or in-person. Early notification of problems such as production scheduling, quality, or delivery enables appropriate action. Follow-up on strategic or critical spend, especially large-dollar and/or long lead-time buys, may be about advance shipping notices (ASNs) or percentage of the production process completed as of a certain date. Follow-up may not occur on lower-value purchases or it may be built into the electronic supply system whereby buyers are only notified of exceptions. Responsibility for follow-up with a services supplier may be placed in the user department to help ensure user compliance with prior commitments and deadlines. Follow-up on internal commitments may become a joint responsibility for the supply manager as well as the supplier. Extensive user interface with supplier personnel before and during service delivery also affects other aspects of services contract administration. For example, if a service is performed on-site after hours, security check-in sheets and access systems may be used to verify work patterns or area activity. Periodic site visits and a walk-through of the facility with the supplier’s representative may lead to a better understanding of user needs. Some form of benchmarking against other providers may also be useful. Figure 4–3 shows a follow-up form. Expediting is the application of pressure on a supplier to meet the original delivery promise, to deliver ahead of schedule, or to speed up delivery of a delayed order. Threats of order cancellation or loss of future business may be used. Expediting should be necessary on only a small percentage of the POs issued. If the buyer has done a good job of analyzing
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FIGURE 4–3
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PURCHASE ORDER FOLLOW-UP
Follow-up Form
(Please Rush Reply) PURCHASING DEPARTMENT • P.O. BOX 21666 • PHOENIX, ARIZONA 85036
Source: Arizona Public Service Company.
Date This is our Request Please Answer Immediately REPLY TO ITEMS CHECKED BELOW BY
❏ This Form
Our Purchase Order No.
Request for Quotation No.
Your Invoice No.
Date
1. RUSH SHIPMENT. ADVISE EARLIEST DATE.
Amount
❏ Wire
❏ Phone
Your Reference
16. WE HAVE NO RECORD OF TRANSACTION COVERED BY INVOICE. ADVISE DATE OF SHIPMENT, NAME OF PERSON PLACING ORDER AND FURNISH SIGNED DELIVERY RECEIPT COPY.
2. WHEN WILL SHIPMENT BE MADE? IF SHIPPED. ADVISE METHOD.
17. INVOICE RETURNED HEREWITH.
3. PLEASE TRACE SHIPMENT.
18. INVOICE IS REQUIRED IN
4. IF SHIPMENT HAS BEEN MADE, MAIL INVOICE, TODAY.
COPIES.
19. PRICE OR DISCOUNT IS NOT IN ACCORDANCE WITH QUOTATION.
5. PLEASE MAIL RECEIPTED FREIGHT BILL.
20. TERMS ON INVOICE ARE NOT IN ACCORDANCE WITH THE PURCHASE ORDER.
6. WHY DID YOU NOT SHIP AS PROMISED? ADVISE WHEN YOU WILL SHIP.
21. ENCLOSED INVOICE SENT TO US IN ERROR.
7. WILL YOU SHIP ON DATE SHOWN ON PURCHASE ORDER?
22. DIFFERENCE IN QUANTITY.
8. RELEASE SHIPMENTS AS SHOWN UNDER REMARKS.
23. UNIT PRICE INCORRECT.
9. PLEASE MAIL US ACCEPTANCE COPY OR OUR PURCHASE ORDER.
24. EXTENSION INCORRECT.
10. PLEASE ACKNOWLEDGE OUR ORDER.
25. PURCHASE ORDER NO. LACKING OR INCORRECT.
11. PLEASE MAKE YOUR SHIPPING DATE MORE SPECIFIC.
26. SALES TAX DOES NOT APPLY – See reverse side of Purchase Order.
12. WHEN WILL BALANCE OF ORDER BE SHIPPED.
27. SHOULD BE BILLED F.O.B. DESTINATION.
13. WHEN WILL PRICES BE SUBMITTED? PLEASE RUSH.
28. HAVE YOU CONSIDERED THIS ORDER COMPLETE?
14. PLEASE MAIL SHIPPING NOTICE. 15. PLEASE INDICATE OUR PURCHASE ORDER NUMBER ON PAPERS REFERRED TO OR ATTACHED.
29.
Reply:
Vendor By 510-00J
Purchasing By SEND WHITE AND PINK COPIES WITH CARBON INTACT.
WHITE COPY IS RETURNED WITH REPLY.
supplier capabilities, only reliable suppliers—ones who will perform according to the purchase agreement—will be selected. Frequently, expediting is caused by poor planning inside the buying organization and may indicate the need for internal process improvements. If material requirements planning is adequate, the buyer should not need to ask a supplier to move up the delivery date except in unusual situations. Of course, in times of severe scarcity, the expediting activity assumes greater importance.
Assess Costs and Benefits One of the costs of doing business with a supplier (and vice versa) is the cost associated with follow-up and expediting. One form of risk assessment and mitigation is matching the degree and type of follow-up with the spend category strategy (typically based on the importance of the purchase to the organization). Follow-up and expediting that cost more than the value added is a form of process waste. It should be captured and included in the total cost of ownership assessment. Expediting may be a prime target for root cause analysis and a reduction or elimination plan. Often, the analysis reveals that the need for expediting is driven by decisions made in the buying organization, not by the supplier, and internal change is needed.
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7. RECEIPT AND INSPECTION The proper receipt of goods and services is of vital importance. Many smaller and singlesite organizations have centralized receiving in one department. Often receiving reports to supply management (see Chapter 16). If just-in-time inventory management systems have been implemented, materials from certified suppliers or supplier partners bypass receiving and inspection and are delivered directly to the point of use. (See Chapter 8.) Receiving also may be bypassed for small-value purchases. The prime purposes of receiving are to: 1. 2. 3. 4. 5.
Confirm that the order placed has actually arrived. Check that the shipment arrived in good condition. Ensure the quantity ordered has been received. Forward the shipment to its proper destination (storage, inspection, or use). Ensure that proper documentation of the receipt is registered and accessible to appropriate parties.
Shortages may occur because material has been lost in transit, short-shipped, tampered with, or damaged in transit. Physical counts can be forced by blocking receiving from access to the quantity ordered. If accurate amounts are entered into the system, the order is closed out, inventory records updated, and the invoice cleared for accounts payable to authorize payment.
Eliminate or Reduce Inspection One goal of supply management is to ensure that quality is built in internally during the design stage and externally in the suppliers’ processes. This reduces or eliminates incoming inspection. (See Chapter 7, “Quality,” Chapter 9, “Delivery,” and Chapter 13, “Supplier Evaluation and Relations.”) In a just-in-time (JIT) environment, production parts go right from the receiving dock to production. This is only possible when the supplier is capable of achieving the right level of quality consistently and the carrier is capable of meeting the delivery windows consistently. When quality is not assured, incoming inspection occurs. Damage may also occur during transit, which has implications for carrier inspection and logistics processes. Decisions must be made about the need for inspection, the appropriate type of inspection, and the most cost-efficient and effective method of inspection.
8. INVOICE CLEARING AND PAYMENT An invoice is a claim against the buying organization. Typically it shows order number and itemized price. Invoice clearance procedures are not uniform. Checks and audits of invoices are established based on cost-benefit analysis. The cost of a person’s time to resolve minor variances may exceed the value of the variance. A decision rule may be used that stipulates payment of the invoice as submitted, as long as the difference is within prescribed limits: for example, plus or minus 5 percent or $25, whichever is smaller. Accounts payable tracks variances to identify suppliers that are intentionally short-shipping.
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Payment for services may vary somewhat from payment for goods. Some services require prepayment, such as an eminent speaker; some, immediately upon delivery, such as hospitality services, whereas others can be delayed. It may be difficult for small suppliers to offer extended payment terms, and early payment may generate price or other concessions. Progress payments are usual for large contracts spread over time, whereas regular payments are appropriate for ongoing services such as building maintenance or food service. Supply or accounting may be responsible for clearing invoices (see Chapter 16). If assigned to accounting, supply is relieved of a nonvalue-adding task, accounting tasks are concentrated in a single function, and a check and balance is established between the commitment to buy and payment. If assigned to supply, immediate action can be taken because supply placed the original order. When the invoice is handled by accounting in a paper-based process, the following procedure is typical: 1. Duplicate invoices are mailed directly to the accounts payable (AP) department. AP time-stamps, checks for accuracy, and certifies for payment except where the purchase order and the invoice differ. AP files one copy; one is returned with payment. 2. Invoices at variance with the purchase order on price, terms, or other features are referred to supply for approval. If information is missing or does not agree with the purchase order, the invoice is returned to the supplier for correction. Ordinarily, the buyer insists that discounts (see Chapter 10) be computed from the receipt of the corrected invoice, not from the date originally received. If a purchase order is cancelled and cancellation charges are paid, supply provides accounting with a “change notice” that defines the payment before approval. If supply clears invoices, the procedure is: 1. After review and adjustments for corrections, the original invoice is forwarded to accounting to be held until supply authorizes payment. The duplicate invoice is retained by supply. 2. When the receiving report is sent to supply, it is checked against the invoice. If the two agree, supply keeps both documents until it receives assurance from inspection that the goods are acceptable. 3. Supply then forwards its duplicate copy of the invoice and the receiving report to accounting, where the original copy of the invoice is already on file. Accounting issues payment. The three-way match of data from the purchase order, the invoice, and receiving also occurs in an electronic procurement system.
Aligning Supply and Accounts Payable Often, payment terms are not met. The root causes of late payment are typically either slow cycle time in the accounts payable process or conflict between finance and supply policy. Slow cycle time can occur because of errors on the invoice, paper-based processes, inefficient mailroom processes at the buying organization, and limited human resources in the mailroom, accounting, and/or supply. Information systems and electronic fund transfers may help address these problems by shortening the cycle time.
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Lack of alignment causes conflict between supply and accounting. Supply views suppliers as valuable contributors to the organization’s success. Living up to the terms and conditions of the contract is one indicator of the commitment to performance of both parties. When buyers negotiate payment terms and their organization fails to live up to those terms, this should be seen as a serious breach by all functional representatives. Accounting views cash management as a primary contributor to the organization’s success. Paying accounts as late as possible allows the buying organization the use of its money for a longer period of time. The perspective on suppliers may be that they are expendable and easily replaceable. Management may put accounts payable and supply into one department to force goal alignment through structure and reporting relationship. Or accounts payable and supply may serve on a joint team to resolve inconsistencies and align processes. The Ross Wood case in Chapter 16 illustrates how changing the accounts payable process and combining accounts payable and supply can improve process efficiency and effectiveness.
Cash Discounts and Late Invoices Sometimes suppliers are slow to invoice, and supply must request the invoice. Or suppliers request payment prior to the receipt of material or services. When invoices provide for cash discounts, do you pay the invoice within the discount period, even though the material may not actually have been received, or do you withhold payment until the material arrives, even at the risk of losing cash discounts? The arguments for withholding payment of the invoice until after the goods have arrived are: 1. Frequently the invoice does not reach the buyer until late in the discount period or after it, if the supplier fails to invoice promptly. 2. It is poor practice to pay without an opportunity for inspection. Legally, the title to the goods may not pass to the buyer until acceptance of them. 3. Commonly, invoices are dated on the shipment date. The buyer should state that the discount period runs from receipt of the invoice or the goods, whichever is later. The arguments for clearing the invoice for payment without awaiting the arrival, inspection, and acceptance of the material are: 1. The financial consideration from discounts may be substantial. 2. Failure to take the cash discounts reflects unfavorably on the credit standing of the buyer. 3. With reputable suppliers, mutually satisfactory adjustments will be made easily.
9. MAINTENANCE OF RECORDS AND RELATIONSHIPS The final step is to update records, including supplier performance scorecards. Electronic files or hard copies of the order-related documents are stored or filed. Law, accounting standards, company policy, and judgment determine which records are to be kept and for how long. For example, a purchase order is evidence of a contract. It may be retained much longer (normally seven years) than the requisition, which is an internal memorandum.
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The basic records to be maintained, either manually or electronically, are: 1. PO log, which identifies all POs by number and indicates the open or closed status of each. 2. PO file, containing a copy of all POs, filed numerically. 3. Commodity file, showing all purchases of each major commodity or item (date, supplier, quantity, price, PO number). 4. Supplier history file, showing all purchases placed with major large total-value suppliers. 5. Outstanding contracts against which orders are placed as required. 6. A commodity classification of items purchased. 7. A database of suppliers. Additional record files may include: 1. Labor contracts, giving the status of union contracts (expiration dates) of all major suppliers. 2. Tool and die record showing tooling purchased, useful life (or production quantity), usage history, price, ownership, and location. This may prevent paying more than once for the same tooling. 3. Minority and small business purchases, showing dollar purchases from each. 4. Bid-award history, showing which suppliers were asked to bid, amounts bid, number of no bids, and successful bidder, by major items. This may highlight supplier bid patterns and possible collusion.
Linking Data to Decisions Data are collected throughout the supply management process. Turning data into usable knowledge is a continuing challenge. From a process perspective, it is important to understand what decisions need to be made; what information is relevant; where it can be found; and how the information will be captured, analyzed, and disseminated to decision makers. Often the problem is information overload that leads to “analysis paralysis,” rather than a lack of information holding up a decision. Electronic tools designed to enable better decisions though information management are discussed later in this chapter. Metrics are discussed in Chapter 13.
Manage Supplier Relationships Internal and external relationships are affected throughout the supply process. They may be initiated, developed, damaged, repaired, or ended. Relationships with key supply chain stakeholders internally and externally should be developed and assessed throughout the process. See Chapter 13, “Supplier Evaluation and Relations.”
IMPROVING PROCESS EFFICIENCY AND EFFECTIVENESS Once the basic information flows and communication techniques that comprise the supply management process are understood, we return to the initial questions: (1) What process(es) will be most effective and efficient to support the buyer–supplier exchange? (2) What information systems might be used to support or enable efficient and effective processes?
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A Supply Process Flowchart The flowchart in Figure 4–4 demonstrates one way an organization might improve efficiency and effectiveness of the supply management process. This begins with an assessment of the nature of the spend. Is the purchase strategic? FIGURE 4–4 A Supply Process Flowchart
Yes Obtain sponsorship
Is the acquisition strategic?
No
Form cross-functional team
Define project
Use efficiency tools: procurement card, blanket orders, systems contracts, e-procurement, online catalogs, etc.
Yes
Is the acquisition under the small-dollar threshold?
No Collect and analyze data
Select supplier
Process purchase order
Yes
Is the supplier on the Approved Supplier List? No
Implement Prepare specs/SOW
Measure, monitor, and report
Issue RFI (optional)
Issue RFQ, RFP, or RFB Manage supplier relationship Evaluate bidders
Capture and transfer best practices
Select supplier
Implement
Measure, monitor, report
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Strategic Spend A common definition of strategic spend is goods or services critical to the mission of the organization. This definition allows for high- and low-dollar-value purchases. How can the supply process for strategic spend be made more efficient (get more things done in a set amount of time) and more effective (get more of the right things done)? And what is the trade-off between efficiency and effectiveness?
Early Supply and Supplier Involvement As the flowchart depicts, a cross-functional sourcing team fosters communication throughout the process, especially during the critical stages of need recognition and description. It makes sense to apply time, money, people and other resources to mission-critical spend. The goals are to assure continuous availability at the lowest total cost of ownership. Information management tools enable this communication process and support decision making. If a trade-off must be made, typically, effectiveness is favored over efficiency in strategic spend management.
Nonstrategic Spend For nonstrategic (nonmission-critical) purchases (the right column of the flowchart), dollar value and repetitiveness drive process decisions. First, a small dollar threshold is established and efficiency tools, especially electronic ones, are used. Second, suppliers are prequalified and tools for efficient order placement are used. Efficiency relates to the number of tasks performed in a set amount of time. For nonstrategic spend, efficiencies are gained by reducing the number of requisitions coming into the supply department, the number of purchase orders issued to suppliers, and the number of invoices and payments processed. Two continual problem areas for supply managers, small value purchases and rush orders, are largely resolved through the use of efficiency tools.
Small Value Orders A Pareto analysis of annual spend reveals that roughly 70 to 80 percent of transactions account for only 10 to 15 percent of spend. These are C items, typically, maintenance, repair, and operating supplies (MRO), with low average transaction amounts. For some goods and services that fall into this category it might be possible that the costs of processing the order and delivering the goods or services may be greater than the value of the purchase. The process cost to transact a $50 purchase may be as much as a $5,000 one. The goal is to minimize the acquisition costs (the process costs not the price) of nonstrategic spend while assuring availability. The problem of small monetary value orders is resolved by simplifying or automating the process or consolidating purchases to reduce the acquisition cycle time (time from need recognition to payment), reduce administrative cost, and free up the buyer’s time for higher-value or more critical purchases. A few examples follow: 1. Vendor/supplier-managed inventory (VMI/SMI), stockless buying, or systems contracting can be used. This is typical for MRO items. (See explanation earlier in this chapter.) 2. A procurement card (also called a purchasing card or a P-card) is a credit card that is provided to internal customers to purchase directly from established suppliers. (See discussion in next section.)
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3. Supply sets up blanket orders against which internal customers issue release orders; suppliers provide summary billing. 4. An electronic procurement or an electronic data interchange (EDI) system is used. Ordering and reordering occur automatically based on preestablished reorder points. 5. In reverse auctions, the buyer prequalifies suppliers and invites them to an online auction during which bidders submit bids and the buyer awards a contract for the predefined items for a set period of time. 6. Authority levels and bidding practices are adjusted, and an e-procurement system, telephone, fax, and auto-fax are used for ordering. 7. Integrated suppliers are used to provide a variety of supplies. 8. Low-value order placement is outsourced to third parties. 9. Persuasion may be employed to increase the number of standardized items requested. 10. Small requisitions are held until a reasonable total, in dollars, has been accumulated. 11. Specific supplies or type of supplier is assigned to a requisition calendar so that all requests are received on the same day. 12. Invoice-less payments (self-billing) are arranged. 13. Users place orders directly with suppliers. 14. A blank check purchase order is issued in which a signed, blank check is sent along with the PO. The supplier ships the full order, completes the check, and deposits it. This reduces paperwork (receiving reports, inventory entries, and payments), saves postage, often enables a larger cash discount, and saves time in accounts payable.
Reducing the Number of Requisitions Marked Rush or Emergency Frequently, an excessive number of requisitions are marked “rush.” Emergencies, such as style or design changes, equipment breakdowns, and unexpected changes in market conditions, may justify a rush order. However, some “rush” orders cannot be justified. These include requisitions caused by: (1) faulty inventory control, (2) poor production planning or budgeting, (3) lack of confidence in the ability of the supply department to get material to the user by the proper time, and (4) the sheer habit of marking requests “rush.” Unnecessary costs occur because of errors from working under pressure and the impact on price to compensate the supplier for the added burden (real or perceived) of a rush order. Education and process improvements may reduce the problem. Supply must educate users about the proper supply procedure and enlist the support of other functions to gain compliance. For example, the requisitioner has to secure approval from the general manager and any extra costs that can be calculated are charged back. Improvements in process efficiency increase the credibility of the process and the supply group. These include preapproved suppliers, purchasing cards, electronic catalogs, and e-procurement systems that reduce lead and cycle time and allow users to issue requests directly to a supplier against an existing contract.
Corporate Purchasing Cards Corporate purchasing cards (also called procurement cards or P-cards) are credit cards issued to internal customers (users) in the buying organization to purchase low-dollar-value,
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high-volume goods and services. P-cards reduce administrative costs (for people, system use and third-party providers) by reducing the number of purchase orders generated and processed and by shortening the process cycle time for authorizing, tracking, purchasing, reconciling, and reporting purchases. P-card use supports other process initiatives such as consolidating spend and suppliers. They can be merged with technology to be electronic commerce compatible and data sensitive to capture information that is integrated into an ERP system. Holders of the card are given dollar limits and lists of preferred suppliers with whom supply has already negotiated prices and terms. P-cards automate many aspects of the system, thereby eliminating purchase orders and individual invoices and ensuring suppliers of fast payment, two or three days versus 30+ in a typical system. By moving the transaction activities to the user department, the supply cycle time and transaction costs are reduced. Also, buyers (and accounts payable) are freed from the day-to-day transactions for smallvalue purchases and can focus on higher-value purchases and issues. The primary perceived risk of P-cards is loss of control. Card issuers have instituted controls that (1) determine, at the point of sale, if the purchase meets preset dollar limits per card; (2) limit the number of transactions per day; (3) limit the value of a single transaction; and (4) determine if it is an approved supplier. By establishing daily and monthly querying and reporting, the administrator manages by exception rather than focusing on monthly statement details. The most sophisticated card programs are able to (1) track and report sales tax information for audit purposes, (2) track and prepare 1099s for unincorporated service providers, (3) identify whether the supplier is a minority business owner, (4) capture specific product information, (5) identify which cost center should be charged for the purchase, and (6) include different types of purchases, including travel and entertainment expenses and fleet expenses.
Supplier- or Vendor-Managed Inventory (SMI/VMI), Stockless Buying, or Systems Contracting Supplier- or vendor-managed inventory (SMI/VMI), systems contracting, or stockless buying are more sophisticated merging of the ordering and inventory functions than blanket contracts.
Systems Contracting Systems contracts rely on periodic billing procedures, allow nonsupply personnel to issue order releases, employ special catalogs, and require suppliers to maintain minimum inventory levels. Normally, the volume of contract items is not specified. These systems improve inventory turnover rates. This technique is used most frequently in buying repetitive items such as office supplies and maintenance, repair, and operating supplies (MRO). MRO supplies are many types of items, all of comparatively low value and needed immediately when any kind of a plant or equipment failure occurs. The technique is built around a blanket-type contract that is developed in great detail regarding approximate quantities to be used in specified time periods, prices, provisions for adjusting prices, procedures to be followed for daily requisitioning and delivery within a short time (normally 24 hours), simplified billing procedures, and a complete catalog (often online) of all items covered by the contract. In an electronic procurement system, the buyer or requisitioner communicates electronically each item and quantity required. If there are large-volume requirements from a
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specific supplier, the supplier stores items in the customer’s plant as though it were the supplier’s warehouse. The buyer’s contact with the supplier is electronic. The system works as follows: 1. The buyer places the blanket order for a family of items, such as fasteners, at firm prices. 2. The supplier delivers predetermined quantities to the inventory area set aside in the buyer’s plant. The items are still owned by the supplier. 3. The buyer sometimes inspects the items when they are delivered. 4. The computer directs storage to the appropriate bin or shelf. 5. The buyer places POs electronically, thus relieving the supplier’s inventory records. 6. Pick sheets are computer prepared. The buyer picks the items from the supplier’s inventory. 7. The supplier submits a single invoice monthly for all items picked. 8. The buyer’s accounting department makes a single monthly payment. 9. A summary report is electronically generated, at predetermined intervals, showing the items and quantity used for the buyer’s and supplier’s analysis, planning, and restocking. Systems contracting is used in service organizations as well as manufacturing and for high-dollar-volume commodities as well as MRO supplies. The shorter cycle time from requisition to delivery leads to substantial inventory reductions and greater compliance with the supply process. The amount of red tape or bureaucracy is minimal. Since the user normally provides a good estimate of requirements and compensates the supplier in case the forecast is not good, the supplier risks little in inventory investment. The degree of cooperation and information exchange required between buyer and supplier often results in stronger relationships than normally exhibited in a traditional arm’s-length trading situation.
Vendor- or Supplier-Managed Inventory (VMI or SMI) In VMI systems, the supplier is responsible for maintaining the buying organization’s inventory levels. The supplier has access to inventory levels (often electronically) and generates purchase orders. Typically, the supplier manages the buyer’s inventory at the buyer’s location. The supplier pulls stock, packs, ships, and invoices. This procedure reduces process cycle time by reducing the number of people/functions touching the process. These systems are tools for managing small orders. VMI may also be used for consignment inventory wherein payment is made after inventory is used.
INFORMATION SYSTEMS AND THE SUPPLY PROCESS Information systems include interconnected components that collect, process, and store raw data and distribute information to support decision making, control, and coordination within the organization. While information systems can be manual (paper based), most information systems rely on information technology infrastructure, consisting of hardware and software, to operate its information systems. Information system technology allows organizations to be connected with important partners in their supply chain networks. Capabilities to exchange reliable information with
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these partners quickly and cost effectively is essential for the improvement of supply chain performance. To determine which information systems might be used to support or enable efficient and effective processes, it is important to understand (1) the benefits of technology, (2) the technology options that provide these benefits, and (3) the trade-offs in costs and benefits when choosing technology.
Benefits of Information Systems Technology Information system technology can provide seven important benefits to the organization: Cost reduction and efficiency gains. These can be achieved by streamlining the supply processes and freeing up supply staff to do more value-adding work. Data accessibility. Quick and easy access to critical data in real time aids sound decision making, makes it easier to identify supply problems earlier, and provides useful information for negotiations. Speedier communication. Faster communication improves supply chain effectiveness and efficiency, especially with global suppliers. Faster turnaround may increase market share and lower inventories. Dedicate resources to strategic issues. More resources (e.g., staff and budgets) can be spent on strategic supply initiatives, and strategic and critical suppliers and projects because less time is spent on administrative and tactical supply activities. Data accuracy. Automation decreases errors, especially data entry errors. Benefits include lower inventories (safety stock) and stockouts, lower expediting costs, and improved customer satisfaction. Systems integration. Integration across departments, suppliers, and customers can provide accurate information on a timely basis to assist with production and materials planning and decision making. Monetary control. Enterprise systems provide control over how and where money is spent.
Technology Options Technology is infrastructure that serves the organization’s purposes. Selecting technology is challenging, especially when it is changing rapidly. Several options are available:
Software Two types of software are needed to operate the computer: operating system and applications software. Operating system software is the interface that connects your computer and its components. Drivers (programs in the system) translate commands from the operating system or the user into commands understood by the associated component (mouse, keyboard, printer, video card, and CD-ROM) and back. The three major operating systems are Windows, Unix/Linux, and Macintosh. Common security issues are flaws (software bugs), instability, and crashes. Applications software programs manipulate data for a specific purpose, such as analyzing supplier performance statistics and formatting a performance scorecard. Procurement
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systems are available from a variety of systems developers such as Ariba and i2. These systems typically cover spend analysis, sourcing, contract management, procurement and expense, invoice and payment, and supplier management. “Off-the-shelf ” purchasing software packages are constantly changing and improving. Organizations typically have different information systems to support the specific needs of each business process. Frequently, systems do not “talk to each other,” resulting in fragmentation of data in separate systems. Enterprise Resource Planning (ERP) systems, such as SAP and Oracle, provide a corporate platform for information technology and include a suite of applications such as financials, channel revenue management, human capital management, and project management. Enterprise systems collect data from key business processes and store it in a single comprehensive accessible data repository. Most ERP systems offer procurement “suites.” Some companies implement specific modules, rather than entire suites. Applications software may be delivered on-premise or on-demand. The growth area is on-demand. On-premise software. Applications software that is installed and run on computers on the premises of the person or organization using the software. Buyers incur an up-front licensing fee and invest in the infrastructure and staff to manage and maintain the IT system. On-demand software—Also referred to as Software as a Service (SaaS). Applications software, content, and services are delivered as flexible Web-based solutions. A single software application is hosted on a remote server and accessed by multiple users through the Internet. Users pay a subscription fee. Service providers typically can supplement an organization’s IT staff, comanage, or manage all applications, including legacy mainframe systems, Web-based and custom applications, and off-the-shelf packaged solutions such as PeopleSoft, SAP, and Siebel Systems. On-demand is a shift from a product-based to a service-based buyer–supplier relationship. Supply personnel can access application functionality (sourcing, contract management, procurement), research and intelligence (supply market data, category templates), and support services (spend data cleansing, sourcing event management) as integrated Web services. On-demand supply management applications are available from many providers, including SAP, Oracle, Ariba, and i2. The benefits of ERP systems have to be weighed against the costs and challenges of implanting a new system. The Hemingway College case at the end of this chapter demonstrates the challenges faced by supply personnel in such an environment.
Types of Information Systems Information systems can be classified into four types, each designed to serve the organization at different levels of management and across functions (see Figure 4–5). The strategic level comprises executive support systems (ESS); management level systems consist of management information systems (MIS) and decision support systems (DSS); knowledge level systems include knowledge work systems (KWS) and office automation systems (OAS); and operational level systems consist of transaction processing systems.
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FIGURE 4–5 Information Systems Strategic Level Systems ESS
Sales planning
Operations planning
Financial forecasts
Corporate budget
H.R. planning
MIS
Sales management
Inventory control
Capital expenditure analysis
Annual budget
Employee relocation analysis
DSS
Regional sales analysis
Production scheduling
SKU profitability analysis
Cost analysis
Union contract cost analysis
KWS
Engineering workstations
Graphics workstations
Managerial workstations
OAS
Word processing
Document imaging
Electronic calendars
Management Level Systems
Knowledge Level Systems
Operational Level Systems TPS
Order tracking
Machine scheduling
Securities trading
Accounts receivable
Payroll
Order processing
Material control
Cash management
Accounts payable
Employee records
Sales and Marketing
Operations
Finance
Accounting
Human Resources
Operational Level Systems These systems process data for routine operations. For supply, this includes generating POs, change orders, and requests for quotation; updating supplier lists; and maintaining commodity prices and supplier history files. Typically, transaction processing systems handle large volumes of repetitive data. These are the foundation of the information system hierarchy. Downtime, for only a few hours, can create major problems. Management Level Systems Management level systems consist of management information systems (MIS) and decision support systems (DSS). Management information systems (MIS) provide reports and information to management to support planning, controlling, and decision making. For supply, these include departmental budget information, supplier spend analysis, supplier performance reports, and raw material requirements forecasts. Decision support systems (DSS) process data to assist in decision making. DSS incorporate information into an analytical framework utilizing techniques such as mathematical relationships, simulations, or other algorithms. The outcome is definitive in nature and presents the results in either a deterministic or probabilistic fashion. DSS typically select alternative actions; management then considers the recommendation of the model with other variables (that may not be quantifiable) in arriving at a final decision. Examples are quotation analysis, price discount analysis, synthetic pricing, forecasting, and forward buying and futures trading models.
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Knowledge Level Systems At the knowledge level, buyer workstations integrate a number of elements to create a total systems package that can result in increased effectiveness and productivity. The ideal technical components of a workstation are (1) an automated transaction system, linked to the company’s databases, which performs routine supply activities, (2) access to decisionsupport software, (3) an expert systems element, and (4) personal productivity improvement software, word processing, spreadsheets, graphics, and database managers. Global databases allow the consolidation of volumes and sourcing strategy. Difficulties include a significant investment, unreliable or nonexistent information networks in some countries, differing technical standards between countries, regulatory obstacles, and internal organizational obstacles. Considering the difficulties in coordinating efforts across multiple business units in North America, it is easy to imagine the complications when different countries, languages, cultures, and business cultures are involved. Some companies have adopted and implemented a single ERP system throughout global operations as a key step in the development of global processes.
Intranets and Extranets The Internet is used by supply professionals to search, retrieve, and read computer files worldwide; exchange e-mail and text messages globally; search databases; access government sources; and search and purchase items from electronic catalogs, suppliers, and distributors. An intranet is a single and widely accessible (for authorized users only) network set up to share information and communicate with company employees. It is a private, secure internal Web. Intranets communicate information and facilitate collaboration among employees. They can be used to display supplier catalogs, provide lists of approved suppliers, and post company supply policies. Supply processes can be enhanced by allowing employees to place orders via Web browsers, approve and confirm purchases electronically, and generate POs electronically. The main advantages of supply-based intranets are low transaction costs and reduced lead times. An extranet is a private intranet that is extended to authorized users outside the company, such as suppliers. Extranets improve supply chain coordination and information sharing with key business partners. Through a Web-based interface, suppliers can link into a customer’s systems and vice versa to perform any number of activities, such as check inventory levels, track the status of invoices, or submit quotes. Because the information exchange is electronic, supply professionals are freed to spend time on value-added activities rather than entering data or checking the status of shipments or payments.
TECHNOLOGY-DRIVEN EFFICIENCY AND EFFECTIVENESS There are a number of technology tools available to improve process efficiency and effectiveness. These tools enable process effectiveness in two ways: (1) They make data more transparent, accurate, and accessible to decision makers, and (2) they relieve supply decision makers of lower value-adding tasks. Supply managers can then focus on higher-value-adding tasks, spend categories, and internal (other functional areas, top management) and external (suppliers) relationships. Also, the development of decision support and knowledge management
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systems enables more sophisticated modeling and facilitates more complex decisions involving multiple variables. The primary benefit of technology is improvements in the efficiency of the supply process. The tools addressed in this section are: e-procurement systems, online catalogs, commodity coding schemas, EDI, e-marketplaces, radio frequency identification (RFID) technology, and online reverse 1 auctions.
Electronic Procurement Systems An e-procurement system is an applications software package that allows the requisitioning, authorizing, ordering, receiving, invoicing, and paying for goods and services over the Internet. Some organizations automate from requisition-to-order and others from requisition-to-pay. An end-to-end e-procurement system that includes contracts and e-payables in the cycle is referred to as procure-to-pay. The adoption of an e-procurement system is often driven by existing process inefficiency, low internal compliance, high transaction costs, low spend visibility, and low control over organizational spend. Performance metrics for an e-procurement system often include: (1) the percent of organizational spend under procurement (also called purchasing or supply) control, (2) requisition-to-order costs, (3) requisition-to-order cycles, and (4) percent of off-contract (maverick) spend. Respondents to a 2007 survey by the Aberdeen Group reported that after implementing an e-procurement system, they increased spend under management by 35 percent, improved transaction costs by 48 percent, reduced transaction time by 60 percent, and reduced maverick spend by 41 percent. From the internal user/customer perspective, a successful e-procurement system is one that makes life easier—faster ordering, faster fulfillment, and a broader range of choices. Depending on the policies and procedures implemented, it may be possible to satisfy internal users as well as meet the requirements for internal control, cost savings, and supply base management.
Streamlining the Receiving, Invoicing, and Payment Process Should the e-procurement system include receiving, invoicing, and payment? A valid question is: Does the organization need to receive an invoice? The invoice provides no new information, yet it costs money to handle. In an invoiceless system, suppliers are notified that payment, based on the agreed-upon cash discount schedule, will be made in a set number of days from receipt of satisfactory merchandise (and they may specify that payment will be made only after the complete shipment has been received). A system match between the PO, receiving report, and inspection report (if conducted) is made, and a check is generated or funds are electronically transmitted on the receipt date at the agreed-upon payment term. The receiving report must be accurate; the PO fully priced, including taxes and cash discount terms; and purchases must be made FOB destination, since there is no way to enter in freight charges. The PO then is the controlling document. For example, Microsoft developed Web-based user-friendly supply systems, compatible with its SAP system, to address problems in accounts payable and procurement processes. In 1996, MS Market (MSM) directed requisitioners to preapproved suppliers, provided supplier assessments, generated POs, and provided fiscal accountability through an online approval process. MSM also provided ordering assistance so that users with specific needs could quickly order, clear invoices, and pay electronically.
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By 2003, MS Spend captured spend data for analysis by supplier, customer, commodity, dollar amount, location, and 40 other categories. MS Inquire allowed payment visibility to end users and suppliers via the Internet and provided end users with accountability in invoice approval. MS Vendor measured vendor performance and provided competencies and ratings. MS Contract tracked Microsoft’s contractual obligations and calculated royalty and other obligation payments. MS Expense streamlined the expense report reimbursement process and provided online approval and coding. Cycle time was reduced to a few days versus four weeks. The e-procurement system provided valuable information for controlling spend and implementing cost-savings initiatives; streamlined and standardized procurement and accounts payable processes; increased transaction velocity and visibility; and clarified roles for users, approvers, and suppliers. Transaction costs savings included accounts payable and invoicing staff reductions of more than 25 percent and 50 percent respectively. Approximately 20 supply people were redeployed from transactional to strategic procurement. Microsoft estimated that the cost of processing a PO was reduced from about $60 per transaction in 1996 to less than $5 by 2002. Transaction cost savings represented a substantial financial impact—in fiscal year 2002 the company issued about 500,000 POs and processed approximately 800,000 supplier invoices.2
Commodity Coding Schema Commodity managers need commodity codes to effectively source, track, and manage spend by category. Users, who want to get to the product quickly and easily, want robust item descriptions that are easily searched. The procurement team must respond to the needs of both stakeholders. The value of a hierarchical commodity coding schema is the ability to evaluate expenditures according to any level of the hierarchy. If a company, such as an architectural, graphic arts, or printing firm, spends a significant amount on writing utensils and supplies, spend analysis may be at the class (ink and lead refills) or commodity (pen refills) levels. This reveals opportunities to consolidate suppliers, find better sources, negotiate volume discounts, or optimize the supply chain in some other way. If this spend is insignificant, analysis may be on the higher family (office supplies) or segment (office equipment, accessories, and supplies) categories only. The U.N. Standard Products and Services Code (UNSPSC) provides an open, global, multisector standard for efficient, accurate classification of products and services. Some supply managers are dissatisfied because the UNSPSC often does not address specific industries or products at a level of detail required for meaningful commodity spend analysis. Also, it is difficult to make updates in an automated environment. Different divisions of the same organization often assign different UNSPSC codes to the same commodity. To effectively use UNSPSC, all databases within an organization and its supply chain need to use the same version of UNSPSC, support backward compatibility for earlier versions, and keep it updated. Costs can be prohibitive. Many procurement departments use government-issued, industry-specific, or proprietary code systems that do not directly integrate or embed UNSPSC. Proprietary codes are developed by, and useful to, a single company. Often they are not hierarchical, meaning they lack roll-up and drill-down capabilities for spend analysis. Such coding schemas can 2
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Johnson, and M. R. Leenders, Supply Leadership Changes, Tempe (AZ: CAPS Research, March 2007).
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be expensive to develop and maintain, and it can be expensive to require trading partners to use the same code.3
Electronic or Online Catalogs An e-catalog or online catalog is a digitized version of a supplier’s catalog. It allows buyers to use a Web browser to view detailed buying and specifying information about the supplier’s products and/or services. Product catalogs include (1) product specification data, and (2) transaction data. Product specification data describe the products and are the same for all buyers. Transaction data (price, shipping and billing addresses, and quantity discounts) are customized to each buyer. Accessibility may be a factor in the supplier selection decision because it is critical to the success of an e-procurement application. If an existing supplier lacks e-catalog capabilities, will this exclude the supplier from future business? If a supplier is developing the capability, how much conversion time will be allowed? For a new supplier, how much weight will this capability carry in the decision? Suppliers have a number of options to digitize their catalogs. The buyer’s solutions’ provider can typically convert the supplier’s catalog to a suitable format. Alternatively, the supplier can purchase an out-of-the box software package and make the conversion or purchase the services of the software provider. Or a data aggregator can develop a library of product specifications from a variety of suppliers and license organizations to use the product specifications and assist in developing the transaction data. In a catalog network, a host company collects the catalogs and customizes the transaction data for each buyer. The buyer can either pull the catalogs onto the company server or access them from the host company. Or the supplier may allow the buyer to “punch out” or access a supplierhosted catalog. Supply can create buyer-controlled catalogs that combine information, such as pricing and specifications, from one or multiple suppliers. Simple database software packages permit the creation of such catalogs, and most enterprise resource planning (ERP) systems have features that permit the creation of customized catalogs. The supplier is responsible for updating and maintaining the catalogs. In-house catalogs permit the user to customize content in terms of supply options and pricing, or to restrict supply options. These catalogs support item standardization and volume purchasing from approved suppliers. The catalog can be integrated into the company’s system to streamline the process and track spending patterns.
Electronic Data Interchange (EDI) EDI allows computer-to-computer exchange of business documents between two organizations using agreed standards to structure the message data. Documents exchanged via EDI include purchase orders, shipping schedules and notifications, and invoices. EDI has been widely adopted in the manufacturing, transportation and retailing sectors. Companies such as Walmart, Home Depot, and Target require supplier compliance with EDI. EDI provides secure transmission and fast turnaround of large amounts of data, greater accuracy internally and with trading partners, shorter process cycle time that may help to lower inventory, provide electronic logs or audit trails, and reduce administrative costs. 3
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A. E. Flynn, Catalog Management: Implementation Strategies (Tempe, AZ: CAPS Research, October 2004).
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There are four types of EDI: 1. A Value-Added Network (EDI VAN) is a private network for secure information exchange between companies. Each trading partner has an account with an EDI VAN that serves as an electronic mailbox used to send and receive documents. The benefits of an EDI VAN are convenience, an alerting service to notify of transmission or receipt, trading partner enablement, management of outsourced EDI, and other EDI integration services that allow companies to seamlessly use back office systems with EDI. 2. Internet EDI or AS2 (Applicability Statement 2). Two computers, a client and a server, communicate with each other securely and reliably via the Internet. An envelope is created by AS2 and uses encryption and digital certificates to send the envelope securely. 3. Web EDI allows document exchange through an easy-to-use Web interface. Data are converted into an EDI standard compliant format and transmitted to a trading partner. Prepopulated forms with built-in business rules are used. Receiving, editing, and sending electronic documents are simple and efficient. The only requirement is an Internet connection. 4. Outsourced EDI Services. The benefits are expert people, processes, and technology to operate a full-featured EDI program. This enables B2B expansion, ongoing management, prompt integration of new trading partners, and robust infrastructure to support transactions, translator services using current e-commerce EDI standards, and reporting.
E-Marketplaces Electronic marketplaces are virtual shopping malls. Business-to-business e-marketplaces are network services on which member companies buy and sell their goods and exchange information. Many offer a broad scope of supply chain activities, such as forecasting and replenishment, industry standards or price discovery and clearing, and provide a range of software solutions and consulting services. Consequently, most e-marketplaces position themselves as “supply chain services” organizations. Members may be small, medium, or large organizations. The benefits of participation in an e-marketplace are the ability to aggregate spend to benefit from economies of scale, to have visibility up and down the supply/value chain, to automate and facilitate transactions, and to eliminate elements of the existing value chain (disintermediation). Biased marketplaces can be either buyer-owned or supplier-owned, whereas neutral marketplaces are owned by independent third parties. E-marketplaces may be vertical or horizontal. Vertical e-marketplaces focus on one specific industry. For example, Global Healthcare Exchange (GHX) is owned by 20 organizations representing manufacturers, distributors, hospitals, and group supply organizations. It is the largest trading exchange in health care worldwide, operating in the United States, Canada, and nine European countries. GHX helps any organization that buys, sells, tracks, and/or uses medical products to realize cost savings, gain efficiencies, and make better business decisions. According to GHX (www.ghx.com) transaction volume has increased 1,500 percent since 2001, approaching $24 billion in 2008. Horizontal e-marketplaces offer a product or service across industries. For example, Quadrem is a transaction delivery network that connects more than 60,000 suppliers and
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1,500 buyers and handles more than $20 billion in order throughput annually. Quadrem’s membership includes Global 1000 buyers and suppliers from a variety of industries, as well as suppliers of all sizes located in metropolitan, rural, and developing regions around the world. Quadrem’s global offices provide expertise spanning technology, procurement processes, and the change management that accompanies e-procurement initiatives.
Online Reverse Auctions Auctions have been used for commercial transactions for centuries. Generally, auctions are classified on the basis of competition, between sellers or buyers, and forward or descending prices. For example, the Dutch flower auctions are declining-price auctions with competition between buyers, while a traditional English-style auction, involving the sale of equipment or furniture, is a rising-price auction with multiple buyers. These models and the Internet provide new techniques for determining price, quality, volume allocations, and delivery schedules with suppliers. Internet auction events can be open offer, private offer, posted prices, and reverse auctions. Open Offer Auctions Suppliers select items, see the most competitive offers from other suppliers, and enter as many offers as they want up until a specified closing time. Private Offer Auctions The buyer offers a target price and quantity. Suppliers enter offer(s) on select item(s) by a specific time. The buyer evaluates and posts a “status.” The status levels are: Accepted: The supplier is awarded the contract, contingent on final qualification. Closed: The supplier may no longer submit offers on the item. BAFO (best and final offer): The supplier may submit one more offer for the item. Open: Bidding may be continued for as many rounds as necessary to accept or close all items. Posted Price Auctions gets the award.
The buyer posts the acceptable price; the first supplier to meet it
Reverse Auctions A reverse auction is an online, real-time, dynamic, declining-price auction for goods or services between one buying organization and a group of prequalified suppliers. Suppliers compete by bidding against each other online using specialized software. Suppliers see the status of their bids in real time. The supplier with the lowest bid or lowest total cost bid is usually awarded the business.
When to Use Reverse Auctions A reverse auction is an alternative sourcing method to RFPs/RFQs, sealed bids, face-toface negotiations, and spot buys from the commodity markets. At a minimum, the following conditions are required: 1. Clearly defined specifications, including technological, logistical, and commercial requirements.
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2. A competitive market with qualified suppliers willing to participate. Typically, at least three suppliers are required. More than six suppliers may add unnecessary costs and complexity. 3. An understanding of the market conditions in order to set appropriate expectations for a reserve price. 4. Buyer and seller familiarity and competency using the auction technology. 5. Clear rules of conduct: for example, conditions for extending auction length and award criteria. 6. The buyer is prepared to switch suppliers if necessary. 7. The buyer believes that the projected savings justify a reverse auction.
Conducting Reverse Auction Events There are three stages: preparation, the auction event, and implementation and follow-up. Preparation The purchaser identifies or certifies appropriate suppliers; sets the quality, quantity, delivery, and service requirements and length of contract; trains internal team members and supplier representatives on the auction technology; tests the technology and communicates the process and award criteria. Event Price visibility can be handled by showing rank order, percentage, or proportional differences. Bid ranks can be adjusted for nonprice factors, such as differences in transportation costs or quality. Auction rules should be known up-front and strictly followed to foster credibility and encourage future participation. Suppliers must know the length of the auction and the rules for extending the time period. Suppliers and the buyer can typically communicate during the auction. Messages may or may not be visible to other participants. Technical assistance should also be available. Implementation and Follow-up The purchaser announces the results to participants and responds to questions. Negotiation or clarification may occur before the final contract is signed. The auction leader communicates the outcome internally. For example, accounting needs to know if there is a change of suppliers and/or pricing. Anything that might improve auctions should be documented.
Issues with Reverse Auctions Potential ethical transgressions on behalf of buyers are: 1. Buyer knowingly accepts bids from suppliers with unreasonably low prices. 2. Buying firm submits phantom bids during the event to increase the competition artificially. 3. Buyer includes unqualified suppliers to increase price competition. Potential ethical issues involving suppliers are: 1. Supplier collusion. 2. Suppliers bid unrealistically low prices and attempt to renegotiate afterwards.
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3. Suppliers “bird watch” or participate in the event but do not bid to collect market intelligence. A rule requiring bids before entering the auction may preclude this behavior. 4. Suppliers submit bids after the auction event in an attempt to secure the business.
Potential Problems with Using Online Auctions4 There are a number of problems that might arise. These include: • • • •
The risk of interrupting good supplier relationships. The risk of developing a reputation for aggressive price-buying over other considerations. The costs of running the auction versus expected savings. The cost savings potential of auctions versus sourcing processes such as RFP/RFQ and negotiation. • Significant up-front preparation and cost required compared to determining price through an RFP/RFQ. • Actual price when unforeseen costs are factored in versus bid price. The Portland Bus Company at the end of this chapter provides an example of a company that uses electronic reverse auctions and the implications for making sourcing decisions.
Radio Frequency Identification (RFID) RFID tags contain a chip and antenna that emit a signal, using energy from a radio frequency reader, which contains information about the container or its individual contents. RFID tags vary widely in memory, frequency, power source, and cost. The most common are passive, read-only tags. Employee identification badges and highway toll payment devices use RFID technology. In the early 2000s, large retailers Walmart, Tesco, and Target announced plans to adopt RFID technology in their supply chain to reduce costs. Expected benefits include elimination of manual counting and bar coding of incoming and outgoing material; automatic tracking of inventory levels; faster, easier, and more accurate inventory identification and picking; and reduced spoilage through improved stock rotation. Implementation has been slower than projected. Implementation is challenging and costly and will take years. By 2010, implementation has varied and many suppliers and retailers do not see value at the current level of cost and performance. RFID adds another level of information and the firm’s information systems must have the capability to capture, process, and analyze the data as they are collected. Implementation requires investments in information technology and support from consultants and systems engineers. Appropriate process controls are required to achieve the benefits of inventory record accuracy.
IMPLICATIONS FOR SUPPLY When applying technology to the acquisition process, supply professionals still play a critical decision-making role. They provide the investigative and analytical skills to source, evaluate, and select suppliers; the influencing and persuading skills to negotiate the best 4
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P. F. Johnson, “Supply Organizational Structures,” CAPS Research, June 2003.
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deal for the organization; and a strategic and long-term planning approach to anticipate and prevent problems down the road. The transactional side is streamlined and responsibility for actually placing orders delegated to the user whenever possible. With rapidly changing technology, it is difficult to predict what the future will look like. It is, therefore, important to identify the key questions that decision makers in supply management must answer before embarking on an e-commerce path. These include: 1. 2. 3. 4. 5.
Should we be a leader or a follower? What should be acquired through e-commerce? What tools should we use to acquire those items? Who should we use as a service provider? Should we enter into an alliance and, if so, what type, or should we work privately?
1. Should we be a leader or a follower? Management must decide to be an early adopter of new technology or wait to see what emerges as the norm or standard. Early adopters often report that, despite the difficulties encountered, there are advantages to being further along than later adopters. Those who choose to wait tend to believe that the high risks and costs associated with adopting new technology in its infancy far outweighs whatever competitive advantages might be gained. Relevant factors are the organization’s risk aversion and success with past technology implementation. 2. What should be acquired through e-commerce? Should the organization purchase indirect goods and services, direct requirements, or both through e-commerce tools, strategic or nonstrategic goods and services? Supply managers must consider the characteristics of each category of purchase (see Chapter 6 for a discussion of purchases categories) to determine what might be successfully procured online. This analysis includes consideration of the existing and desired buyer–supplier relationship to ensure that the method of procurement does not adversely harm the relationship. 3. What tools should we use? Streamlining tools range from lower technology tools, such as procurement cards, to high-technology tools, such as online reverse auctions, e-catalogs, and integrated e-RFx systems. A decision to adopt e-commerce does not necessarily mean that all the available tools will be adopted. The decision maker must determine the appropriateness of the tool to the type of material or service under consideration, the nature of the buyer-supplier relationship, and the comfort level of the internal stakeholders and the suppliers. 4. Who should we use as a service provider(s)? If a third-party service provider is used, a careful assessment must be made of the available providers. Several critical technical issues are compatibility with, or ease of migration from, existing software; scalability (can it grow with your needs?); the supplier’s technical reputation and experience with supply chain management; and expertise of the staff. Some of the key considerations beyond the technical issues are the long-term viability of the provider, user-friendliness of the software, fee structure, and service and support—offline and online. 5. Should we enter into an alliance and, if so, what type, or should we work privately? There are a number of alliance options available: electronic supply through a buyercontrolled system, or through a neutral, third-party-controlled e-marketplace or trading hub. A number of factors must be considered, including the technical standards
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(interoperability and ease of data exchange), the degree of trust (confidence in the provider, confidentiality of information, system reliability, and uptime), and the cost and benefits of membership. The benefits for sellers include improved service quality from more accurate and timely order processing, increased revenues from market expansion, and lower costs. For the buyer, participation in e-hubs may reduce transaction costs, increase competition through reduced search costs, and ultimately lead to lower costs.
POLICY AND PROCEDURE MANUAL A policy and procedure manual may also contribute to the development of an efficient and effective process. It is a carefully prepared, detailed statement of organization, duties of the various personnel, and procedures and data systems (including illustrative forms used, fully explained). A manual is essential for a well-conceived training program, internal transfers, and communication about the process with nonsupply colleagues. The requirements of the Sarbanes-Oxley Act add greater importance to internal controls, standardized processes, and consistent use. The preparation process may reveal inconsistencies and discrepancies that lead to process improvements. Careful advance planning of the coverage, emphasis, and arrangement is essential. It should include a clear definition of the purposes of the manual and its uses. Both purpose and use influence length, form, and content. A manual may cover only policy or it may include a description of the organization and some level of description of procedures. Current manuals and sample manuals from other organizations can serve as guides. Department personnel and internal stakeholders such as design, engineering, marketing, operations, and production should discuss and check the contents for errors and modifications. The manual should reflect the actual policy and procedures, or drive process changes. The manual may be posted on the organization’s intranet and/or in loose-leaf form. The chief executive officer may enhance credibility by writing a foreword defining the supply department’s authority and endorsing its policy and procedures. Common topics are authority to requisition; competitive bidding; approved suppliers; supplier contracts and commitments; authority to question specifications; purchases for employees; gifts, blanket purchase orders; confidential data; rush orders; supplier relations; lead times; determination of quantity to buy; over and short allowance procedure; local purchases; capital equipment; personal service purchases; repair service purchases; authority to select suppliers; confirming orders; unpriced purchase orders; documentation for purchase decisions; invoice clearance and payment, invoice discrepancies; freight bills; change orders; samples; returned materials; disposal of scrap and surplus; determination of price paid; small-order procedures; salesperson interviews; and reporting of data.
Conclusion
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The supply management process has come under increasing scrutiny because of (1) the unrelenting focus on cost management, and (2) the realization that standardized processes and internal and external integration can lead to competitive advantage. Robust processes are the foundation of a successful supply organization. As supply managers continue to transition to a more strategic role in many organizations they also will continue to test and apply new technologies to the supply process. Although current surveys indicate that overall e-commerce adoption has been slower than
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anticipated due to the difficulties of internal and external integration and the lack of data standards, the future holds much promise for technology-enabled process improvements. The challenges are great, but those who see the opportunity for cost reductions, faster cycle times, and improved communication flows will continue to seek ways to use these new tools to their best advantage. Information systems and information technology enable a supply organization to contribute efficiently and effectively to organizational goals and strategies. Without structured and disciplined supply processes, technology expenditures may leave the organization with too many tools and not enough integration or utilization.
Questions for Review and Discussion
1. Where in the supply process is there the greatest opportunity to add value and why? 2. What are the steps in a robust supply management process? 3. What contribution to supply efficiency might be effected through the use of (a) an e-procurement system, (b) online catalogs, and (c) online reverse auctions? 4. What approaches, other than the standard supply procedure, might be used to minimize the small-value-order problem? 5. When would you issue an RFQ rather than an RFP and why? 6. What records are needed for efficient operation of the supply function? How can data collection throughout the process help or hurt buyer–supplier relationships? 7. What are the costs and benefits of follow-up and expediting? Are there opportunities to reduce total cost of ownership at this stage of the process? 8. How can an e-procurement system reduce the problem of small orders? Rush orders? 9. What should be considered before switching from an existing EDI system to a Webbased system? 10. What arguments would you use to convince a supplier to participate in a reverse auction? 11. How does the use of an e-procurement system change the nature of the skills and knowledge required of supply management personnel? 12. What possible improvements in supply could the Internet offer in the future?
References
Beall, S. et al. The Role of Reverse Auctions in Strategic Sourcing. Tempe, AZ: CAPS Research, 2003. Bovet, D., and J. Martha. Value Nets: Breaking the Supply Chain to Unlock Hidden Profits. New York: John Wiley & Sons, 2000. DeHoratius, N. “Inventory Record Inaccuracy and RFID.” The 15th Annual North American Research Symposium on Purchasing and Supply Management Conference Proceedings. Tempe, Arizona, March 2004, pp. 69–76. Farhoomand, A., and P. Lovelock. Global e-Commerce: Text and Cases. Singapore: Pearson Education Asia, 2001. Flynn, A. E. “Raytheon’s Buyerless Tools.” Practix 6. Tempe, AZ: CAPS Research, March 2003. Heijboer, G. Quantitative Analysis of Strategic and Tactical Purchasing Decisions. Enschede, The Netherlands: Twente University Press, 2003.
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Hughes, J.; M. Ralf; and B. Michels. Transforming Your Supply Chain: Releasing Value in Business. London: International Thomson Business Press, 1998. Hur, D., and V. A. Mabert. “Getting the Most Out of E-Auction Investment.” The 15th Annual North American Research Symposium on Purchasing and Supply Management Conference Proceedings. Tempe, Arizona, March 2004, pp. 163–79. Johnson, P. F. “Supply Organizational Structures.” Critical Issues Report. Tempe, AZ: CAPS Research, June 2003. Johnson, P. F., and R. D. Klassen. “e-Procurement,” MIT Sloan Management Review 46, no. 2 (2005), pp. 7–10. Johnson, P. F.; R. D. Klassen; M. R. Leenders; and A. Awaysheh. “Utilizing E-Business Technologies in Supply Chains: The Impact of Firm Characteristics and Teams.” Journal of Operations Management 25, no. 6 (2007), pp. 1255–1274. Laudon, K. C.; J. P. Laudon; and M. E. Brabston. Management Information Systems: Managing the Digital Firm. 4th ed. Upper Saddle River, NJ: Prentice Hall, 2008. Percy, D. H.; L. C. Giunipero; and L. M. Dandeo. “An Analysis of E-Procurement Strategy: What Role Does Corporate Strategy Play?” 13th Annual IPSERA Conference Proceedings. Catania, Italy, April 2004, pp. C-216–27. Rozemeijer, F. Creating Corporate Advantage in Purchasing. Eindhoven, The Netherlands: Technische Universiteit Eindhoven, 2000.
Case 4–1
Bright Technology International Bob Renwick, purchasing manager at Bright Technology International (BTI), was considering a quotation from Electronix for supply of MJ10012 transistors, in his Modesto, California, office. It was Tuesday, March 11, and this was the third time this month he had been asked to consider a volume purchase for a component; he wondered what purchasing policies, if any, he should establish for such situations. Bob had to respond to the supplier’s proposal before the end of the week, and he felt that the MJ10012 transistor purchase would provide a good basis in which to change the current approach used to acquire similar components.
COMPANY BACKGROUND Headquartered in Hartford, Connecticut, BTI designed, manufactured, and marketed proprietary electro-optical instruments. Founded in the early 1980s, BTI went public
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in 1989. Company revenues had grown steadily and sales for the current fiscal year were expected to reach $10 million. BTI’s products were used around the world for medical research, health care, industrial process, quality control, environmental science, and other applications. The company focused exclusively on fluorescence instrumentation and distinguished itself in the marketplace by providing exceptional product support. Fluorescence was a powerful technique for studying molecular interactions in analytical chemistry, biochemistry, cell biology, physiology, nephrology, cardiology, photochemistry, and environmental science. Applications included studying dynamics of the folding of proteins, measuring concentrations of ions inside living cells, studying membrane structure and function, investigating drug interactions with cell receptors, and fingerprinting oil samples. Its advantage over other light-based
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investigation methods was high sensitivity, high speed, and safety. BTI’s products included spectrofluorometers and ratio fluorescence systems. In recent years, the company had expanded internationally, and it currently had sales and service centers in the United States, Canada, Germany, and the United Kingdom. Management expected that approximately 50 percent of its sales for the coming year would be outside the United States and Canada. BTI had nine competitors. Eight of these were about the same size as BTI, while one other controlled nearly one-half of the market. In total, BTI had approximately 80 employees, including 20 in Connecticut and 45 in Modesto. Manufacturing, engineering and R&D, and customer service functions resided at the Modesto facility.
THE MJ10012 TRANSISTOR The MJ10012 was a transistor used in the power supply for several of BTI’s products. Each power supply needed two transistors and the annual demand for this kind of transistor had increased over the past few years. The expected demand for the coming year was estimated to be 2,000 units. BTI had been using transistors manufactured by Steyn Technologies. However, a competitor, Abram Industries, acquired Steyn the previous year, and the MJ10012 transistor was no longer part of the supplier’s core product offering; its supply was currently handled through an independent distributor, Electronix. Checking his records, Bob found that the MJ10012 transistor had been purchased in each of the last three years with the following price history:
PURCHASING AT BTI Bob Renwick handled all purchasing for materials and services related to the production of BTI’s products and reported to the plant manager. He had a background as a technician for a major telecom company before he joined BTI six years earlier. Purchased components accounted for about 80 percent of cost of sales. Although Bob worked with more than 400 vendors, many of whom were located outside North America, approximately three-quarters of the total dollar value for his orders were for custom-designed components, while the balance of the orders were for basic items. He relied heavily on members of the engineering department, who were familiar with the suitability of suppliers to satisfy technical specifications for various components and for recommendations regarding new suppliers. In recent years, there had been a trend of consolidation among the manufacturers of electrical components and optical parts, and the remaining players were mostly big companies with significant bargaining power. While there was still price competition for high-volume components, especially for large customers, suppliers tended to charge a premium when supplying small custom orders. For Bob, this trend meant increased prices for many of his components. To address this problem, he had worked with the engineering department to redesign certain products, eliminating some costly or hardto-get components. However, engineering staff had not been able to solve this issue completely and occasionally customers specified certain types of subcomponents in their orders.
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Year
Price per Unit
Current quote Previous year Two years prior Three years prior
4.95 3.50 2.00 1.69
Bob estimated that there was approximately a two months’ supply in stock, and the supplier was quoting lead times of 30 days.
CONCLUSION As Bob looked at the quotation from Electronix, he considered his alternatives. He was confident that there were other transistors on the market that provided similar performance capabilities; however, these products would have to be located, then tested and approved by engineering. If, on the other hand, he was going to buy the transistors from Electronix, how many should he order? The controller had indicated that it cost about $50 to process an order, and besides, Bob felt his time was best spent on other matters. Bob had to make purchasing decisions about hundreds of different parts; and although the MJ10012 transistor decision was a minor one in terms of dollar amount, it represented a typical issue in the purchase of electrical and optical parts that was of growing concern to him. He wondered whether there was anything else he could do to deal with this and similar issues.
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Case 4–2
Hemingway College Catherine Barkley, manager of purchasing and accounts payable at Hemingway College in Fresno, California, stared at the latest e-mail from one of her staff. She had less than three months to take her department “live” on the new enterprise resource planning (ERP) system and problems continued to pour in. It was now April 6 and Catherine wondered what action she should take in light of the tight deadline she faced. Catherine was expected to make her recommendations to her boss, Dan Kavaliers, in a meeting the following day.
HEMINGWAY COLLEGE Hemingway College was a community college with approximately 12,000 students. It offered training and educational programs in the areas of applied arts, business, health care, human services, hospitality, literacy, academic upgrading, life skills, computers, technology, apprenticeship, and English as a second language. All of its 78 postsecondary certificate and diploma programs remained popular and student intake was on the rise. The college prized itself on its trusted position within the community, citing that almost every fifth person in the city had passed through its classrooms. Catherine reported to Dan Kavaliers, the vice president of finance and corporate services. She was responsible for a staff of 11 people, including four buyers, an accounts payable manager, four accounts payable clerks, a traffic and customs officer, and an administrative assistant. Most purchases were controlled centrally, although some departments had recently lobbied for a more decentralized structure.
RESOURCE PLANNING SYSTEM Two years prior, senior management at Hemingway College decided to implement a new ERP system. Although the old systems provided the basic functionality required, they had become so antiquated and many vendors were discontinuing support for related software and hardware. It was also felt that this would be a good time to integrate various areas—finance, human resources, and student information—as well as upgrade to the latest technology in the market. After a seven-month supplier evaluation process, a cross-functional senior management team, led by the
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vice president of finance and corporate services and the vice president of administration, selected an out-of-thebox ERP package, EduSoft, which had been successfully installed in similar colleges across North America. The first group to get involved in the implementation of the new ERP system was finance, which implemented a new general ledger, including a coding structure for the new system. The next set of processes to be brought on the new system were the purchasing and accounts payable systems, because they tied in most closely with the general ledger. Successful implementation would ease the transition of the entire purchasing module, and in turn, that of other functional modules as well.
IMPLEMENTING THE PURCHASING MODULE Catherine had held her first meeting with EduSoft staff the previous August to start planning the implementation. As team lead for implementing the purchasing module, she quickly realized that there were quite a few challenges ahead. The old in-house system had gradually evolved around the specific policies and needs of the purchasing department. EduSoft, however, had its own functional assumptions on policies and department needs built into the system. Catherine grappled with the issue of whether to try and change the EduSoft system to work with old established policies or to change policies in order to leverage EduSoft’s streamlined built-in processes that seemed to have succeeded in other colleges. Catherine ultimately decided to implement the new streamlined systems, expecting that this decision would yield substantial long-term benefits. From October to December of the previous year, the new purchasing and accounts payable system was tested for the availability of features and for access and security issues. In January, process mapping from the old system to the new one was finished off, and the new system looked set to be rolled out with all features implemented by the end of June.
TRAINING During January and February, Catherine started weekly half-day meetings with staff to train them and give them hands-on exposure to the new system. This was important,
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as she needed to make the staff comfortable with the new system and achieve “buy-in.” She planned to continue staff training throughout the summer since this was the best time for staff to get acquainted with the new system, because they were mostly free from the distractions of catering to everyday student requirements and issues. Currently, the staff training meetings typically lasted 15 to 20 minutes held every day or every second day, focused around specific issues that had come up while using the system, rather than the broad-based training sessions on policy and process change matters held earlier. So far, Catherine had been receiving a continual flow of problems encountered by staff trying to use the new system to deliver the functions they wanted.
IMPLEMENTATION SCHEDULE The current schedule called for purchasing and accounts payable to complete implementation of its modules by the end of June in order that its systems would be functional for the start of the school year in August. The human resources department was scheduled to start implementation of its modules following purchasing, at the beginning of July, so that employee tax and income reporting information could start on January 1 the following year. The director of human resources and vice president of finance and corporate services were adamant that they wanted to avoid running two systems for employee records. Consequently, any delays in implementing the human resource modules would in turn set back overall system implementation by one year. Delaying implementation of the purchasing and accounts payable modules also would create problems. Some old systems had been removed as part of the transition, and reverting back to the old systems was not viewed as feasible.
ALTERNATIVES In order to complete implementation of her department’s modules on schedule, Catherine felt that she had at least two alternatives. First, Catherine believed that more staff time was needed to implement the modules than originally budgeted. This approach would require her to increase staff overtime dramatically and add temporary staff. Catherine would need to hold a one-week workshop with her staff to clear up systems problems and establish a new project plan. She estimated that staff overtime costs would be approximately $3,000 per week and four temporary staff, at a cost of approximately $2,000 per week, would be required. Even with the extra resources, Catherine remained concerned about the ability of her department to keep up with its normal activities, and ultimately staff burnout, if this alternative was adopted. A second option would be to hire consultants from EduSoft to implement the modules. The consultants would require some support from Catherine’s staff, but there would be no need for additional overtime or temporary staff beyond the current budget. In her conversations with representatives from EduSoft, they had indicated that she should budget $12,000 per week for this service. While this option was more convenient, Catherine was concerned about its higher costs and the implications of using a third party to implement the modules. Catherine had a meeting scheduled with Dan Kavaliers the following morning at 9:00 a.m. He was expecting an update from her and recommendations as part of a comprehensive plan that would ensure that implementation of the purchasing and accounts payable modules would occur by the end of June.
Case 4–3
Portland Bus Company Richard Kaplan, buyer at Portland Bus Company (“PBC”), in Portland, Oregon, was preparing for his meeting with Laura Henning, business consultant for Bothe US operations, on October 14. Laura would be assisting Richard in managing a series of reverse auctions for approximately 290 components involving seven suppliers. This would be PBC’s first use of reverse auctions, and several important decisions had to be made before finalizing arrangements for the online bidding event. Before his meeting with Laura, Richard was to review alternatives for the auction
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process, including the type of auction to be used and the policy for selecting suppliers.
PORTLAND BUS PBC was owned by Dawe Motors, a leading global producer of passenger cars and commercial vehicles, headquartered in the United Kingdom. The Portland plant assembled body shells for the Dawe Bus Division. The shells were shipped from Portland to a facility in Medford,
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EXHIBIT 1 Supplier Profiles Supplier
Profile
Current Spend
Dawson Manufacturing
Sheet metal and aluminum fabrication, using laser, CNC machining and plasma cutting technologies. Facility size: 110,000 sq. ft. Subsidiary of a North American-based automotive parts manufacturer with annual revenues of $2 billion.
$575,000
Imperial Fabrication
Sheet metal fabrication using laser and computer integrated systems for the design, engineering and manufacturing of quality custom and standard products. Process capabilities: laser cutting, welding, punching, and bending. Facility size: 100,000 sq. ft. Privately held.
$650,000
Neelin Mfg. Inc.
Contract manufacturing, machining, stamping, and assembly operations. Facility size: 80,000 sq. ft. Privately held.
Being considered for future business
C.R.N. Products Inc.
Sheet metal fabrication, assembly, and painting for smalland high-volume production. Facility size: 60,000 sq. ft.
$210,000
Benson Sheet Metal
Stamping and punching presses, riveting, steel shearing, tube forming, spot welding, and coating services. Facility size: 50,000 sq. ft. Privately held.
$460,000
Beranger Enterprises Ltd.
Light sheet metal processing and welding (1/2⬙ and thinner) as well as CNC machining and turning of carbon steel, stainless steel, and aluminum. Facility size: 100,000 sq. ft. Privately held.
$40,000
Camber Machining Ltd.
Machining, metal punching, and fabrication, using CNC equipment and on-site engineering capabilities. Facility size: 50,000 sq. ft. Privately held.
$40,000
Oregon, approximately 275 miles away, for final assembly and painting. Approximately 550 people worked at the PBC plant. David McGregor, director of materials, headed a staff of 12 people, who were responsible for materials planning, inventory control, and purchasing. Total annual purchases were approximately $250 million across five main commodity groups: fabricated metal, systems, fiber glass, electrical, and power train. However, approximately 75 percent of purchases were set up through corporate purchasing with strategic suppliers, leaving about $60 million to be sourced through David’s organization. Richard reported directly to David and was responsible for sourcing fabricated metal components.
METAL COMPONENTS During the last three months, Richard had analyzed the company’s spend in three fabricated metal parts categories:
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hinges, brackets, and ducts. Ten suppliers were currently responsible for 290 different part numbers, representing an annual spend of approximately $2 million. It had been more than two years since a thorough review of these commodity categories had been conducted, and Richard felt that under current market conditions, significant opportunities existed for cost savings. Four of the PBC’s current suppliers were not in Richard’s future plans because of concerns regarding past performance. Furthermore, Richard intended to include a new supplier, Neelin Mfg. Inc., in the online bidding event. Exhibit 1 provides profiles of the seven suppliers that Richard was considering for participation in the reverse auction.
THE REVERSE AUCTION Richard decided to group components into packages as opposed to running 290 separate online bidding events. Eventually, he settled on 21 packages of complementary
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EXHIBIT 2 Reverse Auction Packages
Package
Annual Spend ($)
7
32,551
Ducts 1
10
208,838
Ducts 2
13
106,236
Brackets 1
12
53,773
Brackets 2
12
119,912
Brackets 3
3
65,389
Brackets 4
9
111,500
Brackets 5
16
54,901
Brackets 6
13
65,997
Brackets 7
12
78,950
Brackets 8
21
48,108
Brackets 9
39
83,557
Brackets 10
15
84,630
Brackets 11
14
55,673
Brackets 12
16
64,734
Brackets 13
7
137,624
Brackets 14
2
71,675
Brackets 15
21
219,922
Brackets 16
18
133,896
Brackets 17
20
166,114
Brackets 18 Total
components, which were similar in terms of manufacturing processes, quality requirements, and production volumes (see Exhibit 2). PBC’s parent company had a contract with Bothe AG, an online bidding event solutions provider, to provide assistance and technical support to all of its divisions for reverse auctions. Located in Europe, North America, and Asia, Bothe provided a range of consulting and technology platforms, working with approximately 200 companies in the automotive, construction, machinery manufacturing, and office supplies industries. Its services included online auctions, supply contract negotiations, supplier management, and a range of Web-based technology solutions. The Dawe passenger car division in Europe had recently completed a reverse auction project with Bothe and was very satisfied with the results.
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# Part Numbers
Hinges
10
49,771
290
2,013,751
Laura Henning, business consultant for Bothe US operations, had been assigned to work with Richard to manage the reverse auction project. Laura and her team would be responsible for: 1. Working suppliers to set up the Bothe technology platform and providing training to their employees. 2. Communicating relevant documentation to suppliers regarding details of the auction packages, such as part specifications, quality requirements, and volumes. 3. Conducting a test auction with suppliers, and subsequently addressing any technical issues or questions that arise. 4. On the day of the auction, Bothe would monitor the online bidding event and provide helpdesk support to
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all parties involved. The Bothe platform allows the buyer to watch the reverse auction live. 5. After the auction, Bothe would provide a detailed auction report to the buyer, including the results, which would be available approximately two hours after the auction event. Laura had indicated that once arrangements were finalized it would take a maximum of two weeks to install the Bothe platform at the suppliers and to train their staff. Testing the platform would take an additional one or two days. Richard expected that suppliers would need at least two weeks to review the packages and prepare for the auctions. Consequently, Richard was planning to run the auctions starting the middle of November, and he hoped to have everything completed by the Christmas holiday.
PREPARING FOR THE REVERSE AUCTION The meeting on October 14 was to finalize the schedule for the reverse auction events, review alternatives for the auction process, including the type of auction to be used, and set policies for selecting suppliers. Since this was PBC’s first reverse auction, David McGregor was sensitive that any decisions might have implications for similar projects in the future. Consequently, he expected to review Richard’s plan before proceeding. Laura explained to Richard that there were a variety of methods for conducting a reverse auction, and the primary
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decisions included visibility (e.g., what the bidders would see during the auction), length of the auction, policies for extending the length of the auction, and target pricing. For example, the Bothe system could be configured such that every bidder could see the current best price only, a ranking of all bid prices (displayed by color codes), or the bidder’s rank only (e.g., best, second, third, etc.). Laura also indicated that while most auctions ran 15 or 30 minutes, it was not uncommon to have policies that extended the event provided there was still bidding activity at the end of the designated time. Furthermore, buyers in some reverse auctions set target prices to provide a pricing benchmark for bidders. Lastly, Richard needed to decide on what basis the packages should be awarded and to what extent prices could be negotiated following the auction. David had indicated to Richard that he expected a 25 percent reduction in costs as an outcome of the reverse auction project. Richard felt that other factors needed to be considered beyond price. For example, he recognized that there would be costs of switching suppliers, and he wondered how this should be taken into account when awarding business. For example, should the lowest bidder be awarded the package if the price savings was less than the costs of switching? Furthermore, to what extent should PBC take into consideration long-term supply relationships when making final sourcing decision from the reverse auctions? Richard wanted to be clear and upfront as possible with the suppliers, some of whom he expected may be reluctant to participate.
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Chapter Five Make or Buy, Insourcing, and Outsourcing Chapter Outline Make or Buy Reasons for Make instead of Buy Reasons for Buying Outside The Gray Zone in Make or Buy
Outsourcing Supply and Logistics Supply’s Role in Insourcing and Outsourcing Conclusion Questions for Review and Discussion
Subcontracting
References
Insourcing and Outsourcing
Cases 5–1 B&L Inc. 5–2 Rondot Automotive 5–3 Alicia Wong
Insourcing Outsourcing
120
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Key Questions for the Supply Decision Maker Should we • Change the way we currently take make or buy decisions? • Consider insourcing more? • Outsource more? How can we • Improve our ability to find insourcing opportunities? • Ensure that supply considerations receive full attention in make or buy decisions? • Develop our outsourcing expertise better?
MAKE OR BUY One of the most critical decisions made in any organization concerns make or buy. When any organization starts its life, a whole series of make or buy decisions need to be made and as the organization grows and as it adds or drops products and/or services from its offerings, make or buy decisions continue to be made. In this text the difference between make or buy and insourcing and outsourcing is defined as follows. Insourcing refers to reversing a previous buy decision. An organization chooses to bring in-house an activity, product, or service previously purchased outside. Outsourcing reverses a previous make decision. Thus an activity, product, or service previously done in-house will next be purchased. Therefore, for any brand new product or service, make or buy decisions need to be made. Later, in view of new internal and external circumstances, these previous make or buy decisions are reviewed and some or all may be reversed. See Figure 5–1. Clearly, there is a major role to play for supply managers in make or buy as well as insourcing and outsourcing. The whole character of the organization is colored by the organization’s stance on the make or buy decision. It is one of vital importance to an organization’s productivity and competitiveness. Managerial thinking on this issue has changed dramatically in the last few years with increased global competition, pressures to reduce costs, downsizing, and focus on the firm’s core competencies. The trend is now toward buying or seeking outside suppliers for services or goods that might traditionally have been provided in-house. Traditionally, the make option tended to be favored by many large organizations, resulting in backward integration and ownership of a large range of manufacturing and subassembly facilities. Major purchases were largely confined to raw materials, which were then processed in-house. New management trends favoring flexibility and focus on corporate strengths, closeness to the customer, and increased emphasis on productivity and competitiveness reinforce the idea of buying outside. It would be unusual if any one organization were superior to competition in all aspects of manufacturing or creating services. By buying outside from capable suppliers those requirements for which the buying organization has no special manufacturing or service advantage, the management of the buying organization can concentrate better on its main mission. With the world as a marketplace, it is the purchaser’s responsibility to search for or develop world-class suppliers suitable for the strategic needs of the buying organization.
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FIGURE 5–1 Make or Buy and Insourcing and Outsourcing Decisions Business Opportunity
What Product/Service to Create in What Market Segment(s)?
Strategic Entrepreneurial
Execution
What Do We Make or Buy?
Strategic Operational
100% Make Later Review
Stay
100% Buy
Gray Zone
Change
Stay
Change
Stay
Outsource
Insource More Make Insource
Gray Zone
Change
More Buy Outsource
100% Buy
Gray Zone 100% Make
Gray Zone
100% Buy
100% Make
Gray Zone
A recent North American phenomenon has been the tendency to purchase services outside that were traditionally performed in-house. These include security, food services, and maintenance, but also programming, training, engineering, accounting, accounts payable, legal, research, personnel, information systems, and even contract logistics and supply. Thus, a new class of purchases involving services has evolved. The make or buy decision is an interesting one because of its many dimensions. Almost every organization is faced with it continually. For manufacturing companies, the make alternative may be a natural extension of activities already present or an opportunity for diversification. For nonmanufacturing concerns, it is normally a question of services rather than products. Should a hospital have its own laundry, operate its own dietary, security, and maintenance services, or should it purchase these outside? Becoming one’s own supplier is an alternative that has not received much attention in this text so far, and yet it is a vital option in every organization’s supply strategy. What should be the attitude of an organization toward this make or buy issue? Many organizations do not have a consciously expressed policy but prefer to decide each issue as it arises. Moreover, it can be difficult to gather meaningful accounting data for economic analysis to support such decisions. If it were possible to discuss the question in the aggregate for the individual firm, the problem should be formulated in terms of: What should our organization’s objective be in terms of how much value should be added in-house as a percentage of final product or
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service cost and in what form? A strong supply group would favor a buy tendency when other factors are not of overriding importance. For example, one corporation found its supply ability in international markets such a competitive asset that it deliberately divested itself of certain manufacturing facilities common to every competitor in the industry.
Reasons for Make instead of Buy There are many reasons that may lead an organization to produce in-house rather than purchase. Competitive, political, social, or environmental reasons may force an organization to make even when it might have preferred to buy. When a competitor acquires ownership of a key source of raw material, it may force similar action. Many countries insist that a certain amount of processing of raw materials be done within national boundaries. A company located in a high-unemployment area may decide to make certain items to help alleviate this situation. A company may have to further process certain by-products to make them environmentally acceptable. In each of these instances, cost may not be the overriding concern. For additional reasons see Table 5–1.
Reasons for Buying Outside There are many reasons why an organization may prefer to purchase goods or services outside. Competitive, political, social, or environmental reasons may force an organization to buy instead of make. Government contracts may require a specified percentage of the organization’s spend to go to minority suppliers. A process may require a large amount of water that is scarce locally, or create difficult disposal issues in a particular location. Frequently, certain suppliers have built such a reputation for themselves that they have been able to build a real preference for their component as part of the finished product. Normally, these are branded items that can be used to make the total piece of equipment TABLE 5–1 Why Make?
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1. The quantities are too small and/or no supplier is interested or available in providing the goods. 2. Quality requirements may be so exacting or so unusual as to require special processing methods that suppliers cannot be expected to provide. 3. Greater assurance of supply or a closer coordination of supply with the demand. 4. To preserve technological secrets. 5. To obtain a lower cost. 6. To take advantage of or avoid idle equipment and/or labor. 7. To ensure steady running of the corporation’s own facilities, leaving suppliers to bear the burden of fluctuations in demand. 8. To avoid sole-source dependency. 9. To reduce risk. 10. The purchase option is too expensive. 11. The distance from the closest available supplier is too great. 12. A significant customer required it. 13. Future market potential for the product or service is expanding rapidly. 14. Forecasts of future shortages in the market or rising prices. 15. Management takes pride in size.
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TABLE 5–2 Why Buy?
1. The organization may lack managerial or technical expertise in the production of the items or services in question. 2. Lack of production capacity. This may affect relations with other suppliers or customers as well. 3. To reduce risk. 4. The challenges of maintaining long-term technological and economic viability for a noncore activity. 5. A decision to make, once made, is often difficult to reverse. Union pressures and management inertia combine to preserve the status quo. Thus, buying outside is seen as providing greater flexibility. 6. To assure cost accuracy. 7. There are more options in potential sources and substitute items. 8. There may not be sufficient volume to justify in-house production. 9. Future forecasts show great demand or technological uncertainty, and the firm is unable or unwilling to undertake the risk of manufacture. 10. The availability of a highly capable supplier nearby. 11. The desire to stay lean. 12. Buying outside may open up markets for the firm’s products or services. 13. The ability to bring a product or service to market faster. 14. A significant customer may demand it. 15. Superior supply management expertise.
more acceptable to the final user. The manufacturers of transportation construction or mining equipment frequently let the customer specify the power plant brand and see this option as advantageous in selling their equipment. For additional reasons see Table 5–2. The arguments advanced for either side of the make or buy question sound similar: better quality, quantity, delivery, price/cost, service, lower risk, greater opportunity to contribute to the firm’s competitive position and ability to provide greater customer satisfaction. Therefore, each individual make or buy decision requires careful analysis of both options. Even in the make decision, there will likely be a significant supply input requirement and there is even a greater one on the buy option. Thus, supply managers are constantly required to provide information, judgments, and expertise to assist the organization in resolving make or buy decisions wisely.
The Gray Zone in Make or Buy Research by Leenders and Nollet suggests that a “gray zone” may exist in make or buy situations. There may be a range of options between 100 percent make or 100 percent buy. (See Figure 5–1.) This middle ground may be particularly useful for testing and learning without having to make the full commitment to make or buy. Particularly in the purchase of services, where no equipment investment is involved, it may be that substantial economies accrue to the organization that can substitute low-cost internal labor for expensive outside staff or low-cost external labor for expensive inside staff. A good example of a gray zone trade-off in the automotive industry is the supplier who takes over design responsibility for a component from the car manufacturer. In maintenance, some types of servicing can be done by the purchaser of the equipment, other types by the equipment manufacturer.
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The gray zone in make or buy may offer valuable opportunities or superior options for both purchaser and supplier.
SUBCONTRACTING A special class of the make or buy spectrum is the area of subcontracting. Common in military and construction procurement, subcontracts can exist only when there are prime contractors who bid out part of the work to other contractors, hence the term subcontractor. In its simplest form, a subcontract is a purchase order written with more explicit terms and conditions. Its complexity and management varies in direct proportion to the value and size of the program to be managed. The management of a subcontract may require unique skills and abilities because of the amount and type of correspondence, charts, program reviews, and management reporting that are necessary. Additionally, payment may be handled differently and is usually negotiated along with the actual pricing and terms and conditions of the subcontract. The use of a subcontract is appropriate when placing orders for work that is difficult to define, will take a long period of time, and will be extremely costly. For example, aerospace companies subcontract many of the larger structural components and avionics. Wings, landing gears, and radar systems are examples of high-cost items that might be purchased on a subcontract. The subcontract is normally administered by a team that might include: a subcontract administrator (SCA), an equipment engineer, a quality assurance representative, a reliability engineer, a material price/cost analyst, a program office representative, and/or an on-site representative. Managing the subcontract is a complex activity that requires knowledge about performance to date as well as the ability to anticipate actions needed to ensure the desired end results. The SCA must maintain cost, schedule, technical, and configuration control from the beginning to the completion of the task. Cost control of the subcontract begins with the negotiation of a fair and reasonable cost, proper choice of the contract type, and thoughtfully imposed incentives. Schedule control requires the development of a good master schedule that covers all necessary contract activities realistically. Well-designed written reports and recovery programs, where necessary, are essential. Technical control must ensure that the end product conforms to all the performance parameters of the specifications that were established when the contract was awarded. Configuration control ensures that all changes are documented. Good configuration control is essential to “aftermarket” and spares considerations for the product. Unlike a normal purchase order of minimal complexity, where final closeout may be accomplished by delivery and payment, a major subcontract involves more definite actions to close. These actions vary with the contract type and difficulty of the item/task being procured. Quite often large and complex procurements require a number of changes during the period of performance. These changes result in cost claims that must be settled prior to contract closure. Additionally, any tooling or data supplied to the contractor to support the effort must be returned. All deliverable material, data, and reports must be received and inspected. Each subcontract’s requirements will vary in the complexity of the closure requirements; however, in all cases a subcontract performance summary should be written to provide a basis for evaluation of the supplier for future bidder or supplier
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selection. Such a report also is necessary in providing information for subsequent claims or renegotiation.
INSOURCING AND OUTSOURCING Insourcing and outsourcing occur when the decisions are made to reverse past make or buy decisions. Just because the decision to make or buy was properly made originally, this does not mean it cannot be changed. New circumstances inside the organization, in the market, or in the environment may require the organization to reverse its stance on a previous make or buy decision. If the previous decision to make or buy was improperly made and can be corrected subsequently, this should obviously be done. However, the arguments for constantly reassessing past make or buy decisions are particularly strong. Perceived risks may have been minimized or eliminated. New technology may permit processes previously considered impossible. New suppliers may have entered the market or old suppliers may have left. New trade-offs between raw materials and components, such as substitution of steel by plastic, may result in new options. It is this constant change in volumes, prices, capabilities, specifications, suppliers, capacities, regulations, competitors, technology, and managers that requires supply managers to review their current make and buy profile continuously in identifying new strengths and weaknesses, opportunities, and threats. The two questions that need to be addressed on an ongoing basis by a cross-functional team including supply, operations, accounting and marketing are: (1) Which products or services are we currently buying that we should be doing in-house? (2) Which products and services that we are currently doing in-house should we be buying outside?
INSOURCING Insourcing, the often forgotten twin of outsourcing, deals with past buy decisions that are reversed. Given the demands on procurement managers’ time, the likelihood that supply managers will initiate an insourcing initiative is relatively small. Continuing to buy what was purchased before is likely to be standard practice. From a supply perspective there are, however, several reasons why supply might have to trigger an insourcing initiative. The most obvious reason is when an existing source of supply goes out of business or drops a product or service line and no other supplier is available. Assuming the requirement for product or service continues, the supply manager needs to find an alternate source. Supplier development or the creation of a new supplier who was previously not selling the product or service is one option. The other is to insource. Similarly, a sudden massive increase in price, the purchase of a sole source by a competitor, political events and regulatory changes, or a lack of supply of a key raw material or component required for the manufacture of the purchased product might force supply to consider insourcing. Thus, anything that threatens assurance of supply may provide supply a reason for insourcing. This might be called the necessity argument: “We would prefer not to produce this product or service in-house, but we really don’t have any other options.” There are other organizational factors, however, aside from the aforementioned supply considerations, that may make insourcing an attractive option. The reasons would be similar
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to the “make” arguments provided earlier in this chapter in the make or buy discussion. We may have developed a unique process for this product or service. Our quality, delivery, total cost of ownership, or flexibility would be vastly improved. We could provide superior customer service and satisfaction. Insourcing would greatly enhance our competitive ability. This might be called the opportunity argument: “We would prefer to do this in-house because it would give us a strategic competitive advantage.” After the decision to insource has been taken, the smooth transition from outside supply to inside manufacture will require supply’s special attention. In the first place, how do we discontinue our dealings with our existing supplier(s)? Can the change-over occur simultaneously with current contract expiries or may penalties have to be paid to terminate existing commitments? With any insourcing initiatives, there is also a new supply issue in terms of raw materials, components, equipment, energy, and services required to produce the particular requirement just insourced. Therefore, supply’s capability to provide the required inputs competently is one of the factors to be considered in any insourcing decision. The Alicia Wong case at the end of this chapter is an interesting example of an insourcing decision. This case describes the opportunity to produce mustard in-house, rather than purchasing it from an outside supplier. Because mustard is used in many products, the decision focuses not only on whether this insourcing is an attractive proposition, but also, if the decision is to go ahead, how to ensure it will be successful.
OUTSOURCING Organizations outsource when they decide to buy something they had been making inhouse previously. For example, a company whose employees clean the buildings may decide to hire an outside janitorial firm to provide this service. That a huge wave of outsourcing and privatization (in the public sector) has hit almost all organizations during the last decade is evident. In the urge to downsize, “right size,” and eliminate headquarters staff, and to focus on value-added activities and core competencies in order to survive and prosper, public and private organizations have outsourced an extremely broad range of functions and activities formerly performed in-house. Some activities, such as janitorial, food, and security services, have been outsourced for many years. Information Systems (IS) is one activity that has received much attention recently as a target for outsourcing. Other popular outsourcing targets are mail rooms, copy centers, and corporate travel departments. Almost no function is immune to outsourcing. Accounts payable, human resources, marketing/sales, finance, administration, logistics, engineering, and even supply are examples of functions now outsourced, but previously done in-house. An entire function may be outsourced, or some elements of an activity may be outsourced and some kept in-house. For example, some of the elements of information technology may be strategic, some may be critical, and some may lend themselves to lower cost purchase and management by a third party. Identifying a function as a potential outsourcing target, and then breaking that function into its components, allows the decision makers to determine which activities are strategic or critical and should remain in-house, and which can be outsourced. The growth in outsourcing in the logistics area is attributed to transportation deregulation, the focus on core competencies, reductions in inventories, and enhanced logistics
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management computer programs. Lean inventories mean there is less room for error in deliveries, especially if the organization is operating in a just-in-time mode. Trucking companies have started adding the logistics aspect to their businesses—changing from merely moving goods from point A to point B, to managing all or a part of all shipments over a longer period of time, typically three years, and replacing the shipper’s employees with their own. Logistics companies now have computer tracking technology that reduces the risk in transportation and allows the logistics company to add more value to the firm than it could if the function were performed in-house. Third-party logistics providers track freight using electronic data interchange technology and a satellite system to tell customers exactly where its drivers are and when the delivery will be made. In a just-in-time environment, where the delivery window may be only 30 minutes, such technology is critical. For example, Hewlett-Packard turned over its inbound raw materials warehousing in Vancouver, Washington, to Roadway Logistics. Roadway’s 140 employees operate the warehouse 24 hours a day, seven days a week, coordinating the delivery of parts to the warehouse and managing storage. Hewlett-Packard’s 250 employees were transferred to other company activities. Hewlett-Packard reports savings of 10 percent in warehousing operating costs. The reasons for outsourcing are similar to those advanced for the buy option in make or buy decisions earlier in this chapter. There is a key difference, however. Because the organization was previously involved in producing the product or service itself, the question arises: “What happens to the employees and space and equipment previously dedicated to this product or service now outsourced?” Layoffs often result, and even in cases where the service provider (third party) hires former employees, they are often hired back at lower wages with fewer benefits. Outsourcing is perceived by many unions as efforts to circumvent union contracts. The United Auto Workers union has been particularly active in trying to prevent auto manufacturers from outsourcing parts of their operations. Additional concerns over outsourcing include: • Loss of control. • Exposure to supplier risks: financial strength, loss of supplier commitment, slow implementation, promised features or services not available, lack of responsiveness, poor daily quality. • Unexpected fees or “extra use” charges. • Difficulty in quantifying economics; conversion costs. • Supply restraints. • Attention required by senior management. • Possibility of being tied to obsolete technology, and • Concerns with long-term flexibility and meeting changing business requirements. As organizations have gained more experience in making outsourcing decisions and crafting outsourcing contracts, they have become better at applying sourcing and contracting expertise to these decisions. From writing the statement of work or request for proposal to defining the terms and conditions, the success of an outsourcing agreement lies in the details. The two cases on outsourcing at the end of this chapter are illustrative of typical outsourcing decisions. B&L Inc. is considering the outsourcing of a part currently produced in-house. Rondot Automotive deals with the outsourcing of a whole process, in this case,
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painting. Both are useful examples of the processes followed by supply managers in analyzing outsourcing decisions.
OUTSOURCING SUPPLY AND LOGISTICS In a CAPS study on outsourcing, it was found that there was little outsourcing of typical supply management activities. The activities most likely to be outsourced were inventory monitoring, order placement, and order receiving, with more than 40 percent of respondents expecting increased outsourcing in inventory monitoring and order placement. Many tasks associated with the logistics function as well as the entire function itself have been heavily outsourced. The tasks typically outsourced include freight auditing, leasing, maintenance and repair, freight brokering, and consulting and training. Deciding what represents a core competency to an organization is not always an easy task, nor is the decision always the same for a specific function. For example, ownership and management of an in-house fleet of vehicles may be subject to the decision to outsource or maintain in-house. In an organization where the sales force is large, the cars for sales representatives may be seen as an extension of the sales force, and part and parcel of the company’s ability to outperform the competition in personal sales. Many of the functions of fleet may be outsourced—leasing rather than owning vehicles, maintenance, resale of vehicles—but the contact with the drivers may be retained as an in-house function because keeping the drivers (sales force) happy is critical to the success of the organization. In a utility company, the mechanical expertise needed to maintain specialty vehicles may be seen as part of the company’s core competency, whereas the maintenance of the automobile fleet may not. The outsourcing decision is a function of many factors, and each organization must assess these factors based on the goals and objectives and long-term strategy of the organization.
SUPPLY’S ROLE IN INSOURCING AND OUTSOURCING Research indicates that supply has had relatively moderate involvement in the outsourcing decisions made in many organizations. However, given the nature of these insourcing and outsourcing decisions, supply managers should be heavily involved to add in the following ways: • • • • • •
Providing a comprehensive, competitive process. Identifying opportunities for insourcing or outsourcing. Aiding in selection of sources. Identifying potential relationship issues. Developing and negotiating the contract. Ongoing monitoring and management of the relationship.
The strategic importance of make or buy, insourcing, and outsourcing decisions is so high that great care needs to be exercised to make sure these decisions are right. Obviously, appropriate supply input is critical for these decisions as well as supply management subsequently to assure the success of whichever option has been chosen.
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Conclusion
Make or buy, insourcing, and outsourcing are key strategic decisions for any organization. That each of these decisions can be reviewed and reversed at a later date, as conditions warrant, adds to the challenge of maintaining an appropriate mix of in-house activities and purchased goods and services. Obviously, effective supply management requires an ongoing active contribution from supply into this continuing assessment process. The more skilled the supply group at exploiting market opportunities and developing competitive sources, the more ready the organization should be to buy outside and outsource.
Questions for Review and Discussion
1. Why should an organization switch from making to buying? 2. What is outsourcing? How might one make the decision to outsource an activity or not? 3. Why is the make or buy decision considered strategic? 4. What is the gray zone in make or buy? What are its implications? 5. Why might an organization decide to insource? Can you give an example? 6. What is subcontracting? 7. Why would an organization outsource its logistics? Engineering? Marketing? 8. In the public sector what name is frequently used for outsourcing? What are some major impediments to outsourcing in the public sector? 9. What role is expected of supply once an insourcing decision has been made? 10. If you were the sole owner of your own company, would you favor the make side or the buy side of the make or buy decision? Why?
References
Carter, Joseph R.; William J. Markham; and Robert M. Monczka. “Procurement Outsourcing: Right for You?” Supply Chain Management Review 11, no. 4, May–June 2007, p. 26. Gilley, K. M., and A. Rasheed. “Making More of Doing Less: An Analysis of Outsourcing and Its Effect on Firm Performance.” Journal of Management 26, no. 4 (2000), pp. 763–790. Halvey, John K., and Barbara Murphy Melby. Business Process Outsourcing: Process, Strategies and Contracts. 2nd. ed. Hoboken, NJ: John Wiley & Sons, 2007. Hayes, R. H; G. P. Pisano; D. M. Upton; and S. C. Wheelwright. Operations Strategy and Technology: Pursuing the Competitive Edge. New York: Wiley, 2005. Mol, Michael J. Outsourcing, Supplier Relations and Internationalisation: Global Sourcing Strategy as a Chinese Puzzle. Rotterdam, The Netherlands: Ersamus Research Institute of Management (ERIM), 2001. Parker, David W., and Katie A. Russell. “Outsourcing and Inter/Intra Supply Chain Dynamics: Strategic Management Issues.” Journal of Supply Chain Management 40, no. 4, Fall 2004, p. 56. Takeishi, A. “Bridging Inter- and Intra-firm Boundaries: Management of Supplier Involvement in Automobile Product Development. Strategic Management Journal 22, no. 5 (2001), pp. 403–433.
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Tompkins, James A.; Steven W. Simonson; Bruce W. Tompkins; and Brian E. Upchurch. “Creating an Outsourcing Relationship: Successful Outsourcing Depends as Much on the Kind of Relationship Developed as It Does on the Details of the Operational Execution.” Supply Chain Management Review 10, no. 2, March 2006, p. 52.
Case 5–1
B&L Inc. Brian Wilson, materials manager at B&L Inc. in Lancaster, Pennsylvania, was considering a proposal from his purchasing agent to outsource manufacturing for an outrigger bracket. It was the end of April and Mr. Wilson had to evaluate the proposal and make a decision regarding whether to proceed.
Manufacturing lead time for the outrigger bracket was two weeks. However, the Metal Fabricating Division had been able to coordinate supply and production with assembly operations. Consequently, finished inventory levels of the outrigger bracket were kept to a minimum. B&L’s inventory holding costs were 20 percent per annum.
B&L INC. BACKGROUND
THE OUTSOURCING DECISION
B&L Inc. manufactured trailers for highway transport trucks. The company comprised three divisions: the Trailer, Sandblast & Paint, and Metal Fabricating Divisions. Each division operated as a separate profit center, but manufacturing operations between each were highly integrated. The Metal Fabricating Division produced most of the component parts of the trailers, the Trailer Division performed the assembly operations, and the Sandblast & Paint Division was responsible for completing the sandblasting and final painting operation. B&L manufactured approximately 40 trailers per year, with about two-thirds produced during the period from November to April.
In an effort to reduce costs, the purchasing agent, Alison Beals, who reported to Brian Wilson, solicited quotes from three local companies to supply the outrigger bracket. Mayes Steel Fabricators (Mayes), a current supplier to B&L for other components, offered the lowest bid, with a cost of $108.20, FOB B&L. Brian met with the controller, Mike Carr, who provided a breakdown of the manufacturing costs for the outrigger bracket. Looking at the spreadsheet, Mike commented: “These are based on estimates of our costs from this year’s budget. Looking at the material, labor, and overhead costs, I would estimate that the fixed costs for this part are in the area of about 20 percent. Keep in mind that it costs us about $75 to place an order with our vendors.” Exhibit 1 provides B&L’s internal cost breakdown and details from the quote from Mayes.
THE OUTRIGGER BRACKET The outrigger bracket, part number T-178, was an accessory that could be used to secure oversized containers. The bracket consisted of four component parts welded together, and each trailer sold by B&L had 20 brackets— 10 per side. The Metal Fabricating Division was presently manufacturing the outrigger bracket. The subassembly parts— T-67, T-75, T-69, and T-77—were processed on a burn table, which cut the raw material to size. Although the burn table could work with eight stations, this machine had only been operating with one station. The final assembly operation, T-70, was performed at a manual welding station.
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EXHIBIT 1 Manufacturing Costs and Mayes Quote: Outrigger Bracket T-178 Parts T-67 T-75 T-69 T-77 T-70 Total
Mayes Steel Fabricators
B&L Manufacturing Costs
$14.60 21.10 18.50 13.00 41.00 $108.20
$17.92 17.92 45.20 10.37 58.69 $150.10
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Brian expected that B&L would have to arrange for extra storage space if he decided to outsource the outrigger bracket to Mayes, who had quoted delivery lead time of four weeks. Because Mayes was local and had a good track record, Brian didn’t expect the need to carry much safety stock, but the order quantity issue still needed to be resolved.
B&L was operating in a competitive environment and Brian had been asked by the division general manager to look for opportunities to reduce costs. As he sat down to review the information, Brian knew that he should make a decision quickly if it was possible to cut costs by outsourcing the outrigger bracket.
Case 5–2
Rondot Automotive It was September 28 and Glenn Northcott, purchasing planner at Rondot Automotive in Jackson, Mississippi, was evaluating an important outsourcing opportunity. For the past three months, Glenn had been working on a project that involved evaluating the feasibility of outsourcing the plant’s painting requirements, and he had just finished collecting much of the necessary technical and cost information. Glenn had to complete his evaluation in advance of a meeting scheduled with his boss, Terry Gibson, purchasing manager, and the plant manager, Dick Taylor, in one week’s time to discuss this matter and to decide what action, if any, needed to be taken next.
RONDOT WORLDWIDE Rondot Automotive was a wholly owned subsidiary of Rondot Worldwide, a leading global designer and manufacturer of electrical and electronic components. Rondot Worldwide operated in more than 100 countries, employing more than 200,000 people. It was a key player in the information and communications, automation and control, power, transportation, medical, and lighting industries. Rondot Automotive operated 85 plants in 25 countries. It was known for providing high-quality, innovative products in automotive electronics, electrics, and mechatronics. The Jackson, Mississippi, plant manufactured small motors for a number of applications, including engine cooling, HVAC (heating, ventilation, and cooling), and antilock brake systems. The plant produced approximately 7 million motors per year, which were shipped directly to OEM assembly facilities for customers such as Ford, GM, DaimlerChrysler, Honda, Toyota, and BMW. Rondot Automotive was facing considerable global competition and significant pressures from its customers for price reductions. As a result, total sales and employment at the Jackson plant had steadily declined over the past five years. The number of employees at the plant had
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dropped from 1,450 to 600, and plant management was under pressure to lower costs and regain market share. The purchasing organization at Rondot Automotive was a hybrid structure. The corporate strategic purchasing group operated from the company’s head office in Troy, Michigan, and was responsible for negotiating major contracts with suppliers and working on new product development initiatives. Plant-level purchasing organizations reported to the plant managers on a solid-line basis and corporate purchasing on a dotted-line basis. Plant purchasing managers were responsible for materials management, negotiating contracts for local requirements and small-value purchases. The purchasing department at the Jackson plant consisted of four people, including two buyers, a planner (Glenn), and Terry Gibson. Glenn had joined Rondot right out of college the previous year.
OUTSOURCING OPPORTUNITY A steel housing was manufactured for each of the six different families of motors manufactured at the Jackson plant. The housings were “deep drawn” in large stamping presses in a batch operation. Following stamping, the housings were processed through a zinc phosphate treatment for cleaning and then painted. Quality specifications stipulated that the coating on the housing had to be capable of withstanding 240 hours of salt spray testing. The cleaning and painting process involved a continuous-flow wet paint system that had been installed in a 20,000-square-foot section of the plant approximately 17 years prior. The system had undergone a number of upgrades and modifications, in part to comply with evolving environmental regulations. Based on data from the plant controller, Ken Lee, Glenn had learned that the cleaning and painting operations cost 25¢ for each housing. Ken commented to Glenn: “We estimate our costs to include 10¢ in material, 3¢ in labor,
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and the rest in overhead, including expenses such as taxes, energy, maintenance, and charges from corporate office.”
GREVEN E-COATING Glenn had been approached by an enterprising local vendor several months back, inquiring about Rondot’s painting requirements. Cathy Stirling, representing Greven E-Coating Company (Greven) proposed that she prepare samples for each family of housings and provide cost estimates to Glenn. Eager to explore cost savings opportunities, Glenn readily agreed. Electrocoating, or e-coating, uses a system whereby a DC electrical charge is applied to a metal part immersed in a bath of oppositely charged paint particles. The metal part attracts the paint particles, forming an even film over the entire surface, until the coating reaches the desired thickness. E-coating was generally considered more cost efficient compared to traditional wet paint systems. Samples from Greven were sent to Rondot’s quality control department for testing and the results seemed encouraging. The tests indicated that parts for five of the six families of housings, representing approximately 60 percent of the Jackson plant’s housing volume, could be converted to e-coating using Greven at a cost of 15¢ each. One family of housings failed the tests because of problems with the method of adhering a magnet to the housing. Rondot’s assembly process required a magnet to be attached to the top inner portion of each housing using either a cold or hot bonding adhesion process. The use of either method was dependent on product design,
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and engineering specified the adhesion method used. The one family of housings that used a cold-bond adhesion process had failed the test, while the other five families, which used a hot-bond process, passed the testing process. As part of thes range: $220,000 to $250,000
2. The seller and purchaser do not overlap. The gap $220,000
$250,000
The purchaser's range: $220,000 to $250,000
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$270,000
$300,000
The seller's range: $270,000 to $300,000
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7. Plan the negotiation strategy. Which issues should be discussed first? Where is the buyer willing to compromise? Who will make up the negotiation team (it frequently is composed of someone from both engineering and quality control for a good, or the primary internal consumer for a service, headed by the buyer)? Establishing a range and a target for each objective sets reasonable objectives that the negotiator feels can be achieved. The tactics used in the actual negotiation may mean starting out at a more extreme position than the negotiator truly believes is achievable. The decision about tactics should be based on the negotiator’s understanding of the situation and the parties involved in the negotiation. If the goal of negotiation is performance, then the way negotiation is conducted is important because it affects the intention to perform. If the tactics used leave the other party feeling negative toward the negotiator or the results, there may be little commitment to the agreement or to solving any problems that might arise during the life of the contract. 8. Brief all persons on the team who are going to participate in the negotiations. 9. Conduct a dress rehearsal for the people who are going to participate in the negotiations. 10. Conduct the actual negotiations with an impersonal calmness. All negotiation has an economic as well as a psychological dimension. It is important to satisfy both of these dimensions to achieve a win-win result. The trends toward teaming, single sourcing, partnering, and empowerment reinforce the need for supply personnel to be superior negotiators, both with suppliers and with others in their own organization. Actually, negotiations inside one’s own organization to obtain cooperation and support for supply initiatives may be more challenging than those with suppliers.
Conclusion
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The notion that an attempt should be made to identify and analyze all costs of ownership drives many of the supply strategies discussed in this book. For example, long-term, collaborative buyer–supplier relationships; partnering arrangements and alliances; and early supplier and supply involvement all can facilitate total cost modeling, improve negotiations and decision making, and result in increased competitiveness for the organization. Supply professionals concerned with contributing effectively to organizational goals and strategies need to be concerned with managing costs instead of prices. Beating up suppliers for unreasonable price concessions can be as damaging as “leaving too much on the table” in a negotiation with an important supplier. Understanding where and how supply chain costs can be reduced or eliminated can represent an opportunity to gain competitive advantage. Negotiation and supplier cost analysis complement each other. Cost analysis identifies the opportunity and secures the result. Costs drive pricing, and negotiations with suppliers that concentrate on costs focus both parties on opportunities to improve competitiveness as opposed to posturing around prices and win/lose bargaining. The skilled supply professional not only understands the value of reliable supplier cost data but is also resourceful in collecting such information and capable of using it effectively in a negotiation.
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Questions for Review and Discussion
1. What is cost-based pricing? How and why is it used? 2. What are the major cost categories that you would include when estimating a supplier’s cost for a manufacturing item? How would you estimate such costs if the supplier was either unwilling or unable to provide a detailed cost breakdown? 3. What are the major cost categories that you would include when estimating a supplier’s cost for a service? How would you estimate the cost if the supplier was either unwilling or unable to provide a detailed cost breakdown? 4. When, and how, is negotiation used, and what can be negotiated? 5. What is a learning curve and how can it be used? 6. Why do firms use target pricing? How are target prices established? 7. What is activity-based costing (ABC), and how can the buyer use ABC to reduce costs? 8. What is total cost of ownership (TCO), and how is it determined? 9. What is the difference between “managing costs” as opposed to “managing prices”? 10. Please comment on the following statement: Target pricing can only be used for manufactured items and cannot be applied to services.
References
Cooper, R., and R. Slagmulder. Target Costing and Value Engineering. Portland, OR: Productivity Press, and Montvale, NJ: The IMA Foundation for Applied Research Inc., 1997. Ellram, L. M.; W. L. Tate; and C. Billington. “Understanding and Managing the Services Supply Chain.” The Journal of Supply Chain Management 40, no. 4 (2004), p. 17. Ellram, L. M. The Role of Supply Management in Target Costing. Tempe, AZ: CAPS Research, 1999. Ellram, L. Strategic Cost Management in the Supply Chain: A Purchasing and Supply Management Perspective. Tempe, AZ: CAPS Research, 2002. Ellram, L. “A Taxonomy of Total Cost of Ownership Models.” Journal of Business Logistics 15, no. 1 (1994), pp. 171–91. Ellram, L. “Total Cost of Ownership: Elements and Implementation.” International Journal of Purchasing and Materials Management, Fall 1993. Ferrin, B. G., and R. E. Plank. “Total Cost of Ownership Models: An Exploratory Study.” Journal of Supply Chain Management 38 no. 3 (2002), pp. 18–29. Fisher, R., and D. Ertel. Getting Ready to Negotiate: The Getting to Yes Workbook. New York: Penguin Books, 1995. Fisher, R.; W. Ury; and B. Patton. Getting to Yes: Negotiating Agreement Without Giving In. New York: Penguin Books, 1991. Flynn, A. E. Consumption and Specification Management at Bristol Myers Squibb. Practix, Tempe, AZ: CAPS Research, 2005. Lewicki, R. J.; D. M. Saunders; and B. Barry. Negotiation. 5th ed. Burr Ridge, IL: McGraw-Hill/Irwin, 2005. Ury, W. Getting Past No: Negotiating Your Way from Confrontation to Cooperation. New York: Bantam Books, 1993.
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Case 11–1
Deere Cost Management On Wednesday, February 18, Jim Elsey, cost management specialist at Deere & Company in Moline, Illinois, received a call from Glen Lowery, sales manager in the Agricultural Products Division: Jim, I need you to look into our costs on the gatherer chain. Our margins have really shrunk and we need to do something about this problem. Get back to me and let me know what you think.
THE GATHERER CHAIN
FINANCIAL ANALYSIS
Deere & Company (Deere) manufactured and distributed a full line of agriculture equipment as well as a broad range of construction and forestry equipment and commercial and consumer equipment. The company had annual sales of $14 billion with operations in more than 160 countries. A popular product sold by the Agricultural Products Division was a conveyor system. Materials placed on the front end of the conveyor sat on the gatherer chain, which carried the material to the opposite end. The gatherer chain was joined together in links, fastened by pins, and included small hooks that helped to carry the material. It sat on rollers that required regular lubrication to keep the conveyor system in good working condition. The Agricultural Products Division had produced the conveyor system for several years, with only slight modifications in its design. As standard practice for each product, Deere sold replacement parts, including gatherer chains, through its dealer network. It was the intention of management to ensure that its aftermarket products were price competitive. As a result, the sales department regularly benchmarked pricing for its products. Jim learned that the gatherer chain was purchased from Saunders Manufacturing (Saunders), a supplier located in Decatur, Illinois. Saunders was a family-owned business run by Wayne Saunders, the son of the company’s founder. Saunders had a long-term relationship with Deere, and
EXHIBIT 1 Profitability Analysis for Gathered Chain
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Aftermarket price Purchase cost Cost–price ratio Unit sales
Wayne had a reputation as a tough, successful businessman who had grown the company to the point where it now employed approximately 300 people. Reviewing the sales margin for the gatherer chain, Jim could see why Glen was concerned. Over the past three years, the sales revenue and margin had been declining steadily (see Exhibit 1). The budgeted selling price for the current year was based on the need to match the price set by a major competitor.
Jim arranged a meeting the following day with Susan Tessier, from purchasing, and Jose da Costa, from engineering. During the meeting, Jim laid a gatherer chain on the conference room table and asked Jose to estimate the raw material content. After a little bit of work, Jose estimated that the product consisted of approximately 11.6 pounds of steel and 46 pins that joined the links. He also expected that Saunders would have approximately a 20 percent scrap rate, for steel only, as part of their normal production cost. Jose also commented that Saunders could use general-purpose equipment for the manufacturing and assembly process. Susan then pulled out her material cost file and made the following observations: We just finished negotiations with our steel suppliers and expect to pay approximately $28.00 per hundredweight for this type of material. I am also buying the same pins for a couple of our divisions, and I figure Saunders is paying about 3.5¢. Don’t forget that for this part we pay the freight, which usually costs about 3 percent of the purchase price, and they pay the packaging. We have looked around for other suppliers for this part and haven’t been able to find anyone that capable of beating the current price. Saunders has been a good supplier. Their quality and on-time delivery performance have been excellent. I wouldn’t want to lose them as a supplier.
Two Years Ago
Last year
Current Year Budget
$ 40.00 $ 21.25 53% 475,000
$ 36.25 $ 22.61 62% 410,000
$ 30.00 $ 24.12 80% 350,000
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Following the meeting, Jim examined the Annual Survey of Manufacturers, published by the U.S. Department of Commerce. Within the report was a breakdown of manufacturing costs, as a percentage of sales, for U.S. companies in Saunders’ industry code. According to data from the previous year, the breakdown was material, 42 percent; direct labor; 13 percent; indirect labor, 6 percent; and overhead, 20 percent.
SUPPLIER NEGOTIATION Glen felt that the budgeted cost–price ratio for the gatherer chain was unacceptable and was anxious to see what could be done to address the problem. He remarked to
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Jim, “The competition is pretty strict about maintaining a 50–50 cost–price ratio on their product lines. Why is it they can sell this product for $30.00 and we can’t match their cost structure?” Jim felt that he had gathered enough information to do some preliminary analysis. However, he was aware that he needed to think about how he could use the information in his negotiation with the vendor. Susan had indicated that Wayne Saunders had been a tough negotiator, with a “take it or leave it” attitude regarding pricing, and had been unwilling to share any specific cost information to justify his requests for price increases.
Case 11–2
McMichael Inc. Art Flynn, packaging buyer for McMichael Inc. (MI), was working on an import substitution project involving a local minority supplier. He was concerned, however, that his efforts would be fruitless because his original proposal had been flatly rejected by the plant manager as too expensive. McMichael Inc., a medium-sized company, had over the years specialized in prescription skin-care products, a market niche in which it had developed an excellent reputation. About three years ago, after extensive testing, MI had introduced a new facial cream in a special package that allowed for precise measurement of the quantity dispersed. The container, manufactured by a French firm for a different application, was fairly expensive at an FOB MI’s factory cost of $0.36. What concerned Art Flynn even more, however, were the quality and delivery problems encountered. Communications with the manufacturer were difficult, and Art had the impression the manufacturer did not seem to care much about MI’s business, which, as Art knew, was only a small proportion of their total volume produced. With the cooperation of MI’s marketing, engineering, production, and quality control personnel, Art had found a local minority supplier who appeared capable of meeting MI’s requirements. This custom molding firm, OSA Inc., was owned by Bert Wood, a bright engineer, who had purchased the firm several years earlier when
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the previous owner wished to retire. OSA Inc. had its own tool and die manufacturing operation as well as its own molding shop. It depended heavily on automotive contracts, a situation Bert Wood wished to correct by acquiring more nonautomotive business. In conjunction with MI’s engineers, Bert Wood had worked out a mold design for the cream dispenser and included several suggestions for minor improvements. The cost of the mold was $56,000, an investment Bert Wood was in no position to make and that MI would have to absorb up front. Bert Wood quoted a unit price of $0.27 based on purchase quantities of 30,000 units at a time and an annual volume estimated at 300,000 units. Bert Wood had submitted a cost breakdown of this quote as follows: Resin Labor Overhead*
16¢ 3¢ 8¢ 27¢
*Overhead breakdown: Power Depreciation Interest Space, insurance, light and heat, taxes, supervision
1¢ 1¢ 3¢ 3¢
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When Art submitted this quote along with the request for a $56,000 mold investment up front, the plant manager and treasurer both turned it down, arguing that the 24-month payback on the mold was far too long and that the company had better investment opportunities with a 12-month payback. Art was disappointed, because he had hoped this project would assist in helping him meet his savings target for the year. When he talked the idea over with his manager, Louise Moffat, she suggested he give it another try. She said, “I am sure that if you can get the mold payback down to 15 months, you will get a warmer reception. There are not that many deals around this company that pay for themselves in one year.” She also suggested that Art talk to marketing to see if some other products could use the same packaging, and to the production scheduling group to check if different production quantities could be ordered. When Art talked to the marketing people, he found out that the package was ideal for another product to be introduced shortly and with an annual demand estimated at 100,000 units. Marketing had been uneasy about using the French package because of the difficulties encountered with it and assured Art that if he could get a reliable domestic source, this option would be highly attractive.
The scheduling group, for a number of years, had used a modified MRP system. When Art discussed the new package idea with them, they told him that if the new product and the older one were to be packaged in the same package, a total package requirement of about 40,000 units would make sense and that the master production schedule could easily be adjusted to run the two products in conjunction. Art also discussed the situation with the resin supplier, who indicated that his quote to Bert Wood had been based on the lot size of 30,000 packages, but that a 40,000 unit lot would fall into a new price bracket 5 percent lower than the originally quoted price. Art wondered just what effect all of this new information would have on his original proposal. He knew that Bert Wood had been adamant about his $0.27 quote. Bert Wood had said, “I know I am classified as a minority supplier. But I don’t want to hide behind that fact. I want no special favors from any of my customers. Nor am I in a position to make special gifts to anyone else. I have had to borrow at what I consider to be ridiculously high interest rates to buy this company. Now I have to make it pay off. My $0.27 price is as low as I can go, as far as I can see.”
Case 11–3
City of Granston* On November 25, Ted Barton, the new purchasing manager at the City of Granston in Canada, was considering a contract extension for two years for the supply of mineral aggregates (rock, sand, and gravel). The contract had to be signed within a week.
CITY OF GRANSTON The City of Granston had an annual budget of $700 million and employed 9,000 people. There had been a steady population increase over the past two decades. The purchasing department consisted of three support staff, six buyers, and a manager. City budgets were usually adjusted annually to cover the cost of inflation.
THE AGGREGATE INDUSTRY The city purchased about $3 million worth of aggregates for road construction and repairs and construction projects. The local mineral aggregate sector consisted of three
major extracting and processing companies—Lamoulin, Richmond, and Atlantic—and several smaller ones. Lamoulin and Atlantic owned the two dominant concrete production facilities. The local aggregate industry was near capacity with major construction projects underway and increased demand in export markets.
AGGREGATE PURCHASING A request for quotation had been issued in 2000 for a three-year agreement for the supply of aggregates, with prices firm for the first three years. If the parties agreed, a two-year option was available, with prices being subject to inflation. Lamoulin and Richmond were the only two bidders and each received about half of the total contract with each bidder quoting for separate components of the total aggregates contract (see Exhibit 1).
*This case was prepared by Larry Berglund, CPP, MBA, and Collin Ashton, CPP, December 2003.
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EXHIBIT 1
Description
A Selection of Mineral Aggregates Supplied by Lamoulin and Richmond
Screening* Crushed rock* Drain rock** Tailings** Mulch**
Cost Management 311
Original Price
Current Price
New Price Request
City Requirement (metric tons)
9.80 8.80 12.20 8.00 7.10
9.59 8.57 11.88 7.80 6.98
9.78 8.74 12.11 7.95 7.12
3,000 6,500 3,000 75,000 250,000
Prices include delivery and are in $Cdn based on annual estimated requirements. * Lamoulin ** Richmond
On November 25, both Lamoulin and Richmond sent notice that they were willing to extend the current threeyear contract to five years. Both wanted an increase of 2 percent to cover the increased cost of doing business. The suppliers were referring to the Consumer Price Index (CPI) clause in the agreement for price reviews. This clause allowed the supplier an annual price increase based on the change in the CPI. According to the city engineers’ department, both suppliers had performed reasonably well during the past three years. Because of a significant slump in the local construction industry, both suppliers had voluntarily lowered their prices by about 3 percent after year one of the contract. However, in the past few months the local economy had shown signs of revival.
TED BARTON Ted Barton had become purchasing manager for the City of Granston after having worked in private industry as a supply manager for several decades. He had been selected because the city’s administrators wished to integrate supply better into the overall decision processes and to help search for better value for the taxpayer’s dollars. Shortly
after arriving on his new job, Ted Barton hired a part-time professional to help him develop better metrics for the city’s supply function. One of the metrics that concerned Ted was the city’s price performance. Thus, he developed a representative basket of 128 city requirements for which the amount used appeared to vary little from year to year. For this basket he asked his assistant to develop a price index, going back three years, starting with a base of 100.0 (see Exhibit 2). Ted’s assistant also developed a list of key cost indicators based on published indices from a variety of sources (see Exhibit 3).
THE DECISION Ted Barton wondered whether any of the metrics he had recently developed were relevant for his decision on whether to extend the current mineral aggregates contract. Since a significant number of existing city contracts were also of the multiyear, extendable type, he believed his actions on the aggregate contract might have a bearing on how to deal with other requirements. Having only one week left, he wondered what action to take.
EXHIBIT 2 City of Granston Price Index for a 128-Item Basket of City Requirements Current Year Year
3 Years Ago
2 Years Ago
1 Year Ago
Q-1
Q-2
Q-3
Cost of supplies (basket of goods)
100.00
.9199
.9446
.9477
.9410
.9614
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EXHIBIT 3 Selected List of Key Cost Indicators Current Year Key Indicators Business prime rate (%) CPI Fats & oils Raw industrials Textiles Diesel fuel Coarse road salt Natural gas Copper (US$ per ton) Metals subindex
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3 Years Ago
2 Years Ago
1 Year Ago
Q-1
7.000 111.4 161.82 258.06 236.39 50.36 57.28 4.50 1788.00 236.06
6.875 114.7 165.38 235.55 230.50 52.56 52.91 6.08 1578.00 193.55
4.250 116.2 194.44 231.72 221.41 54.34 52.91 3.82 1559.00 178.92
4.750 121.9 218.99 258.69 234.29 65.04 52.91 6.22 1663.00 201.50
Q-2 5.00 122.0 221.02 260.01 241.01 56.41 52.91 6.00 1641.00 207.09
Q-3 5.00 122.2 236.98 269.91 239.83 58.69 52.91 5.96 1753.00 218.15
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Chapter Twelve Supplier Selection Chapter Outline The Supplier Selection Decision Decision Trees Identifying Potential Sources Information Sources Standard Information Requests Additional Supplier Selection Decisions Single versus Multiple Sourcing Manufacturer versus Distributor Geographical Location of Sources Supplier Size Supplier Development/Reverse Marketing
Evaluating Potential Sources Level 1—Strategic Level 2—Traditional Level 3—Current Additional Ranking Potential Suppliers Conclusion Questions for Review and Discussion References Cases 12–1 Loren Inc. 12–2 Russel Wisselink 12–3 Kettering Industries Inc.
313
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Key Questions for the Supply Decision Maker Should we • Use cross-functional sourcing teams to select suppliers? • Use one or more suppliers? • Switch from informal to formal supplier evaluation? How can we • Reach agreement with internal business partners on evaluation criteria and weighting? • Balance financial and nonfinancial factors when selecting suppliers? • Be sure that we choose the best supplier available?
THE SUPPLIER SELECTION DECISION “If you choose the right suppliers, all of your supply problems will be solved” is old supply wisdom. It is at the supplier selection stage that all of the preparation in understanding and specifying organizational needs comes to fruition. The supply professional’s key challenge is to match the organization’s needs to what the market can supply. The critical decision is which supplier(s) to select. This chapter will first discuss the identification of potential suppliers, where to find them, and the collection of information. The next topics include whether to select single or multiple sources, deal directly with manufacturers or go through distributors, and choose small or large suppliers and domestic or foreign ones. In case no satisfactory source can be found, supplier development provides an existing alternative to routine supplier selection. This will be followed by how potential suppliers are evaluated according to the three levels of criteria described in Chapter 6 and how to rank them. The decision to place a certain volume of business with a supplier should always be based on a sound set of criteria. The art of good supply management is to make the reasoning behind this decision as sound as possible. Traditionally, the analysis of the supplier’s ability to meet satisfactory quality, quantity, delivery, price/cost, and service objectives governed this decision. Some of the more important supplier attributes related to these prime criteria may include past history, facilities and technical strength, financial status, organization and management, reputation, systems, procedural compliance, communications, labor relations, and location. Obviously, the nature and amount of the purchase will influence the weighting attached to each objective and hence the evidence needed to support the decision. For example, for a small order of new circuit boards to be used by engineers in a new product design, quality and rapid delivery are of greater significance than price. The supplier should probably be local for ease of communication with the design engineers and have good technical credentials. However, for a large printed circuit board order for a production run, price would be one key factor, and delivery should be on time, but not necessarily unusually fast. Thus, even on requirements with identical technical specifications, the weighting of the selection criteria may vary.
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FIGURE 12–1
Supplier Selection 315
Satisfactory
A Simple OneStage Supplier Selection Decision
P er A
pli
p Su
1–
p
Unsatisfactory Su
Satisfactory
ppl
ier
B
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1–
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Unsatisfactory
It is this sensitivity to organizational needs that separates the good supply manager from the average. The one result every supply professional wishes to avoid is unacceptable supplier performance. This may create costs far out of proportion to the size of the original purchase, upset internal relationships, and strain supplier goodwill and final customer satisfaction.
Decision Trees The supplier selection decision can be seen as a decision made under uncertainty and can be represented by a decision tree. Figure 12–1 shows a very simple one-stage situation with only two suppliers seriously considered and two possible outcomes. It illustrates, however, the uncertain environment present in almost every supplier choice and the risk inherent in the decision. To use decision trees effectively, the supply professional must identify the options and the criteria for evaluation and assess the probabilities of success and failure. This simple tree could apply to a special one-time purchase without expectation of followon business for some time to come. The more normal situation for future repetitive purchases is shown in Figure 12–2. Whether the chosen source performs well or not for the current purchase under consideration, the future decision about which supplier to deal with next time around may well affect the present decision. For example, if the business is placed with supplier C and C fails, this may mean that only A could be considered a reasonable source at the next stage. If having A as a single source, without alternatives, is not acceptable, choosing C as the supplier at the first stage does not make any sense. It is necessary to consider the selection decision as part of a chain of events, rather than as an isolated instance. This addition of a time frame—past, present, and future—makes the sourcing decision even more complex. However, as long as the objective of finding and keeping good sources is clearly kept in mind, the decision can be evaluated in a reasonable business context.
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FIGURE 12–2 Simplified Three-Stage Decision Tree for Supplier Selection
ss
ce uc
A B C
S
Fa
ilu
A B C
Su
pp
lie rA
re
S F S F
A B C
S F
S F S F S F
S F S F S F
ss
cce
Su
Supplier B Fa
ilu
re
rC lie pp Su
ss
cce
Su
Others
Fa
ilu
re
S
A
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A
A
IDENTIFYING POTENTIAL SOURCES There are three potential supply options for any new need/requirement of an organization. The make option or doing it in-house may be realistic for some needs but not for others. These decisions have already been discussed in Chapter 5 under make or buy, insourcing, and outsourcing. The second option is to acquire the new need from a current supplier of other requirements. Most supply professionals would be keen to pursue this option. There is already a record of past performance and communication and logistics demands are in place. Assuming past dealings with the current supplier have been satisfactory, the expectation would be that additional business might secure an even better value proposition on the total set of requirements supplied. Therefore, current good or superior suppliers have a right to expect additional volumes of business as a reward for their performance on current and past business. Both purchaser and supplier stand to benefit from this understanding.
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FIGURE 12–3 Identification of Potential Sources a New Need/Requirement 1. Can We Make In-House?
2. Can a Current Supplier Meet?
3. Find Potential New Supplier
No
Yes Yes
Make
Yes No
No
Buy
No Supplier Can Meet One Supplier Can Meet
Two or More Suppliers Can Meet
Can We Make In-House?
One Supplier Can Meet
Two or More Suppliers Can Meet
Can We Use Supplier Development to Create Supplier?
Yes
No
No Can We Redesign/Re-specify so that Existing or New Supplier Can Meet?
Rethink
Yes
The third option is to engage in a search for potential suppliers, assuming the first two options were not satisfactory or the supply professional was anxious to test the market. Figure 12–3 diagrams the three options and the potential outcomes. When no suitable supplier can be found, the supply professional still has the option of using supplier development (discussed later in this chapter) or redesign or re-specification to see if a suitable source can be found or developed. There is a remote chance that, despite all efforts, no solution is found. Then the supply professional needs to get together with the requisitioner to see if an alternative or substitute solution can be found.
Information Sources The identification of potential sources is a key driver of the ultimate success or failure of the supplier solution effort. Every supply professional is always on the alert for potential new sources. Knowledge of sources is therefore a primary qualification for any effective supply manager. Online searches, e-catalogs, and company Web sites are the most common tools used today. Other sources include trade journals, advertisements, supplier and commodity directories, sales interviews, colleagues, professional contacts, and the supply department’s own records.
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Online Sources The Internet and the World Wide Web provide a rapidly growing and ever-changing body of information for supply professionals. The challenge is not just finding information, but identifying, sorting, analyzing, and using relevant information. The following brief list contains Web addresses for some sites of interests to supply. D & B www.dnb.com D&B provides basic company reports online for a fee, and company’s location and products gratis. Thomas Register www.thomasregister.com The most comprehensive online resource for finding companies and products manufactured in North America. Services include online order placement, viewing and downloading millions of computer-aided design (CAD) drawings, and viewing thousands of online company catalogs and Web sites. It includes listings for over 173,000 companies in the United States and Canada and over 8,000 online supplier catalogs and Web links. Worldpages.com www.worldpages.com This is an Internet and Yellow Pages directory company with listings in the United States and Canada and links to more than 350 international directories. It also links to a directory of toll-free (800/888) numbers in the United States. World Wide Yellow Pages www.yellow.com/ This is a worldwide listing of companies. Ziff Davis Media Publications www.zdnet.com This is a resource for information on e-commerce.
Catalogs A well-managed purchasing and supply department must have catalogs of the commonly known sources of supply, covering the most important materials in which a company is interested. The value of catalogs depends largely on presentation form, accessibility, and frequency and extent of use. Electronic catalogs (discussed in Chapter 4) are increasingly used. The advantage of eCatalogs is that both buyers and internal customers have ready access to them and they can be customized to include the prices and other terms and conditions negotiated by the buyer with the seller. Management of eCatalog content is as serious an issue as management of hard-copy catalogs. Advances in online catalog management continue to increase the ease of access and improve the form of presentation. The accessibility of catalog content is driven by the manner in which it is indexed and filed, a not-so-simple task even with online catalogs. Catalogs are issued in all sorts of sizes and formats that make them difficult to handle. Proper indexing of catalogs is essential. Some companies still use microfilm files and loose-leaf binders with sheets especially printed for catalog filing; others use a form of card index. Indexing should be according to suppliers’ names as well as products listed. It should be specific, definite, and easily understandable. Distributors’ catalogs contain many items from a variety of manufacturing sources and offer a directory of available commodities within the distributors’ fields. Equipment and machinery catalogs provide information about specifications and the location of a source of supply for replacement parts as well as new equipment. Catalogs frequently provide price information, and many supplies and materials are sold from standard list prices or by quoting discounts only. Catalogs are also used as reference books by internal customers.
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Trade Journals Trade journals also are a valuable source of information about potential suppliers. The list of such publications is, of course, very long, and the individual items in it vary tremendously in value. Yet in every field there are worthwhile trade magazines, and buyers read extensively those dealing with their own industry and with those industries to which they sell and from which they buy. These journals are utilized in two ways. The first use is to gain general information from the articles that might suggest new products and substitute materials as well as information about suppliers and their personnel. The second use is a consistent perusal of the advertisements to stay current on offerings.
Trade Directories Trade directories are another useful source of information. They vary widely in their accuracy and usefulness, and care must be exercised in their use. Trade registers, or trade directories, are volumes that list leading manufacturers, their addresses, number of branches, affiliations, products, and, in some instances, their financial standing or their position in the trade. They also contain listings of the trade names of articles on the market with names of the manufacturers and classified lists of materials, supplies, equipment, and other items offered for sale, under each of which is given the name and location of available manufacturing sources of supply. These registers are organized by commodity, manufacturer, or trade name. Standard directories include the Thomas Register (www.thomasregister.com), MacRae’s Blue Book (www.macraesbluebook.com) and Kompass publications (www.kompass.com). Trade directories of minority- and women-owned business enterprises can assist purchasers with a goal or requirement to increase the percentage of contracts awarded to these firms. For example, the Central Contractor Registration (www.ccr.gov) simplifies the federal contracting process by creating an integrated database of small, disadvantaged, 8(a), and women-owned businesses that want to do business with the government. Searches can be based on SIC Codes, keywords, location, quality certifications, business type, and ownership race and gender. Diversity Information Resources (www.diversityinforesources.org) fosters minority economic development through the publication of directories of minority- and women-owned businesses with access to a database of over 9,800 certified M/WBE suppliers, veteran, service-disabled veteran, and HUBZone suppliers. A number of organizations also certify businesses as minority- and women-owned, including the Women’s Business Enterprise National Council (WBENC) (www.wbenc.org); the National Women Business Owners Corporation (NWBOC) (www.nwboc.org); the National Minority Supplier Development Council (NMSDC) (www.nmsdc.org); and in the public sector, the Office of Small Disadvantaged Business Utilization (OSDBU) (www.sbu.gov/GC/OSDBU.html).
Sales Representation Sales representatives may constitute one of the most valuable sources of information available, with references to sources of supply, types of products, and trade information generally. One challenge for supply personnel is balancing the need to meet with sales representatives with other responsibilities and time constraints. It is essential to develop good supplier relations that begin with a friendly, courteous, sympathetic, and frank attitude toward the supplier’s salesperson. After contact, relevant information should be captured in a format that can be easily accessed and used effectively. Some organizations develop
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routing mechanisms on their Web sites to alleviate the time pressure on buyers and sellers by providing information about how to do business with the organization and routing callers to the appropriate person.
Supplier and Commodity Databases Information from any source, if of value, should be captured. For example, an index of catalogs makes it easy to access a needed catalog. Two common databases are of suppliers and commodities. The supplier database includes information on each active supplier, including locations and contact information, open orders and past orders, supplier performance scorecards, and other pertinent information that might be of value to future decisions. Supplier databases may be managed online, in a simple computer file, or in a card file. A commodity database classifies material on the basis of the product and includes information related to the sources from which the product has been purchased in the past, perhaps the price paid, the point of shipment, and a link or cross-reference to the supplier database. Miscellaneous information is also given, such as whether specifications are called for, whether a contract already exists covering the item, whether competitive bids are commonly asked for, and other data that may be of importance. Accompanying files dealing with sources are, of course, those relating to price and other records. Some of these have already been discussed in earlier chapters, and others will be discussed later. The information management aspects of enterprise resource planning (ERP) systems and e-procurement systems are discussed in Chapter 4.
Visits to Suppliers Some supply managers feel that visits to suppliers are particularly useful when there are no difficulties to discuss. The supply manager can talk with higher-level executives rather than confining discussion to someone who happens to be directly responsible for handling a specific complaint. This helps to cement good relations at all levels of management and may reveal much about a supplier’s future plans that might not otherwise come to the buyer’s attention. Such a visitation policy does raise certain problems not found in the more routine types of visits, such as who should make the visits, how best to get worthwhile information, and the best use of the data once obtained. Experience has indicated that the best results come from (1) developing, in advance, a general outline of the kinds of information sought; (2) gathering, in advance, all reasonably available information, both general and specific, about the company; and (3) preparing a detailed report of the findings after the visit. When the visits are carefully planned, the direct expense incurred is small compared with the returns.
Samples In addition to the usual inquiries and a plant visit, samples of the supplier’s product can be tested. This requires thinking about the “sample problem.” Frequently a sales representative for a new product urges the buyer to accept a sample for test purposes. This raises questions about what samples to accept, how to ensure a fair test of those accepted, who should bear the expense of testing, and whether or not the supplier should be given the results of the test. (See “Testing and Samples” in Chapter 5.)
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Colleagues Frequently, internal business partners are valuable sources of information about potential sources of supply. Purchase requisitions may invite the requisitioner to identify potential sources.
References Often buyers will include a request for references in the RFQ, RFP, or RFB. To get the most useful information possible, it is the job of the interviewer to set the parameters for the interview. First, make sure that the reference is a company of similar size and objectives. Second, talk to people with firsthand knowledge of the supplier’s performance. Third, ask open-ended questions that allow the reference to describe the performance of the supplier and the relationship. For example, a new customer might be asked about the implementation process: “Did it go smoothly? Tell me about a time things weren’t going according to plan. How did the supplier deal with the problem or change?” A veteran customer might be asked about the supplier’s actions to stay competitive or to continuously improve: “Tell me about a time when the supplier initiated an improvement that also benefited you (the customer)?” Past customers might be asked about the transition process to another supplier: “When you switched suppliers, how did the original supplier handle the transition of information? materials? and so forth?” Potential sources need to be evaluated.
Standard Information Requests Additional information from the supplier itself is usually sought during the identification of potential suppliers stage and before supplier selection takes place. As described in Chapter 4, the nature of these communications takes a variety of forms.
The Request for Information (RFI) The request for information or expression of interest serves several purposes. It signals that the supply professional has identified a supplier as a potential source of supply. It is also an opportunity for the supplier to indicate its willingness to enter into a potential business relationship. Although the content of the RFI may vary considerably from technical data to interest in receiving an invitation to bid, it is clear to both parties that the RFI does not commit either party to future business. If the information collection process could result in significant additional expense for the supplier, it is appropriate for the supply professional to offer reimbursement of some or all of these costs.
The Request for Quotation (RFQ) or Request for Bid (RFB) or Invitation to Bid or Tender These requests represent a serious inquiry of the supplier on a specific requirement or a variety of requirements. The RFQ and its equivalents ask the supplier to declare at what price and what terms they are prepared to supply. In the public sector, it is usually assumed that the lowest bidder will be awarded the contract. In the public sector, it is often an organizational requirement that all requirements exceeding a certain dollar amount be put out to bid. Bidders are required to submit their bids by a certain deadline and meet all of the conditions stated in the invitation to bid or tender. Suppliers are invited to attend a public opening of bids and, thus, each bidder knows exactly what prices have been quoted by all bidders. After the public opening, public supply professionals usually require some
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additional time to examine all bids for compliance with conditions and to deal with possible exceptions. Fair as this process may appear, it is still occasionally abused. Various bidders may collude to rig prices. A recent example involving road construction contracts in Montreal had a group of bidders, reported to be Mafia related, deciding on the lowest bid beforehand and who was allowed to be the lowest bidder. This resulted in an elevation of construction costs exceeding 10 percent. In the private sector, there is no public opening of bids and the lowest bid may not be accepted if, in the opinion of the supply professional, a higher bid represents better value. Because the preparation of a bid always entails costs for the supplier and may raise expectations, it is deemed ethical practice to invite only those suppliers to bid who have a serious chance of receiving the business. In the RFQ, RFB, and Invitation to Bid, the assumption is that requirement specifications are sufficiently descriptive and standard so that multiple suppliers can meet these requirements. Therefore, the price and terms quoted become the differentiation between various suppliers.
The Request for Proposal (RFP) When it is difficult to describe a requirement adequately, or the supply organization lacks the ability to create an RFQ or the supply professional expects that innovation or creativity in the market might result in a superior solution, the RFP allows more latitude to the supplier than an RFQ. The RFP permits the supplier to fit the proposal to its strengths. For the supply professional, comparison of RFPs received is considerably more difficult than an RFQ evaluation and may involve a lot of judgment. Also, the preparation of an RFP is often more expensive for the supplier than an RFQ, and the issue of reimbursement for supplier costs incurred in its preparation needs to be resolved. Moreover, if the RFP contains proprietary technical or commercial information, protection of confidentiality is extremely important. Often the RFP is used as the first stage of a two-stage process in which only certain suppliers are invited to quote on the business or enter into negotiations for the final round.
ADDITIONAL SUPPLIER SELECTION DECISIONS The discussion on supplier selection in this chapter has thus far focused on the identification of potential suppliers and information about them. There are, however, additional decisions that need to be identified and five, in particular, are highlighted here: 1. 2. 3. 4. 5.
Should we use a single source, dual sources, or more than two? Should we buy from a manufacturer or a distributor? Where should the supplier be located? Relative to our organization, should the supplier be small, medium, or large? If no supplier can be found, should we use supplier development?
Single versus Multiple Sourcing Should the supply professional choose a single supplier or utilize several? The answer to this question must be the very unsatisfactory one: “It all depends.”
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Table 12–1 lists the main arguments for placing all orders for a given item with one supplier and Table 12–2 provides the main arguments for multiple sourcing: TABLE 12–1 Single Sourcing
TABLE 12–2 Multiple Sourcing
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1. Prior commitments, a successful past relationship, or an ongoing long-term contract with a preferred supplier might prevent even the possibility of splitting the order. 2. The supplier may be the exclusive owner of certain essential patents or processes and, therefore, be the only possible source. 3. A given supplier may be so outstanding in the quality of product or in the service or value provided as to preclude serious consideration of buying elsewhere. 4. The order may be so small as to make it not worthwhile to divide it. 5. Concentrating purchases may make possible certain discounts or lower freight rates that could not be had otherwise. 6. The supplier will be more cooperative, more interested, and more willing to please if it has all the buyer’s business. 7. When the purchase of an item involves a die, tool, mold charge, or costly setup, the expense of duplicating this equipment or setup is likely to be substantial. 8. Deliveries may be more easily scheduled. 9. The use of just-in-time production, stockless buying, or systems contracting. 10. Effective supplier relations require considerable resources and time. Therefore, the fewer suppliers the better. 11. Single sourcing is a prerequisite to partnering.
1. It has been traditional practice to use more than one source, especially on the important requirement. 2. Knowing that competitors are getting some of the business may keep the supplier more alert to the need for giving good value. 3. Assurance of supply is increased. Should fire, strikes, breakdowns, or accidents occur to any one supplier, deliveries can still be obtained from the others for at least part of the needs. 4. The supply organization has developed a unique capability of dealing with multiple sources. 5. To avoid supplier dependence on the purchaser. 6. To obtain greater flexibility, because the unused capacity of all the suppliers may be available. 7. Even in situations involving close and cooperative supplier relationships, it is possible to make backup arrangements so that supplier X specializes in product Q and backs up supplier Y, who specializes in product R and backs up supplier X. 8. Strategic reasons, such as military preparedness and supply security, may require multiple sourcing. 9. Government regulations may insist that multiple suppliers, or small or minority sources, be used. If there is high risk associated with a small or single-minority source, multiple sourcing may be necessary. 10. Sufficient capacity may not be available to accommodate the purchaser’s current or future needs. 11. Potential new or future suppliers may have to be tested with trial orders, while other sources receive the bulk of the current business. 12. Volatility in the supply market makes single sourcing unacceptably risky.
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Genuine concern exists among supply executives about how much business should be placed with one supplier, particularly if the supplier is small and the buyer’s business represents a significant portion of the seller’s revenue. It is feared that sudden discontinuance of purchases may put the supplier’s survival in jeopardy, and yet the purchaser does not wish to reduce flexibility by being tied to dependent sources. One simple rule of thumb traditionally used was that no more than a certain percentage, say 20 or 30 percent, of the total supplier’s business should be with one customer. If a decision is made to divide an order among several suppliers, there is then the question of the basis on which the division is to be made. The actual practice varies widely. One method is to divide the business equally. Another is to base the allocation on geographical coverage. Another is to place the larger share with a favored supplier and give the rest to one or more alternates. In the chemical industry, as in a number of others, it is common practice to place business with various suppliers on a percentage of total requirements basis. Total requirements may be estimated, not necessarily guaranteed, and there may not even be a minimum volume requirement. Each supplier knows what its own percentage of the business amounts to, but may not be aware who the competition is or how much business each competitor received if the number of sources exceeds two. There is no common practice or “best” method or procedure, although renewed interest in single sourcing is consistent with a number of current trends, especially the quality movement, partnerships, and strategic sourcing.
Manufacturer versus Distributor Should a supply professional deal with the manufacturer directly or through some trade channel such as a wholesaler, distributor, or even a retailer? Occasionally, various types of trade associations pressure supply professionals to patronize the wholesaler, distributor, or mill supply house. The real issue is often closely related to buying from local sources. The justification for using trade channels is found in the value-added services rendered. If wholesalers are carrying the products of various manufacturers and spreading marketing costs over a variety of items, they may be able to deliver the product at a lower cost, particularly when the unit of sale is small and customers are widely scattered or when the demand is irregular. Furthermore, they may carry a stock of goods greater than a manufacturer could afford to carry in its own branch warehouse and therefore be in a better position to make prompt deliveries and to fill emergency orders. Also, they may be able to buy in car- or truckload lots, with a saving in transportation charges and a consequent lower cost to the buyer. Local sentiment may be strongly in favor of a certain distributor. Public agencies are particularly susceptible to such influence. Sometimes firms that sell through distributors tend, as a matter of policy, to buy, whenever possible, through distributors. On the other hand, some large organizations often seek ways of going around the supply house, particularly when the buyer’s requirements of supply items are large, when the shipments are made directly from the original manufacturer, and when no selling effort or service is rendered by the wholesaler. Some manufacturers operate their own supply houses to get the large discount. Others have attempted to persuade the original manufacturers to establish quantity discounts—a practice not unlike that in the steel trade. Still others have sought to develop sources among small manufacturers that do not have a widespread distribution organization. Some attempts have been made to secure a special
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service from a chosen distributor, such as an agreement whereby the latter would add to its staff “two people exclusively for the purpose of locating and expediting nuisance items in other lines.” A similar arrangement might place a travel agent directly on the purchaser’s premises to improve service. Systems contracting and stockless purchasing systems depend heavily on concentrating a large number of relatively small purchases with a highly capable distributor. Ultimately, every participant in the value chain needs to add value. This guiding principle should apply also to the selection of nonmanufacturers in the distribution network.
Geographical Location of Sources Shall purchases be confined as largely as possible to local sources, or shall geographical location be largely disregarded? Most supply managers prefer to buy from local sources. This policy rests on two bases. First, a local source can frequently offer more dependable service than one located at a distance. For example, deliveries may be more prompt both because the distance is shorter and because the dangers of interruption in transportation service are reduced. Knowledge of the purchaser’s specific requirements, as well as of the seller’s special qualifications, may be based on an intimacy of knowledge not possessed by others. There may be greater flexibility in meeting the purchaser’s requirements; and local suppliers may be just as well equipped with facilities, know-how, and financial strength as any of those located at more distant points. Thus, there may well be sound economic reasons for preferring a local source to a more distant one. In just-in-time and lean production systems, proximity of the supplier’s plant to that of the purchaser is vital. For example, automotive manufacturers encourage suppliers to locate plants close to automobile assembly operations. A second basis for selecting local sources rests on equally sound, although somewhat less tangible, grounds. The organization owes much to the local community. The facility is located there, the bulk of the employees live there, and often a substantial part of its financial support, as well as a notable part of its sales, may be local. The local community provides the company’s personnel with their housing, schools, churches, and social life. Executives are constantly asked by local business owners or managers at local professional and social gatherings why they are not receiving any business. To recognize these facts is good public relations. Therefore, if a local source of supply can be found that can render as good a value as can be located elsewhere, it should be supported. Moreover, supply managers should attempt to develop local sources when potential exists. This policy has two complicating elements. One is supply’s primary responsibility to manage acquisition well. Emotion should rarely supplant good business judgment because in the long run it will hurt the local community. A second complication arises through the difficulty of defining “local.” Technological changes have affected not only the size and distribution of the centers of population but also the commercial and business structure, resulting, among other things, in a widening of market areas and hence the sources from which requirements can be obtained. Therefore, what once might properly have been called local has, for many areas and many items, become state, provincial, or national. There is no easy rule by which a supply professional can decide the economic boundaries of the local community. As e-commerce activities grow, the boundaries of time and space will shrink even more. As it becomes easier to access information about potential suppliers and to move information between and among organizations, it may also become easier to do business with international suppliers.
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FIGURE 12–4 Relative Purchaser and Supplier Size
Purchaser Size Small
Medium
Large
Supplier Size Small Medium Large Small Medium Large Small Medium Large
Supplier Size If a supply professional has the option of buying from a large, medium, or small supplier, which size of supplier should be favored? How does the size of the purchasing organization affect the decision? A matrix of relative sizes can be developed (see Figure 12–4). The size and nature of the requirement may also affect the decision, because it is general wisdom that the larger the requirement, the larger the supplier should be. Generally, smaller suppliers tend to be local for those smaller requirements where flexibility, speed of response, and availability tend to be more important than price. Larger suppliers tend to be more appropriate for high-volume requirements where technology, quality, and total cost of ownership may be critical; medium suppliers fall in between. The trouble with generalizations is that exceptions abound. Small suppliers tend to fill niches that the larger ones cannot or may have chosen not to cover. According to Hispanic Business magazine, the leaders of its fastest-growing 100 companies focus on a strategy of focusing on, and filling, one niche in the marketplace. Small suppliers have traditionally shown a loyalty and service deemed impossible from larger suppliers, but the customer service focus of many larger organizations is trying to reverse this perception. Small suppliers tend to depend on the management of a key ownermanager, and this person’s health and attitude will affect the risk of doing business. Larger organizations tend to have greater stability and greater resources, reducing the day-to-day risk of supplier performance. Interest in diversity of customers, employees, and suppliers has renewed interest in the large purchaser–small supplier interface and the role of education, assistance, and continuing watchfulness on the part of supply to help the supplier succeed.
SUPPLIER DEVELOPMENT/REVERSE MARKETING In supplier selection the assumption has so far been made that at least one suitable and willing supplier already exists and that the purchaser’s problem is primarily one of determining who is the best supplier. It is possible, however, that no suitable source is available and that the purchaser may have to create a source. Reverse marketing or supplier development implies a degree of aggressive procurement involvement not encountered in supplier selection. For example, it places a supply manager in a position where a prospective supplier
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FIGURE 12–5
THE MARKETING CONTEXT
Supplier Development Initiative with the Purchaser
Marketing initiative
Supplier
Purchasing response
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Purchaser
THE SUPPLIER DEVELOPMENT CONTEXT Supplier
Sales response
Purchaser
Purchasing initiative
must be persuaded to accept an order. In this no-choice context, the purchaser does not initiate supplier development as an appropriate technique or tool; it is the only alternative other than making the part or producing the service in-house. Reverse marketing/supplier development also has a broader point of view. It defines the need for developing new or existing suppliers as follows: The purchaser is aware that benefits will accrue to both the supplier and the purchaser, benefits of which the supplier may not be aware. These benefits may be limited to the particular order at hand, or they may include more far-reaching aspects, such as technical, financial, and management processes, skills, or quality levels; reduction of marketing effort; use of long-term forecasts or permitting smoother manufacturing levels and a minimum of inventory; and so on. It is the aggressiveness and initiative by the supply professional that makes the difference (see Figure 12–5). In the normal market context, the purchaser responds to marketing efforts. In reverse marketing, the purchaser, not the supplier, has the initiative and will predetermine prices, terms, and conditions as part of the aggressive role. Taking the initiative requires extensive homework on the part of the supply professional to understand fully the organization’s short- and long-term needs, operationally and strategically, and assess the supplier’s capability to meet these needs so that a win-win proposal can be made. This is why the term reverse marketing has been chosen as a synonym for supplier development. Numerous examples show that high payoffs are possible from this supply initiative and that suppliers of all sizes may be approached in this fashion. A further reason for reverse marketing is that there are bound to be deficiencies in the normal industrial marketing process in which the marketer traditionally takes the initiative. Even when a supplier and a purchaser have entered into a regular buyer–seller relationship, often neither party is fully aware of all the opportunities for additional business that may exist between them. This might arise because of salesperson and supply professional specialization, a lack of aggressiveness by the salesperson, or a lack of inquisitiveness by the purchaser. If gaps are evident even where an established buyer–seller relationship exists, there must be even greater shortcomings where no such relationship has yet been established. For example, a supplier may be unable to cover its full market because of geography, limited advertising, or lack of coverage by its sales force, distributors, or agents. Most suppliers have lines of products that receive more management attention and sales push than other products also made or sold by the same company. It is always difficult to keep entirely up
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to date. A time lag may exist between the time of product or service introduction and the time the supply manager finds out about it. By filling these gaps through aggressiveness, the supply professional effectively strengthens this whole process. One of the most important arguments in favor of reverse marketing not yet mentioned arises from future considerations. If the supply role is envisaged as encompassing not only the need to fill current requirements but also the need to prepare for the future, reverse marketing is valuable in assuring future sources of supply. There are at least three outside forces that suggest the increasing necessity for purchaser initiative in the creation of future sources of supply. One of these forces is technological. The increasing rate of development of new products, materials, and processes will tend to make the industrial marketing task even more complex and more open to shortcomings. In addition to this, the stepping-up of international trade will tend to widen supplier horizons and may create a need for purchaser aggressiveness in the development of foreign sources of supply. One of the most demanding and important tasks of management of a subsidiary in an underdeveloped country is the problem of supplier development. Lastly, new management concerns with extracting competitive advantage from the supply chain require purchasers to be more aggressive with suppliers and to develop sources to their expectations.
EVALUATING POTENTIAL SOURCES Obviously, the evaluation of an existing supplier is substantially easier than the evaluation of a new source. Since checking out a new supplier often requires an extensive amount of time and resources, it should be done only for those suppliers that stand a serious chance of receiving a significant order. Where such a potential supplier competes with an existing supplier, the expected performance of the new source should, hopefully, be better than that of the existing one. The use of trial orders has been mentioned as a popular means of testing a supplier’s capability, but it still fails to answer the question about whether the trial order should have been placed with a particular source at all. Even though a supplier may complete a trial order successfully, it may not be an acceptable source in the long run. The evaluation of potential sources, therefore, attempts to answer one key question: 1. Is this supplier able to supply the purchaser’s requirements satisfactorily, strategically, and operationally in both the short and long term? The question must be assessed on the basis of the three levels of need criteria described in Chapter 6. It is useful to repeat the three levels of need criteria and, hence, supplier evaluation and selection criteria here: level 1—strategic; level 2—traditional: quality, quantity, delivery, price, and service; and level 3—current additional:financial, risk, environmental, regulatory, social, and political. The following sections will address supplier evaluation according to these criteria.
Level 1—Strategic Effective sourcing decisions form the basis of sound supply for any organization. These decisions should be driven by a sourcing strategy that is directly linked to organizational
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strategy, goals, and objectives. Many organizations have adopted the term strategic sourcing to capture the linkage between sourcing strategy and organizational strategy. A strategic sourcing process considers suppliers and the supply base integral to an organization’s competitive advantage. It is important to define clearly the term strategic and establish what makes a purchase or a supplier strategically important to the organization. Typically, a strategic purchase is one that is mission critical. The good or service has the potential to either help or hinder the attainment of the organization’s mission. Categorizing purchases into strategic and nonstrategic buckets is a first step in the strategic sourcing process. This type of categorization drives the decisions throughout the sourcing and selection process, including the allocation of resources to any specific buy. Without this categorization, the supply manager or sourcing team may overinvest resources, time, and attention in tactical or operational purchases and underinvest in strategic ones.
Linking Sourcing with Strategy From various sources of information, the supply professional is able to make up a list of available suppliers from whom the necessary items can be acquired. The first level of analysis is finding out which suppliers might be able to meet the buying organization’s requirements. The second level of analysis is determining which of these the supply manager or sourcing team is willing to consider seriously as a source. For items that are high risk and high value, the investigation may be drawn out and extensive, requiring the collaboration of supply, internal users, and technical experts such as engineering, quality control, systems, and maintenance on a formal or informal team. The cost of analysis greatly outweighs the advantages for items that are inexpensive and consumed in small quantities. It is not possible to separate risk assessment from strategy development. Therefore, risk assessment and strategy development are discussed jointly as level 1 valuation criteria. Although the same argument can be applied for the other level 2 and 3 criteria, they will be discussed later.
Risk Assessment Every organization’s management makes decisions about the risks it is willing to take in light of the expected returns. It takes actions to avoid, mitigate, transfer, insure against, limit, or explicitly assume risk. For the supply manager, it is essential to consider each decision in the context of the organization’s risk profile. Research into risk assessment behavior of supply professionals shows that the perceived risk of placing business with an untried and unknown supplier is high. Likewise, the perceived risk associated with routine, repetitive purchases is much less than the risk of new or less standard acquisitions. In general, the risk is seen to be higher with unknown materials, parts, equipment, or suppliers and with increased dollar amounts. Commodity managers can take a number of actions to avoid, mitigate, transfer, limit, or insure against risk. For example, a supply professional may attempt to transfer risk by asking for advice, such as engineering judgment, or by seeking additional information, including placing a trial order, or hedging in the commodities market. He or she may require bid bonds, performance bonds, or payment bonds to insure against risk, or avoid risk by not doing business with suppliers in certain countries, or mitigate risk by dual or multiple sourcing rather than single sourcing. It is possible to limit risk by negotiating payment terms that allow progress
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payments when certain milestones are met, but withholds a percentage of the payment until completion and acceptance of the service provided. When a supply professional takes an action such as selecting a supplier, or switching suppliers, or agreeing to certain terms and conditions, he or she should take these actions with the explicit understanding of both the risk at which the decision puts the organization, the return expected, and the balance between the two. Loss Exposure. There are selective buying situations in which the specifications may well expose the buying organization to risk. Robert S. Mullen, director of purchasing at Harvard University, cited the instance of a purchase of fireproof mattresses, costing only about $1,000 more in total to avoid a multimillion dollar suit in case of student injury or death. Environmental risks represent another category. Another form of loss exposure is related to the possibility of pilferage. The attractiveness of the requirements to consumers and the ease of resale may be reasons for theft. An alert purchaser can significantly cut down on losses by purchasing in smaller quantities, insisting on tamper-proof packaging, choosing the appropriate transportation mode, following the advice of security experts, and making sure that quantities are carefully controlled throughout the acquisition and disposal process.
Strategy Development Risk assessment is a key step in strategy development. Supply risks can be assessed in several ways. Pareto analysis (see Chapter 6), which compares dollar volume to variables such as percent of suppliers, percent of inventory, and number of orders, focuses strategy development on high-dollar purchases. Portfolio analysis typically includes supply market risks in the assessment and focuses attention on the value-generating capability of a purchase in light of the risks of acquiring the purchase in the marketplace. While there are numerous two-by-two matrices in existence, Figure 12–6 is a classic example of this approach. From this analysis the actual goods and services purchased by an organization can be placed in the appropriate quadrant, broad strategies developed by quadrant, and specific commodity strategies for each commodity in a quadrant; and decisions can then be made about the most appropriate sourcing strategy and tools for each category (also see Figure 11–1 in Chapter 11). The Delphi Corporation case in Chapter 13 provides an illustration of how a large automotive parts supplier uses a similar framework to assess the risk/volume tradeoff as part of their strategic sourcing process. Noncritical and leverage purchases share the same market risk, between low and medium, which means there are multiple suppliers and market forces keep prices competitive. Since the items are fairly standard, quality is comparable and substitutes are available. Therefore, convenience, ease of acquisition, low acquisition costs, and delivery systems may be the most important decision criteria. As the required volume of standard items increases, leverage opportunities increase and price per unit becomes a critical variable. Volume gives the buying organization more power in the marketplace, and the supply manager focuses on developing strategies to leverage volume and scale. The supply manager may develop a strategy to move items from the noncritical to the leverage category by bundling items differently, standardizing purchases, or consolidating the supply base. These moves push the item to the right on the value or x-axis and result in price savings from increasing volume. These initiatives usually focus attention on internal processes and
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Supply Risks and Dollars Extended
Source: Peter Kraljic, “Purchasing Must Become Supply Management,” Harvard Business Review, September–October 1983.
Strategic
Bottleneck
High
• Unique specification • Supplier’s technology is important • Production-based scarcity due to low
• Continuous availability is essential to the
operation • Custom design or unique specifications • Supplier technology is important • Few suppliers with adequate technical
demand and/or few sources of supply • Substitution is difficult • Usage fluctuates and is not routinely
MARKET RISK
• Changing source of supply is difficult • Substitution is difficult
Noncritical
Leverage
• Standard specification or “commodity”
• Price per unit is key because of volume • Substitution is possible • Competitive supply market with several
type item Low
capability or capacity
predictable • Potential storage risk
• Substitute products readily available • Competitive supply market with many
sources
suppliers Low
VALUE
High
business relationships as supply develops the means to analyze and consolidate spend that is often dispersed throughout the organization. The items in the leverage category merit special attention because they represent the “low hanging fruit” that companies pick when they begin to focus attention on purchasing and supply management. Many of the eBusiness tools discussed in Chapter 4 are especially appropriate in managing leverage purchases. By reducing the supply base to as few as the risk profile indicates is appropriate, the supply manager can generate price savings that free up cash for other uses such as reallocating to support or generate revenue growth. Bottleneck purchases, which are medium to high risk to acquire, represent a difficult category to manage because of the uniqueness built into the specification. Interestingly, often it is the decisions made by members of the buying organization that elevate the risk. The more unique or customized the good or service, the more difficult it is to acquire. One of supply’s objectives discussed in Chapter 2 was to standardize wherever possible. The challenge of fulfilling this objective is felt most strongly when managing bottleneck purchases: for example, if an organization wants to develop supply management training for its global supply group of 2,500 people located in 25 countries across multiple time zones, cultures, and languages. If the company sends out an RFP to solicit proposals and requires highly customized courses, there will be few providers with the capabilities to do the job, and the proposals and quotes will reflect this complexity. If the internal training design team can develop a statement of work that clearly delineates the standard course content from the customized content, they will in effect reduce the risk (and cost) of acquisition. The challenge for the manager of bottleneck goods and services is as much an internal
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challenge as an external one. The supply manager must work with internal business partners to determine the appropriate level and type of customization required to satisfy the needs and wants of the final customer. Any uniqueness that is not valued by the final customer is waste and should be eliminated. This is clearly a high-risk decision because the cost of building in unnecessary uniqueness can be quite high, and the cost of eliminating a unique characteristic that the final customer truly values may be even more costly. The tools to extract value from this category include cross-functional and cross-organizational teams, value analysis, total cost modeling, and customer relationship management. For example, automotive manufacturers have successfully standardized many parts across both make and model of car without harming the perceptions of buyers or the company’s pricing strategy. Bottleneck purchases represent cost reduction or savings opportunities that require concerted cross-functional and often cross-organizational effort to realize. Strategic purchases represent both the greatest risk and the greatest reward opportunity for an organization and its supply network. Strategic purchases share the same characteristics of bottleneck purchases in that they often are highly customized or possess some characteristic that limits the number of viable suppliers. The difference is that strategic purchases have the greatest potential to help or hurt attainment of the organization’s mission. For example, if the mission of the organization is summed up in a phrase such as “Select and Use,” then any purchase that drives a potential customer to select and use a product might be considered strategic. This might include the ingredients in a detergent or the artwork on the packaging, but not the office supplies used in general operations. The acquisition of strategic purchases and management of strategic spend historically have been handled by many people outside of the supply organization. For example, jet fuel for an airline or energy supplies for certain manufacturing concerns may represent both highdollar and high-value purchases, and those with primary ownership of these purchase categories were business specialists with technical rather than supply management skills. The trend is toward joint ownership of strategies, goals, objectives, metrics, and accountability for these purchases. Supply brings expertise such as supply base knowledge, negotiating skill, contract development and management skill, and the ability to build and manage a long-term relationship to complement the technical knowledge of the internal business partner. The tools and techniques applied to strategic purchases include total cost modeling, value analysis and engineering, cross-functional teams, and strategic alliances. Many of the efficiency tools and process improvements described in this text free up time for supply personnel to focus resources and human talent on the acquisition and management of strategic purchases. One strategic option different from those discussed is the potential to use the supply expertise and clout in the market of the buying organization to purchase for suppliers, customers, or other supply chain members. In such dealings, the more common occasion is the acquisition of direct materials, parts, and/or packaging for first-tier suppliers. Clearly, this gives the supply professional cost and quality control. In certain industries in which purchasers are much larger companies than suppliers, the supply professional may have the power to direct small suppliers to use specific sources of supply. Under this kind of arrangement the supplier receives a processing fee and an administrative margin. Automotive suppliers of stampings commonly worked under this kind of arrangement for steel supply.
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Level 2—Traditional Applying the traditional level 2 evaluation criteria of quality, quantity, delivery, price, and service is still a fundamental assessment task in evaluating potential suppliers. These are typically evaluated on the basis of the technical, engineering, manufacturing, and logistics strengths of potential suppliers.
Technical, Engineering, Manufacturing, and Logistics Strengths Technical and engineering capability, along with manufacturing strength, impinges on a number of supply concerns. The most obvious factor is the quality capability of the supplier. It is possible, however, that a company capable of meeting current quality standards may still lack the engineering and technical strengths to stay current with technological advances. Similarly, manufacturing may lack capacity, or the space to expand, or the flexibility to meet a variety of requirements. Presumably, the reason for selecting one supplier over another is that of greater strengths in areas of importance to the purchaser. The evaluation of the supplier, therefore, should focus not only on current capability, but also on the supplier’s future strengths. Only in very large organizations might the supply group have sufficient technical strength to conduct such supplier evaluations on its own. Normally, other functions such as engineering, manufacturing, internal users, or quality control provide expert assistance to assess a potential supplier on technical and manufacturing strengths. Should the supplier be a distributor, the stress might be more on logistics capability. The nature of the agreements with the distributors’ supplying manufacturers, their inventory policies, systems capability and compatibility, and ability to respond to special requirements would all be assessed, along with technical strengths of the personnel required to assist the supply professional to make the right choices among a series of different acceptable options. A number of distributors have developed strong supplier-/vendor-managed inventory programs, permitting organizations the option of outsourcing the total MRO supply function and reducing the total supply base significantly.
Management and Financial Evaluation As the tendency toward greater reliance on single sources for a longer period of time continues, along with greater interest in lean operations, lean supply, and strategic sourcing, a potential supplier’s management strengths take on added significance. From the supply point of view, the key question is this: Is the management of this supplier a corporate strength or a weakness? This will require a detailed examination of the organization’s mission, its corporate values and goals, its structure, qualifications of managers, management controls, the performance evaluation and reward system, training and development, information systems, and policies and procedures. It is also useful to have an explanation about why the supplier’s management believes it is managing well and an indication of its most notable successes and failures. A functional assessment of strengths and weaknesses in areas like marketing, supply, accounting, and so on will substantiate the overall picture. For example, in a contract in which the supplier spends a substantial percentage of total volume on raw materials and parts with outside suppliers or subcontractors, the supply group of the buying organization would be best suited to evaluate the supplier’s procurement system, organization, procedures, and personnel. This is especially important when assessing supply chains that consist of multiple tiers of suppliers.
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Supplier documentation and personal visits by the sourcing team are typically required. For large contracts in large organizations, the sourcing team’s formal report detailing the management strengths and weaknesses of potential suppliers will be the deciding factor in the selection process. The financial strengths and weaknesses of a supplier obviously affect its capability to respond to the needs of customers. The supply professional must determine the extent of the financial assessment appropriate for each purchase. As discussed earlier in this chapter, the critical question is this: Is the product or service strategic? If so, then the supplier is strategically important and a full financial analysis is necessary. While short-term alternatives may lessen the risks, the strategic nature of the purchase indicates the need for complete understanding of the long-term risks and opportunities from the supplier’s financial situation. Many supply managers focus on early warning systems to alert them to changes in the financial situation of key suppliers that may affect the buying organization. This allows them to step in and work with the supplier or strengthen their contingency plans if the supplier’s situation worsens. There are often substantial opportunities for negotiation if the purchaser is fully familiar with the financial status of a supplier. For example, the offer of advance payment or cash discounts may have little appeal to a cash-rich source but highly attractive to a firm short of working capital. A supplier with substantial inventories may be able to offer supply assurance and a degree of price protection at times of shortages that cannot be matched by others without the materials or the funds to acquire them. Individual financial measures that may be examined include, but are not limited to, credit rating, capital structure, profitability, ability to meet interest and dividend obligations, working capital, inventory turnover, current ratio, and return on investment. Presumably, financial stability and strength are indicators of good management and competitive ability. Financial statements, therefore, are a useful source of information about a supplier’s past performance. Whether the supplier will continue to perform in the same manner in the future is an assessment the purchaser must make, taking all available information, including the financial side, into account. Some of the financial ratios that a buyer may want to take a look at include profit and loss, inventory turnover, account receivables turns, and current ratio. This information is available from a variety of sources including Dun & Bradstreet (www.dnb.com) and Hoovers (www.hoovers.com). For privately held companies, the buyer may have difficulty accessing sufficient financial information depending on the buyer’s strength in the relationship. There is general agreement among supply executives that a supplier’s management capability and financial strength are vital factors in source evaluation and selection. Even after a satisfactory evaluation of management, financial, and technical strengths of a supplier has been completed, the question remains about what weight should be accorded to each of the various dimensions. Also, should the supply manager take the initiative in insisting that the supplier correct certain deficiencies, particularly on the management or financial side? Many examples exist that illustrate the need for supplier strength. These are normally related to the long-term survival of the company. Small suppliers are frequently dependent on the health, age, and abilities of the owner-manager. Every time this individual steps into an automobile, the fate of the company rides along. The attitudes of this individual toward certain customers may be very important in supply assurance.
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Most long-term and significant supplier–buyer relationships are highly dependent on the relationships and communication channels built by the respective managers in each organization. Unless each side is willing and able to listen and respond to information supplied by the other side, problems are not likely to be resolved to mutual satisfaction.
Level 3—Current Additional In the following section, the current additional criteria for financial consideration, environmental impact, innovation, regulatory compliance, and social and political factors will be addressed. All of these potentially impact the strategic aspects of supply, and risk has already been discussed in that context.
Financial Considerations Financial considerations other than price may impact the supplier selection decision. The financial health of the supplier has already been discussed as part of the normal supplier assessment process, when the prime concern is the supplier’s viability as an ongoing enterprise in the long term. In this additional context an opportunistic perspective is used to find potential ways of strengthening the purchasing organization’s financial statements beyond obtaining a lower price. For example, is it possible to have the supplier manage and own inventories so that they do not show up on the financial statements of the purchasing organization? Can capital purchases be timed to achieve tax savings? Can judicious use of international finance experts facilitate global supply agreements in terms of trade credit, payment, guarantees, and inventory financing?
Environmental Impact Sustainability is the ability to achieve economic prosperity while protecting the natural systems of the planet and providing a higher quality of life. To accomplish this, decision makers must consider the role of four types of capital: financial capital (cash, investment, and monetary instruments), manufactured capital (infrastructure, machines, tools, and factories), human capital (labor and intelligence, culture, and organization) and natural capital (resources, living systems, and ecosystem services). Supply managers play a key role in an organization’s sustainability initiatives in product or service design, sourcing and contracting, and asset or investment recovery. Consequently, supply’s role in helping to achieve this goal needs to be examined carefully. The first issue is, how can our organization design products and services that directly or indirectly contribute to sustainability? The second issue is, how can our organization purchase materials, products, or equipment that directly or indirectly contribute to sustainability? How can the supply group raise sustainability questions when others in the organization fail to do so? The third issue is, how can we purchase from sources, domestic or international, that we know are committed to sustainability and sound practices? These are not easy questions answered glibly out of context. It is possible to evade the issue by putting government in the control seat, saying, “As long as government allows it, it must be all right.” A practical consideration is that government may shut down a polluting supplier with little notice, endangering supply assurance. Environmental supply chain strategies range from merely trying to avoid violations to including environmental considerations from the design stage forward. The preferred
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hierarchy is (1) source reduction—design or use less, (2) reuse—multiple use of same item such as a package or container, (3) recycle—reprocess into raw material, (4) incinerate—at least extract energy, but create CO2 pollution at a minimum, (5) landfill—require space and transportation to store with potential impact on land and water. The introduction of gaselectric hybrid vehicles and the development of fuel cell technology are examples of source reduction initiatives. “Designing for recycling” requires manufacturers of appliances and automobiles to design products for ease of disassembly to allow for recovery of useful materials. In the automobile industry, this represents a particularly difficult challenge. Much of the weight-reduction emphasis to improve government-required fuel ratings has come about by the substitution of lightweight, but difficult to retrieve and recycle, plastics for heavier but easily recycled metal parts. Obviously, suppliers can aid substantially in addressing these priorities to minimize the environmental impact of purchaser’s and their customer’s requirements. In many organizations, supply’s role as an information link between environmentally affected individuals, internal functions, and suppliers in the handling of waste and hazardous materials has been established already. Government regulations stipulate precautions for the use, transport, storage, and disposal of hazardous materials. For example, in the United States, the Department of Transportation, the Occupational Safety and Health Administration, and the Environmental Protection Agency all have regulations pertaining to hazardous goods. In Canada, there are federal and provincial regulations related to hazardous goods. There are many organizations and programs available to support the efforts of supply managers. For example, since 1982, Rocky Mountain Institute (RMI) has worked with corporations, governments, communities, and citizens to help solve problems, gain competitive advantage, increase profits, and create wealth through the more productive use of resources. RMI’s Research & Consulting team helped a semiconductor manufacturer improve its buildings and equipment in ways that also radically reduced energy costs and carbon emissions; showed urban planners how to spur economic development through better building design and water infrastructure; and helped conceive a successful floorcovering service utilizing resource-efficient, closed-loop industrial processes with an innovative business model. The U.S Environmental Protection Agency (www.epa.gov) offers programs and tools that contribute to sustainability in the areas of planning and practices, scientific tools and technology, and measuring progress. Its publication, The Lean and Green Supply Chain: A Practical Guide for Material Managers and Supply Chain Managers to Reduce Costs and Improve Environmental Performance, illustrates the efficiency-enhancing opportunities that arise when companies incorporate environmental costs and benefits into mainstream materials and supply chain management decision making. It provides introductory guidance on how to identify these costs and benefits and how to adjust existing information systems and analysis techniques to better account for this significant category of costs. The EPA’s Sector Strategies Program seeks industrywide environmental gains through innovative actions taken with a number of manufacturing and service sectors. The Office of Policy, Economics, and Innovation (OPEI) works with participating trade associations; EPA programs; and regions, states, and other groups to find sensible solutions to sector-specific problems. The EPA’s Environmental Accounting Project provides tools for calculating the environmental costs of nonprevention approaches and the economic benefits of pollution prevention. The project makes available a number of case studies, benchmarking projects,
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and calculation and spreadsheet tools for conducting environmental cost analysis for business decision making (http://www.epa.gov/oppt/acctg/). The U.S. National Recycling Coalition (www.nrc-recycle.org) represents all the diverse interests committed to the common goal of maximizing recycling to achieve the benefits of resource conservation, solid waste reduction, environmental protection, energy conservation, and social and economic development. For example, it sponsors the Electronics Recycling Initiative to promote the recovery, reuse, and recycling of obsolete electronic equipment, and to encourage the design, manufacture, and purchase of environmentally responsible electronic equipment. Internationally, the ISO 14000 certification, developed along the lines of ISO 9000, is a process for certifying the environmental management system of an organization. In a 1999 CAPS Research report, ISO 14000: Assessing Its Impact on Corporate Effectiveness and Efficiency, respondents from ISO 14000 certified plants reported that other than lead times, certification has a large, positive impact on the perceived efficiency and effectiveness of the organization’s environmental management system. Strategic supply management is all about maximizing opportunities and minimizing risks. In the area of environmental impact and sustainability, there are many opportunities for supply managers who are at the forefront of environmental awareness. By being ahead of, rather than behind, legislative requirements, supply managers may find that opportunities to tap government financial support and public recognition for innovative experiments may exist. The simple fact is that almost every supplier selection decision is likely to be impacted by environmental considerations.
Innovation Assessing a supplier’s potential for innovation requires evidence of continuing improvement and managerial and technical competence. Also references from existing customers are relevant in this regard. Where innovation is a strategic issue, the skills required to assess a supplier’s potential go well beyond those of the typical supply professional. Strategic innovation acquisition may involve mergers and acquisitions, patents, licensing, and contracts. These specialized areas are well beyond the scope of this text. Suffice it to say here that even the more common innovation initiatives of continuous improvement, suggestions from both purchaser and supplier involving each other’s operations, and a conviction that the status quo is not acceptable for the future are vital to effective innovation.
Regulatory Compliance The supply professional obviously does not want supply arrangements to go to naught because of a lack of supplier attention to regulatory compliance. Therefore, it is appropriate to assess a potential supplier in terms of compliance. What evidence can the supplier provide to assure the supply professional that compliance will not become a future issue? The lack of citations can be seen as one sort of evidence. So can the speed of correction in case of citations. The very broad range of regulations regarding trade, employee treatment, financial dealings, the environment, international business, workplace safety and health, and so forth requires a comprehensive approach to compliance valuation.
Social and Political Factors Noneconomic factors may have a significant bearing on sourcing decisions. These include social and political concerns. In a CAPS Research study, Carter and Jennings defined the supply
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manager’s involvement in the socially responsible management of the supply chain as “a wide array of behaviors that broadly fall into the category of environmental management, safety, diversity, human rights and quality of life, ethics, and community and philanthropic activities.”1 Social. Most organizations recognize that their existence may affect the social concerns of society. Some social problems can be addressed through supply policy and actions. For example, it is possible to purchase certain services or goods from social agencies employing recovering addicts, former prisoners, or the physically and mentally handicapped. It is possible to purchase from suppliers located in low-income areas or certain geographical areas of high unemployment. Government legislation requiring suppliers on government contracts to place a percentage of business with designated minority- or woman-owned businesses has forced many purchasers to undertake searches for such suppliers. Many supply managers have initiated assistance and educational programs to make their minority sourcing programs work. For example, the secretary of the Department of Energy (DOE) established a mentor-protégé program in which prime contractors help energy-related small minority businesses increase their capabilities in return for subcontracting credit and other incentives. In one sense these early reverse marketing efforts provided useful insights into the process of developing partnerships with larger suppliers as well. Companies in the private sector often engage in these actions voluntarily out of a sense of corporate social responsibility and to gain strategic advantage. For example, Detroit’s big three automotive manufacturers have positioned supplier diversity as a strategic advantage because they see the connection between from whom they buy and to whom they sell. By helping to develop the economy of the ethnic community through its supplier development programs it is also increasing the purchasing power of the community’s members. There are problems and opportunities when exercising purchasing power in the social area. Balancing the often conflicting goals of the organization (lowest total cost with social responsibility), and assessing and mitigating the risks presented by supplier diversity programs adds a level of complexity to what may already be a complex sourcing decision. Most supply managers agree that the “deal” must make good business sense. There are a number of resources and publications available to link buyers and minority and women business owners including • The U.S. Small Business Administration (SBA) (www.sba.gov). • The National Minority Supplier Development Council and its regional Purchasing Councils, (www.nmsdcus.org). • Minority Business Entrepreneur (MBE) magazine, www.mbemag.com. • Hispanic Business magazine, www.hispanicBusiness.com. Political. The basic question in the political area is, should the acquisition area be seen as a means of furthering political objectives? Public agencies have long been under pressure of this sort. “Buy local” is a common requirement for city and state purchasing officials. “Buy American” is a normal corollary requirement. The attempt by the Canadian government to spread purchases across the country, approximately in line with population distribution, is
1
Craig R. Carter and Marianne M. Jennings, Purchasing’s Contribution to the Socially Responsible Management of the Supply Chain (Tempe, AZ: Center for Advanced Purchasing Studies, 2000), p. 7.
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another example. For military purposes, the U.S. government has a long-standing tradition of support and development of a national supply base to afford security protection in the case of conflict and, recently, to reward other countries for their support of U.S. initiatives. The question always arises about how much of a premium should be paid to conform with political directives. Should a city purchasing agent buy buses from the local manufacturer at a 12 percent premium over those obtainable from another state or other country? The debate over offshore outsourcing has raised the political stakes, and many public entities are passing legislation to prevent offshore outsourcing that results in a loss of jobs domestically. Politics aside, whether this behavior is good for the economy in the long run is an ongoing debate. For private industry, political questions are also present. Should the corporation support the political and economic aims of the governing body? Governments have little hesitation on large business deals to specify that a minimum percentage should have domestic content. In the aerospace and telecommunications industry, for example, foreign orders are often contingent on the ability to arrange for suitable subcontracting in the customer’s home country. It is interesting that governments have no fear to tread where private industry is forbidden to walk. Multinationals often find themselves caught in countries with different political views. U.S. companies for many years have not been allowed to trade with Cuba, yet their subsidiaries in other countries face strong national pressure to export to Cuba the same products that the U.S. parent is not allowed to sell from U.S. soil. The same holds for purchasing from countries with whom trade is not encouraged by the government. American subsidiaries frequently find themselves caught between the desire of the local government to encourage local purchases and the U.S. government, which encourages exports from the parent or the parent’s suppliers. The growing role of government in all business affairs is likely to increase difficulties of this kind in the future. Their resolution is far from easy and will require a great deal of tact and understanding. Chapter 17 also covers the role of supply in corporate social responsibility.
Level 3 Criteria Conclusion The supplier’s performance according to level 3 criteria has become a matter of considerable concern in supplier selection. What environmental programs does the supplier have in place to assure compliance with current environmental regulations? What plan does the supplier have to meet future requirements, and what is management’s attitude towards the environment? What is the supplier’s attitude to corporate social responsibility? Nick’s share value has been significantly discounted in the past because it was found to be using shoe manufacturers in underdeveloped countries where child labor and poor working conditions were prevalent. Thus, suppliers do affect the reputation of the purchasing organization and the potential reputational risk is high. The belief that in any organization, customers, employees, and suppliers should be treated equally leads to the conclusion that organizations with similar values make for good customers and suppliers of each other. This shows up in leadership, attitude towards innovation and continuing improvement, concern for the environment and society, as well as employee, customer, and supplier satisfaction. Although the full evidence of compatibility may not be forthcoming until well after a trading relationship has been established, significant clues can be extracted in face-to-face meetings between corporate leaders, examination of corporate publications, and reactions from customers.
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RANKING POTENTIAL SUPPLIERS During the first two stages of the acquisition process, need identification and description, it is important to establish which of the three levels of selection criteria are most relevant for this particular requirement. This will not only assist in identifying potential suppliers but also in evaluation of bids and ultimate supplier selection. Letting suppliers know how bids will be evaluated and what weights will be used to compare competitive bids is considered good practice. Thus, in the traditional context, quality might be assigned 60 points, price 30 points, and delivery 10 points for a particular purchase. Even in such a simple three-factor, no strategy, or level 3 consideration, judgment is required to establish three weightings and how to assign points for differing bids. Almost all of the cases in this text require this kind of judgment. Because many purchasing organizations use formal supplier performance evaluations for existing and new suppliers, the criteria used for selection and subsequent actual performance should be similar. If more than one potential supplier is available, the supply professional’s ranking of each supplier in relation to one another and the selection interview will determine the best available source. A recent multimillion dollar purchase of paper at the World Bank resulted in supply’s rethinking of how to measure the environmental impact of this requirement. This resulted in a new set of seven environmental evaluation criteria: fiber type, transportation pulp to mill and mill to Bank, chemical processing, certifications when sourcing, energy source at the mill, packaging, and compliance and other sustainability considerations. A low environmental score disqualified potential suppliers, even though their traditional offering in terms of quality, quantity, delivery, price, and service would have been deemed acceptable in prior years. In the supplier ranking scheme of 100 points, 70 points were assigned to the technical environmental evaluation criteria mentioned above. A total of 30 points were assigned to total annual cost, with the full 30 points given to the lowest bidder. The highest points assigned on the technical side were below 40, suggesting either lots of further improvement potential for the future or the need for a recalibration of point assignment. The next chapter on supplier evaluation and relations describes ranking systems and, therefore, the coverage in this chapter is brief.
Conclusion
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The most critical decision for the supply professional deals with the selection of suppliers. Based on his or her understanding of the organization’s strategic and operational needs, short and long term, the supply manager has to find the best way of matching the marketplace to these needs. Finding potential suppliers and gathering relevant information about them are standard tasks prior to supplier selection. Options of in-house, existing supplier, and new supplier need to be considered as well as single and multiple sourcing, dealing with manufacturers or distributor, local or foreign supplier, and small or large supplier. Whether supplier development should be used operationally or strategically is also a consideration. Evaluating potential sources according to the three levels of acquisition criteria requires a disciplined and reasoned approach. There is always a risk that actual supplier performance will not match expectations and risk management is intricately linked with the supplier selection decision.
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Questions for Review and Discussion
1. Why might a supply manager prefer to place additional business with an existing supplier? Why not? 2. What challenges do you see in assessing a supplier’s environmental performance? 3. Why is the trend toward single sourcing? What are the disadvantages to this trend? 4. What are standard supply risks? 5. Why might it be preferable to buy from a distributor or wholesaler rather than directly from the manufacturer? 6. What are the advantages of purchasing from small local sources? 7. When might it be appropriate to conduct an informal, rather than a formal, supplier evaluation? 8. What are the similarities and differences between evaluating new and existing sources of supply? 9. Why is supply focusing more attention on a supplier’s management as part of the evaluation process? How might this evaluation be conducted? 10. How might social or political issues impact a supplier selection decision?
References
Carter, Craig R., and Marianne M. Jennings. Purchasing’s Contribution to the Socially Responsible Management of the Supply Chain. Tempe, AZ: CAPS Research, 2000. DeBoer, L.; E. Labro; and P. Morlacchi. “A Review of Methods Supporting Supplier Selection.” European Journal of Purchasing and Materials Management 7 (2001), pp. 75–79. Flynn, Anna E. “Knowledge-Based Supply Management.” Chap. 8. In The Purchasing Handbook. 7th ed., eds. J. L. Cavinato and R. G. Kauffman. New York: McGraw-Hill, 2005. Gottfredson, M.; R. Puryear; and S. Phillips. “Strategic Sourcing: From Periphery to the Core.” Harvard Business Review 83, no. 2 (2005), pp. 132–139. Heriot, Kirk C., and Subodh P. Kulkarni. “The Use of Intermediate Sourcing Strategies.” Journal of Supply Chain Management 37, no. 1 (Winter 2001), pp. 18–26. Kannan, Vijay R., and Keah Choon Tan. “Supplier Selection and Assessment: Their Impact on Business Performance.” Journal of Supply Chain Management 38, no. 4 (Fall 2001), p. 11. Krause, D. R., and T. V. Scannell. “Supplier Development Practices: Product and Service Based Industry Comparisons.” Journal of Supply Chain Management 38, no. 2 (2002), pp. 13–22. Krause, Daniel R., and Robert B. Handfield. Developing a World Class Supply Base. Tempe, AZ: CAPS Research, 1999. Nelson, David; Patricia E. Moody; and Jonathan R. Stegner. The Incredible Payback: Innovative Sourcing Solutions That Deliver Extraordinary Results. New York: AMACON, 2005. Sako, M. “Supplier Development at Honda, Nissan and Toyota: Comparative Case Studies of Organizational Capability Enhancement.” Industrial and Corporate Change 13, no. 2 (2004), pp. 281–308. Seegers, L.; R. Handfield; and S. Melynk. “Green Movement Turns Mainstream for Corporate America.” Environmental Leader.environmentalleader.com. 2007.
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Case 12–1
Loren Inc. On June 15, Brent Miller, raw materials buyer, had to prepare his recommendation for Loren’s annual hexonic acid requirements. Four suppliers had submitted substantially different bids for this annual contract to commence August 1. Brent knew his recommendation would involve a variety of policy considerations and wondered what his best option would be.
COMPANY BACKGROUND Loren (Canada) was the Canadian subsidiary of a larger international chemical company. The company sold both consumer and industrial products and had over the years established an excellent reputation for quality products and marketing effectiveness. This was evidenced by a substantial growth in total sales and financial success. Total Canadian sales were approximately $800 million and after-tax profits were $40 million. Raw material and packaging costs were about 50 percent of sales.
PURCHASING Brent Miller, a recent graduate of a well-known business school, knew that purchasing was well regarded as a function at Loren. The department was staffed with 12 wellqualified persons, including a number of engineering and business graduates at both the undergraduate and master’s levels. The department was headed by a director who reported to the president. It was organized along commodity
EXHIBIT 1 Purchasing Objectives
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lines, and Brent Miller had recently been appointed raw materials buyer reporting to the manager of the chemicals buying group. The hexonic acid contract would have to be approved by his immediate supervisor and the director of the department. Brent was aware that several Loren purchasing policies and practices were of particular importance to his current hexonic contract decision. The purchasing department had worked very hard with suppliers over the years to establish a single-bid policy. It was felt that suppliers should quote their best possible offer on their first and only quote, and all suppliers should be willing to live with the consequences of their bid. Long-term supplier relations with the best possible long-term opportunities were considered vital to the procurement strategy. Assured supply for all possible types of market conditions was also of prime concern. Multiple sources were usually favored over single sources where this appeared to be reasonable and where no strong long-term price or other disadvantages were expected. Frequent supplier switching would not be normal, although total volumes placed with suppliers might change depending on past performance and new bids. Brent recognized that any major departure from traditional practice would have to be carefully justified. Exhibit 1 shows the four prime objectives of the purchasing department and Exhibit 2 contains excerpts from the company’s familiarization brochure for new suppliers.
The basic objectives for the Loren purchasing department are: A) Assurance of Material Availability. The major objective of purchasing must be the guarantee of sufficient supply to support production requirements. B) Best Value. Loren recognizes that value is a combination of price, quality, service, . . . and that maximum profitability can only be obtained through the purchase of optimal value on both short- and long-term basis. C) An Ethical Reputation. All dealings must respect all aspects of the law and all business relationships must be founded on a sound ethical approach. D) Gathering of Information. Purchasing involves a constant search for new ideas and improved products in the changing markets. A responsibility also exists to keep the company informed on industry trends including information on material supply and costs.
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EXHIBIT 2 Excerpts from Brochure for New Suppliers The purpose of the information contained herein is to give our suppliers a better understanding of certain policies and practices of Loren. We believe it is important that we understand our suppliers and, in turn, that they understand us. As you know Loren believes in free enterprise and in competition as the mainspring of a free enterprise system. Many of our basic policies stem from a fundamental belief that competition is the fairest means for Loren to purchase the best total value. However, the policies and practices we want to outline here for you relate to Loren business ethics and the ethical treatment of suppliers. In brief, fair dealing means these things to us: 1. We live up to our word. We do not mislead. We believe that misrepresentations, phantom prices, chiseling, etc., have no place in our business. 2. We try to be fair in our demands on a supplier and to avoid unreasonable demands for services; we expect to pay our way when special service is required. 3. We try to settle all claims and disputes on a fair and factual basis. 4. We avoid any form of “favored treatment,” such as telling a supplier what to quote to get our business or obtaining business by “meeting” an existing price. In addition, all suppliers that could qualify for our business are given identical information and an equal opportunity to quote on our requirements. 5. We do not betray the confidence of a supplier. We believe that it is unethical to talk about a supplier with competitors. New ideas, methods, products, and prices are kept confidential unless disclosure is permitted by the supplier. 6. We believe in giving prompt and courteous attention to all supplier representatives. 7. We are willing to listen to supplier complaints at any level of the buying organization without prejudice concerning the future placement of business. We also do not believe in reciprocity or in ”tie-ins” which require the purchase of one commodity with another. We believe that supplier relationships should be conducted so that personal obligations, either actual or implied, do not exist. Consequently, we do not accept gifts and we discourage entertainment from suppliers. Similarly, we try to avoid all situations which involve a conflict of personal interest.
HEXONIC ACID—RECENT MARKET HISTORY Loren expected to use approximately 3,000 tons of hexonic acid in the following year. Requirements for the past year amounted to 2,750 tons and had been supplied by Canchem and Alfo at 60 and 40 percent, respectively. Hexonic acid was a major raw material in a number of Loren products. Its requirements had grown steadily over the years and were expected to remain significant in the years to come. The availability of this material in the marketplace was difficult to predict. The process by which it was produced yielded both hexonic and octonic acids and the market was, therefore, influenced by the demand for either product. Two years previously there had been major shortages of hexonic acid due to strong European and Japanese
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demand. Furthermore, capacity expansions had been delayed too long because of depressed prices for hexonic and octonic acid over the previous years. During this period of shortage, both of Loren’s suppliers, Alfo and Canchem, were caught by the market upsurge. Alfo had just shut down its old Windsor plant and had not yet brought its new Quebec City plant up to design capacity. At the same time, Canchem was in the midst of converting its process to accommodate recent chemical improvements, and they, too, found themselves plagued with conversion problems. Both companies were large multiplant companies in Canada and had supplied Loren for many years. The parent companies of both Alfo and Canchem had been faced with too high a demand in the United States to be able to afford any material to help meet the Canadian commitments of their subsidiaries. As a result, both Canadian suppliers were forced to place many of their customers
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EXHIBIT 3 Hexonic Acid—Purchase History
Period
Total Volume Purchased
Three years ago Two years ago Last year
1,800 tons 2,200 tons 2,750 tons
Canchem Percent Delivered/Cost
Alfo Percent Delivered/Cost
50% $828 / ton 50% $1,176 / ton 60% $1,384 / ton
50% $828 / ton 50% $1,084 / ton 40% $1,296 / ton
on allocation. However, through considerable efforts both were able to fulfill all of Loren’s requirements. The increased prices charged throughout this period fell within the terms of the contracts and were substantially lower than those that would have been incurred if Loren would have had to import offshore material. Quotations on such imports had revealed prices ranging from $1,920 to $2,880 per ton. The past year was relatively stable with both producers running almost at capacity. Loren again had contracted its requirements with Alfo and Canchem, both of whom continued to perform with the same high quality and service to which Loren had become accustomed over the years. For the past year, Brent’s predecessor had recommended a split in the business of 60 percent to Canchem and 40 percent to Alfo based on a number of factors. Important to the decision at the time was the start-up of the new Alfo plant. Alfo’s quotation of $1,292 per ton delivered offered a lower price per ton than Canchem’s at $1,384 per ton, but it had been uncertain whether the new plant would be able to guarantee more than 40 percent of Loren’s hexonic acid requirements. Currently, however, Alfo had brought their plant up to capacity and could certainly supply all of the 3,000 tons required, if called on (see Exhibit 3 for a recent history of hexonic acid purchases). Brent thought that recently the hexonic acid cycle had turned around. Hexonic acid demand had eased and now it was octonic acid that was in high demand by the booming paint industry. Recent plant expansions by a number of suppliers had been completed. The overall result seemed to be a building of excess hexonic acid inventories. Brent believed this would be reflected in a buyer’s market in the coming year and looked forward to aggressive quotes from all potential sources.
building strong relationships with suppliers. It was the buyer’s responsibility to assure that all information between buyer and seller would be completely confidential. The director of purchasing believed it was important to build a reputation so that suppliers could trust Loren purchasing personnel. On May 14, Brent sent out the hexonic acid inquiry to the four suppliers he believed had a chance of quoting competitively on the needs of the Hamilton plant. The two current Canadian suppliers, Alfo and Canchem, were included as well as two American companies. The deadline for bids was June 7 at 4 p.m. Brent knew that on receipt of the inquiry, supplier sales representatives would be eager to discuss it. Actually, he had two contacts before the inquiry was sent out.
MEETINGS WITH HEXONIC ACID SUPPLIERS
Mr. Wallace, sales representative of Michigan Chemical, assured Brent over the telephone on April 30 that his company would be a contender this year. He said that Michigan Chemical would be represented by their Canadian distributor, Carter Chemicals Ltd., located in Niagara Falls, Ontario. Brent remembered that Michigan Chemical had
An important part of the buyer’s job at Loren was to become an expert in the materials purchased. Among other things, this meant keeping an open ear to the market and
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MEETING WITH ALFO Mr. Baker, sales representative of Alfo, met with Brent on April 20. He said that Alfo had unfilled capacity at its new Quebec City plant and he appeared eager to receive an indication of Loren’s future hexonic acid requirements. Mr. Baker informed Brent that he was aware of low-priced hexonic acid on the European market, but also made sure to emphasize that it would be uncompetitive in the Canadian market after the cost of duty and freight were added. Brent said it was a published fact that inventories were building in the United States as other hexonic acid users showed signs of easing their demands. The meeting ended with the assurance from Brent that Mr. Baker would again receive an invitation to quote on the next period’s business.
PHONE CALL BY MICHIGAN CHEMICAL
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a good record with Loren (U.S.). According to the U.S. raw materials buying group, Michigan Chemical had supplied close to 99 percent of its commitment in the recent period of shortage. Brent emphasized to Mr. Wallace over the telephone that the present suppliers held the advantage and that he would have to offer better value in order for Loren to swing any business away from them. Brent said at the end of the call that Michigan Chemical would receive an inquiry and that their quote would be seriously considered.
MEETING WITH CANCHEM On June 3, Mr. Aldert, sales representative for Canchem, personally brought in his company’s quotation and presented the terms to Brent with a distinct air of confidence. Mr. Aldert explained that although his delivered price of $1,384 per ton was the same as that which Loren was currently paying for delivered Canchem material, it remained a competitive price. Brent could not help showing his disappointment to Mr. Aldert, and he said that he had expected a more aggressive quote. However, he assured Mr. Aldert that every consideration would be given to Canchem once all the quotations were in by the June 7 deadline.
MEETING WITH AMERICAN CHEMICAL INC. (AMCHEM) On the morning of June 7, two representatives from AMCHEM delivered their hexonic acid quotation and explained its contents to Brent. AMCHEM had recently completed a plant expansion at its Cleveland plant and clearly had the ability to supply many times Loren’s total requirements. Brent thought the quote of $1,204 per ton appeared attractive and noted that the price per ton depended on the specific volume allocated to AMCHEM. The price of $1,204 applied to an annual volume to 1,050 tons. For a volume of 2,250 tons per year, the delivered price would be lowered to $1,192. When the representatives had left, Brent searched the hexonic acid material file for any information about past dealings with AMCHEM. He found that Loren had been supplied with AMCHEM hexonic acid seven years previously. At that time, AMCHEM apparently had quoted a price below Canchem and Alfo and, as a result, had been allocated a portion of the business. This had the result of sparking aggressiveness into the two Canadian suppliers during the next inquiry. Both fought to gain back the tonnage that had been taken away from them. Apparently,
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neither Canchem nor Alfo had been aware who their competitor was at the time. Brent also telephoned the purchasing department of Loren (U.S.) in an effort to draw any information about their experience with AMCHEM. Supplier information like this flowed quite freely within the corporation on a need-to-know basis. The U.S. buyer informed Brent that AMCHEM did at one time supply the parent with hexonic acid and that quality and service were excellent. However, he did caution Brent that during the recent period of shortage, AMCHEM did place Loren (U.S.) on allocation and as a result fell short of its commitment by a considerable extent.
MEETING WITH ALFO Mr. Baker, sales representative of Alfo, presented his company’s quote to Brent at 3 p.m., the afternoon of June 7. He explained that the contractual terms and $1,296 delivered price offered were the same as those under the current contract with Alfo. Brent thanked Mr. Baker for his quotation and told him he would be informed in late June when a decision had been made.
QUOTATION BY CARTER CHEMICAL The quotation from Carter Chemical arrived in the afternoon mail on June 7. The $1,268 per ton FOB destination quote was a pleasant surprise to Brent. He thought that Michigan Chemical had been right when they had said that their distributor would make an aggressive offer. Brent now had received two quotes that offered a better laid-down cost than the two current suppliers.
VISIT OF CANCHEM At 3:45 p.m. on June 7, Brent received another visit from Mr. Aldert of Canchem, who had apparently been disheartened after his earlier meeting on June 3. He had obviously gone back to his management, for he now had a new quotation prepared. His new quote offered Loren hexonic acid on a three-year contract for $1,192 per ton. With freight included, this price appeared to be equal to the lowest bid that had been received. Brent realized that he had probably inspired Mr. Aldert to resubmit his quotation by the feedback he had given him during their June 3 meeting. With this in mind, Brent was wary of accepting this quotation for fear he would be setting a bad precedent. He told Mr. Aldert that he might not be in a position to accept his bid, but would let him know
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EXHIBIT 4 Quotation Summary: Hexonic Acid Price Spot
Contract
Terms
Alfo
$1,296.00 / ton
$1,296.00 / ton
Min. period: 1 year Min. volume: — Price protection: 90 days Notice: 15 days
Canchem
Bid 1 $1,384.00 / ton
$1,384.00 / ton
Bid 2 $1,192.00 / ton
$1,192.00 / ton
Min. period: 3 years (Bid 2) Min. volume: 1,000 tons Price protection: 30 days Notice: 30 days
American Chemicals $1,607.72 / ton Carter Chemicals (Michigan $1,268.00 / ton Chemical Material)
Min. 1,050 tons
Min.2,250 tons
$1,204.00 / ton
$1,192.00 / ton
Min. 750 tons $1,268.00 / ton
subsequently. The following day Brent discussed the situation with his superior, Mr. Williams. Mr. Williams retraced the steps Brent had gone through. It had been normal practice at Loren to open quotes as they were received. It had also been standard policy not to give suppliers any feedback on their quote until all quotes had been received. Mr. Williams told Brent to think the situation over in his own mind and to make a recommendation on how Canchem’s second bid should be treated as part of his hexonic acid contract deliberations.
Min. period: 1 year Min. volume: Stated Price protection: Firm Notice: — Min. period: 1 year Min. volume: 750 tons Price protection: 90 days Notice: 15 days
QUOTE SUMMARY Brent prepared a quote summary to put all bids on an equal footing (see Exhibit 4). To be able to compare quotes fairly, it was necessary to examine the laid-down cost of each of the four options. Brent realized he did not have much time left and the unusual situation surrounding Canchem’s second bid gave him further concern. Mr. Williams was expecting his written analysis and recommendation no later than June 17.
Case 12–2
Russel Wisselink “Have a plan ready for me by 9:00 a.m. tomorrow morning” was the instruction Russel Wisselink, senior buyer for Trojan Technologies in London, Ontario, Canada, received from Randy Haill, Trojan’s materials manager. In the morning of March 12, Russel Wisselink had received
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an e-mail from China stating that Trojan’s UV4 crystal glass sleeves requirements would not be met because of a governmental ban on the use of its raw material. Russel, aware of the consequences of stockouts on this critical part, had immediately notified Randy.
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TROJAN TECHNOLOGIES Trojan Technologies Inc. (Trojan) was a leading water treatment technology company with the largest installed base of ultraviolet water treatment systems in operation around the world. Trojan specialized in the design, manufacture, and sale of pressurized and open-channel, ultraviolet disinfection and water treatment systems for industrial, municipal, commercial, and residential applications. Trojan’s head office was in London, Ontario, Canada. The company had sales of $140 million, employed approximately 400 people in offices around the world, and served its customer base through an extensive network of dealers and representatives. Trojan was owned by Danaher Corporation (Danaher), which had acquired the company in 2004. Danaher was a diversified global manufacturer, with businesses in professional instrumentation, industrial technologies, and tools and components. Sales revenues were $6.8 billion with a net profit of $746 million, and Danaher employed approximately 37,000 people. Management used its Danaher Business System (DBS) of continuous improvement to guide and measure operations and business activities. Trojan’s current product line consisted of 10 systems across its five markets: (1) residential water treatment, (2) municipal drinking water, (3) municipal wastewater, (4) environmental contaminant treatment, (5) and industrial process. Systems for commercial and government customers ranged from approximately $50,000 to more than $1 million. These systems, which typically had a product life cycle of 7 to 10 years before being replaced with a new design, were designed and manufactured at the London facility and modified to meet individual customer requirements. In a typical year, Trojan manufactured 500 to 600 systems for its commercial and government customers.
LOW-COST REGION SOURCING PROJECT Following its acquisition of Trojan, Danaher implemented several new initiatives aimed at improving corporate performance. One area targeted was low-cost region sourcing (LCR)—an initiative originally championed by Russel’s boss, Randy Haill. Russel had been given responsibility for the LCR sourcing project in January after his predecessor left the company. One of the products critical for Trojan’s UV water treatment and purification systems was a crystal quartz sleeve that acted as an ultratransparent barrier between the water and the UV lamp. These sleeves were built to
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custom specifications for size and optical transparency for each of Trojan’s product applications, making them very expensive and difficult to procure. Depending on the system, several crystal quartz sleeves could be required for each unit. The company had traditionally sourced its crystal quartz sleeves from Advanced Material Solutions, Inc. (AMS), located in Dearborn, Michigan, approximately 150 miles from Trojan’s plant in London, Ontario. AMS produced the sleeves from various types and purities of silica sand. While there were a number of locations that could have supplied the silica sand used for manufacturing crystal quartz sleeves, China was selected as the primary location for LCR sourcing for three reasons. First, China had a good supply of both regular quartz sand for standard sleeves, and uncontaminated crystal sand for UV4 sleeves. Second, Danaher already had an established sourcing group in China and as a result Trojan would not have to do much of the work to locate suppliers. Third, Trojan had been developing plans to establish its own manufacturing operations center in China to service the region. These plans were ready for implementation but had been stalled due to slowing demand in the Asia-Pacific region. AMS’s pricing for crystal quartz sleeves for Trojan’s UV4 model (part number GA-311) was $51 per unit, and the delivery lead time was approximately two weeks. Trojan’s annual requirements for the UV4 sleeves was about 10,000, which represented roughly 15 percent of Trojan’s total sleeve orders, but approximately 30 percent of total sleeve costs. Very few places in the world had crystal sand resources of sufficient quality (e.g., very low levels of impurities) to produce sleeves with the necessary optical transparency for UV4 applications. After Trojan’s careful screening of potential suppliers, Juntao was chosen in May the previous year to be the primary Chinese supplier. The net cost savings to Trojan on the sleeves would be 70 percent. However, the delivery lead time from Juntao would be extended to eight weeks due to longer lead times for production and shipping. Once the sourcing relationship was established, it took approximately six months for Juntao to begin accepting orders from Trojan because of communication problems, which Russel found particularly frustrating. The first shipment of sleeves from Juntao arrived at Trojan in February.
DELIVERY PROBLEMS The original procurement plan developed by Russel’s predecessor was to use an 80/20 production ratio with Juntao and AMS respectively. However, when AMS
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became aware that Trojan was going to source from China they issued an ultimatum: “Keep 100 percent of the business with us or the pricing for sleeves would be increased to $77 per sleeve. Furthermore, delivery lead time will be extended to 12 weeks because we will now longer stock sleeves for Trojan.” This development led Trojan to decide to source 100 percent of the sleeves from Juntao. Russel felt that AMS believed that they would ultimately lose all of Trojan’s business to offshore suppliers, and thus they wanted to extract a premium price from Trojan. On March 12, Russel received an e-mail stating that new regulations imposed by the Chinese government temporarily banned all uncontaminated crystal sand mining because government officials wanted to establish regulations for usage of natural resources. According to the e-mail, it was uncertain how long the ban would be in place and what the new regulations would entail. Trojan had not received any warning or indication regarding the change in government regulations. However, this new development meant that Juntao would be unable to provide the crystal sleeves for Trojan once their existing supply of crystal sand was depleted. Because Trojan did not stock the crystal sleeves, any disruption in supply would rapidly lead to negative impacts on customer orders and projects.
IDENTIFYING OPTIONS As soon as Russel received the e-mail he informed Randy, who asked him to put together a list of viable options and to make a recommendation. Top among Randy’s concerns
were to minimize the financial impact while ensuring no disruptions to Tojan’s customers. Juntao only had a small supply of the crystal sand on hand, which meant that Trojan would face a sleeve shortage in approximately 30 days. Juntao had offered to import crystal sand for use in sleeve production; however, this alternative would require time to run tests to ensure that the new crystal sand would meet the purity requirements for making UV4 sleeves. It was unlikely that the samples using the new imported sand would be available within the next month. Furthermore, importing raw material would add to Juntao’s costs, which would represent doubling of its prices, increasing to approximately $28 per sleeve. Russel felt he could order just the crystal sleeves on an as-needed basis from AMS and keep all other sleeve production with Juntao, but the downside to this option would be the premium cost of $77 per sleeve and the extended lead times. Alternatively, Russel had an option to sign a one-year contract with AMS at $51 per sleeve on the condition that AMS provided 100 percent of Trojan’s UV4 sleeve requirements. Another option was to investigate alternative suppliers of crystal quartz sleeves in China who might have raw material stockpiles in reserve. Russel felt that dual sourcing would help reduce Trojan’s risk exposure, provided supply from China eventually returned to normal. Russel knew that a plan needed to be put in place quickly to ensure continuous supply. However, Randy was expecting that Russel would address both the longterm sourcing strategy for crystal quartz sleeves as well as the short-term supply issue.
Case 12–3
Kettering Industries Inc. In late February, Victoria Jackson, supply manager at Kettering Industries Inc. in Dayton, Ohio, needed to decide which glass supplier(s) to choose. She was not sure whether her past approach to buying glass would still be appropriate in future.
KETTERING INDUSTRIES INC. Kettering Industries Inc. (KII) competed in the regional window market in the Midwest home remodeling industry. The plant initially manufactured low-cost products such as storm doors, storm windows, school bus windows, and low-end replacement aluminum windows. Over the years, storm door and replacement aluminum window produc-
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tion was eliminated and vinyl window production was initiated. The 86,000 sq. ft. facility manufactured vinyl windows (800/day), storm windows (200/day), and school bus aluminum windows (50/day). A total of 160,000 windows was produced last year. Sales were approximately $25 million. Sales of vinyl windows were seasonal with primary demand in the warmer months, from May to October. The company sold its high-priced, high-quality vinyl windows through a number of branches located across the Midwest. The delivery goal to customers was 10 days from the date the order was received at the plant. In order to maintain competitiveness and increase returns to shareholders, KII was committed to becoming a
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in thicknesses of each 3 mm or 4 mm. Low energy glass was a special glass with an invisible metal coating that reduced penetration of infrared rays and decreased heat loss. Currently, low energy glass windows accounted for about 22 percent of the plant’s vinyl window production. Low energy glass window production, as a percentage of total vinyl window production, was increasing monthly.
world-class manufacturer. Programs were developed and implemented to meet goals of improved quality, delivery performance, customer responsiveness, and better engineered products.
VINYL WINDOW PRODUCTION All production at KII was based on custom orders. Windows were usually manufactured and shipped on the same day, reducing the need for work-in-process inventory. Due to cost and performance advantages of vinyl over wood and aluminum windows, management projected that demand would continue to grow, and production, as measured by total blocks of glass used, would double over the next five years. All of this growth was expected to be in low energy glass windows. Vinyl windows could be made with either clear glass or low energy glass; both types of glass were available
PURCHASING OF GLASS Last year, KII purchased a total of $1.15 million of clear and low energy glass from four different suppliers (Exhibit 1). Glass was purchased by the block with each block consisting of 40 sheets for 4 mm glass and 50 sheets for 3 mm glass. Due to the nature of the glasscutting equipment that the company used, 3 mm glass had to be ordered in sheets of 72⬙ ⫻ 96⬙ and 4 mm glass in sheets of 60⬙ ⫻ 96⬙.
EXHIBIT 1 Kettering Industries Inc. Last Year’s Glass Consumption
Supplier
3 mm Clear
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4 mm Clear
3 mm Low Energy
4 mm Low Energy
Total
Ross Industries 666 blks
541,090
$541,090
Clear View Distributors 94 blks 8 blks 110 blks 12 blks
77,812 5,618 234, 882 16,631
$334,943
0
$192,218
7,073
$83,119
$23,704
$1,151,370
Travers Glass Ltd. 104 blks 42 blks 36 blks
85,902 29,494 76,822
West Bend Glass 36 blks 4 blks Blks Total
0 $704,804
Clear Glass Total Low Energy Glass Total TOTAL
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0 $35,112 872 198 1,070
blocks blocks
76,046 $387,750
$739,916 441,454 $1,151,370
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Glass sheet order quantities were determined based on historical usage reports and sales forecasts. In order to take advantage of quantity discounts and obtain the best possible price, Victoria usually ordered by the truckload. Truckload size could vary between 8 to 18 blocks depending on the capacity of the truck, the packaging, and weight restrictions. The amount of glass that could be held in inventory was constrained by a storage capacity of 32 blocks. During the past year, to maintain production during peak periods (May through October), six blocks of glass per day were required. Only 13 blocks of glass per week were needed for the November through to April period. Each week an inventory count was undertaken so that purchasing orders could be adjusted as necessary. Last year raw material glass inventory turned about 14 times. KII occasionally manufactured products using obscure glass instead of clear or low energy glass. Rather than stocking the obscure glass in inventory it was only ordered as required.
SELECTING SUPPLIERS Victoria wanted one or more suppliers to be able to meet forecasted needs. The company had set a goal of increasing raw material inventory turns from 14 times a year to
EXHIBIT 2
30–35 times a year within two years. In addition to requiring less working capital, increased inventory turns would free up floor space that was needed for other production activities. A Vendor Certification Program was also being implemented to assist in the setup of long-term relationships with suppliers in a partnership mode to encourage delivery of on-time, zero-defect materials to the plant. KII’s president had asked Victoria to research four potential suppliers and recommend the arrangements the company should make for purchasing glass. Victoria had asked several suppliers to submit quotes, from which she had narrowed the alternatives to three of last year’s suppliers and one former supplier, Jackson Glass Co. She summarized these quotes in her bid summary as shown in Exhibit 2.
SUPPLIER ALTERNATIVES Ross Industries. Ross Industries was a glass manufacturer that had provided KII with excellent service and good quality glass for 20 years. Their low energy glass did not meet KII’s testing standards and, therefore, mixed truckloads of clear and low energy glass were not possible. To get the quoted 3 mm clear glass truckload price of $.3278/sq. ft./blk delivered, a minimum of 12 blocks had to be ordered at one time. If quantities of less than
Clear
Bid Summary and Past Year Prices Paid (in dollars per square foot)
Low Energy
3 mm (822 blocks 2400 ft2/bl)
4 mm (50 blocks 1600 ft2/bl)
Ross Ind.
.3278 12 min .33 1 min [.3384]1
.4371 .44
Clear View
.33 [.3449]
8 min
Travers
.3172 [.3445]
12 min
Jackson
.33
West Bend2
6 min
3 mm (234 blocks 2400 ft2/bl)
4 mm (124 blocks 1600 ft2/bl)
.44 [.3489]
.8920 [.8900]
1.142 [1.135]
.4389 [.4389]
.8830
1.160
.44
1.092 0.8794
1
brackets indicate last year’s actual prices. Because West Bend Glass was a Canadian manufacturer and unable to price its glass competitively in the United States, it was not asked to submit a quote for either clear glass for the current year.
2
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12 blocks were ordered, the delivered price was $.33/sq. ft./blk. The Ross plant was located 150 miles from Dayton and lead time was one week. They had access to an associated supplier in Illinois as an alternate source of glass if they were unable to meet KII’s demands. Clear View Distributors. Clear View Distributors was a small local glass distributor that had supplied KII for three years. They had provided consistent, on-time delivery of low energy glass. They had also built sealed units for KII, but there had been problems with some units. Both clear glass (made by Ross Industries) and low energy glass (made by West Bend Glass) were available on a mixed eight-block truck. Delivery was available daily, if requested, and they were willing to stock inventory for KII. Travers Glass Ltd. Travers Glass Ltd. was a glass distributor about twice the size of Clear View Distributors. They had provided KII with service for 15 years and had been an excellent backup service for Ross Industries. They offered clear glass (made by Jackson Glass Co.) at the lowest delivered price of $.3172/sq. ft./blk in a straight or mixed truckload of at least 12 blocks with low energy glass (made by West Bend Glass). The quote for 4 mm clear glass was $.4389/sq. ft./blk. For low energy
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glass their quote was $0.6734/sq. ft./blk for 3 mm and $0.9512/sq. ft./blk for 4 mm glass. Clear glass made by Ross Industries was also available at a higher price than the clear glass made by West Bend Glass. Their distribution centre was located 135 miles from Dayton. Lead time was two to three days and they could deliver three to four times a week. They were willing to stock inventory for KII. Jackson Glass Co. Jackson Glass Co. was a glass manufacturer which had been one of several suppliers to KII in the past. They were very interested in doing business with KII again. Their glass quality was good and they would supply 3 mm clear glass at a delivered price of $.33/sq. ft./blk for a minimum order of six blocks. Their quote for 4 mm clear glass was $.44/sq. ft./blk. Their low energy glass would require KII’s testing lab’s approval. Their distribution center was located about 130 miles from Dayton and lead time was one week. They were aligned with a Canadian supplier that could provide an alternate source of glass if required. Now that she had gathered the necessary information, Victoria needed to proceed with her analysis. She knew that she would have to make her recommendation soon.
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Chapter Thirteen Supplier Evaluation and Supplier Relations Chapter Outline Measuring Supplier Performance Key Supplier Performance Indicators Evaluation Methods Informal and Semiformal Evaluation and Rating Executive Roundtable Discussions Formal Supplier Evaluation and Rating Weighted Point Evaluation Systems Supplier Ranking Unacceptable Suppliers Acceptable Suppliers Preferred Suppliers Exceptional Suppliers Supplier Relations Supplier Relations Context Supplier Goodwill The Purchaser–Supplier Satisfaction Matrix Supplier Relationship Management
Partnerships SEMATECH’s Partnering Perspective Early Supplier/Supply Involvement (ESI) Partner Selection The Longer Time Perspective Co-location/In-Plants Concerns about Partnerships Strategic Alliances Conclusion Questions for Review and Discussion References Cases 13–1 APC Europe 13–2 Plastic Cable Clips 13–3 Delphi Corporation
352
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Supplier Evaluation and Supplier Relations
353
Key Questions for the Supply Decision Maker Should we • Change the way we evaluate supplier performance? • Have annual top executive meetings with our key suppliers? • Have more or fewer partnerships? How can we • Reduce the number of unacceptable suppliers? • Improve our relations with suppliers? In supplier relations? • Find out how satisfied our suppliers are with us as a customer?
There are two key decisions in this chapter: (1) How do we evaluate supplier performance? and (2) How do we manage our supplier relations? Obviously, these two questions are interrelated. How we relate to a supplier may affect its performance and the reverse, how the supplier performs may affect our relations. Supplier performance evaluation is addressed first.
MEASURING SUPPLIER PERFORMANCE Collection and analysis of performance data are the basis for determining how good a job the supplier is doing. This information also allows for intelligent decisions about sources for rebuys and useful feedback to current suppliers about areas of improvement. Normally, the performance of the supplier is assessed regularly to reveal cycle time reductions, opportunities for process improvements, cost reduction, and quality and service improvements. Regular performance assessment is a catalyst for continuous improvement. There are many metrics that may be included in a supplier performance measurement system. Some organizations use a few critical metrics while others develop systems that track dozens. There should be a clear link between data and decisions to avoid expending excessive resources capturing information that is never used by decision makers. Some of the more common metrics are discussed in the following section.
Key Supplier Performance Indicators Direct measures quantify supplier performance at the time work is completed. Examples are on-time delivery, number of rejects, increase in sales after a marketing campaign, and cycle time to develop a specific product/service/technology in a development stage. Automation of real-time metrics such as quality, quantity, price, and on-time delivery measures and careful selection of more time-consuming data collection activities help to reduce the time spent measuring results. The supplier scorecard may include a summary statement of the supplier’s cost, quality, and timeliness performance and a compilation of satisfaction surveys, real-time metrics, variance of invoice amounts to estimates or contract negotiated rates, and other contract related terms.
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Most supply professionals tend to separate suppliers into two categories: new and current. A new supplier is one about which no track record is yet available. This is a supplier new to the buying organization and in the process of attempting to meet its obligations under its first contract. The new supplier can be considered probationary and will normally be watched closely to ascertain whether preselection expectations warranted awarding the business. For current and longer-term suppliers who have already proven in the past that their performance meets minimum expectations, at least, the evaluation of their performance may be more routine.
EVALUATION METHODS The supplier evaluation process can be informal or highly structured and formalized depending on the nature of the acquisition. In this section, several methods are discussed, including informal, categorical, and weighted point evaluations.
Informal and Semiformal Evaluation and Rating Informal evaluation includes assessments of the supplier by internal users and others anywhere in the buying organization where supplier contact takes place. “How are things going with supplier X?” is a typical question that can and should be asked by supply personnel when in contact with others in their own organization. Similarly, information gleaned from conversations at professional meetings, conferences, and from the media can be useful in checking out and comparing such personal impressions. An experienced supply professional will have accumulated a wealth of such information on suppliers and will always be on the alert for signs that new information may affect the overall assessment of a supplier. In fact, in most small organizations almost all evaluation of current sources is carried out informally. When users and supply managers are in daily personal contact and feedback on both satisfactory and unsatisfactory supplier performance is quick, such informality makes a lot of sense. In larger organizations, however, communication lines are stretched, supply personnel and internal users may be in different locations, and large contracts may be negotiated by a centralized supply group or a prime contractor located at a primary facility, while daily supplier contact is handled at various locations. If suppliers are also large, requirements in different locations of the country or the world may be met with varying degrees of success by different plants or offices belonging to the same supplier. As the buyer–supplier network grows in complexity, the need to have a more formal system for evaluating current sources also increases.
Executive Roundtable Discussions One simple semiformal supplier evaluation tool is the regular, annual discussion between top executives in the buying organization and those of the supplier. Normally, these toplevel discussions are confined to major suppliers of major or strategic requirements. The presence of top executives of both sides lends weight to the occasion and permits discussion of past performance; future expectations; economic, social, and technological trends; long-term plans; and so on in a high-level context. The chief supply officer (CSO) normally takes the lead in organizing and facilitating such sessions and invites the appropriate
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executives to take part. These roundtable discussions can help cement relationships between the two organizations at a high level, and when repeated over time can provide invaluable information for both sides. They would normally, but not exclusively, take place at the buying organization. Obviously, the number of such high-level sessions must be limited. Equivalent lowerlevel sessions for suppliers further down on the priority list also have considerable merit and permit a regular update in a broader context than the normal supplier–purchaser contacts geared to specific current orders.
Formal Supplier Evaluation and Rating Accompanying the trends of supply base rationalization, strategic sourcing, and closer relations with key suppliers is the growing sophistication in supplier performance rating. Often, continuous improvement is tracked along with more traditional factors such as quality, quantity, delivery, and price. In other cases suggestions for product or service redesign, valuechain improvements, willingness to work on supply chain teams, assistance in investment recovery or disposal, or the development of anything that would provide better value for the ultimate customer may be tracked and recorded. In evaluating current sources, the question is, How well did the supplier do? To use this information in future supplier selection decisions, the key question is, “What is this supplier’s performance likely to be in the future?” Most formal supplier rating approaches attempt to track actual performance over time. Advances in supply process software allow for easier tracking on a real-time basis and greater performance visibility. As orders are delivered, quality, quantity, delivery, price, and service objectives and other terms and conditions are tracked. Thus, corrective action can be taken as needed on the existing contract. Also, when it is time to place another order, the past record can be used to assess whether the same supplier should again be seriously considered or not. A simple scheme for smaller organizations might include a notation only as to whether these factors were acceptable or not for specific orders received. More detailed evaluations include a summary of supplier performance over time. It is normal to track a supplier’s quality performance closely and in sufficient detail to pinpoint corrective action. In many organizations, only certified suppliers are considered for potential future business, and extensive evaluations on quality and other dimensions of supplier attributes and performance are carried out accordingly. Delivery performance of a current supplier is fairly easily tracked if good records exist of delivery promises and actual receipts and few modifications have been made on an informal basis. In a JIT mode, nonperformance on delivery is just as critical as unsatisfactory quality, and actual delivery is closely monitored. In the example below, different levels of delivery performance are described and assigned a category rating (excellent, good, fair, poor).
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Excellent:
a. Meets delivery dates without expediting. b. Requested delivery dates are usually accepted.
Good:
c. Usually meets shipping dates without substantial follow-up. d. Often is able to accept requested delivery dates.
Fair:
e. Shipments sometimes late, substantial amount of follow-up required.
Poor:
f. Shipments usually late, delivery promises seldom met, constant expediting required.
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Quantifying the assessment is often preferred because it signifies an attempt to remove subjectivity from the process. Some performance areas, such as delivery, are more easily quantified than others such as service. For example, the on-time delivery window might be defined by a particular company as anywhere between two days early and zero days late as committed by master scheduling. Deliveries are tracked and performance is rated according to a preestablished rating system. For example, delivery may be worth 15 out of 100 points, which means that delivery performance carries 15 percent of the weight of the decision. Points for on-time delivery might be allocated as follows: 15 points
⬎ 98 % on-time
10 points
95–97.9% on-time
5 points
90–94.9% on-time
0 points
⬍ 90% on-time
Actual price performance of a supplier is easily tracked, as discrepancies between agreed-to prices and those actually invoiced by suppliers should normally be brought to supply’s attention anyway. Price ratings of suppliers are, therefore, often of a comparison type, actual price versus target, or actual price versus lowest price received from other suppliers supplying the same requirement. Assessment of total cost of ownership from one supplier to another is more difficult to track, and often far more important than year-overyear price savings. Estimating total cost of ownership for a potential supplier rather than a current one is even more difficult and adds a level of complexity to the decision process. It is in the service area that perhaps the most judgment is called for. Opinions need to be collected on the quality of technical assistance, supplier attitude and response time to requests for assistance, support staff qualifications, and so on. It is normal, therefore, to have a relatively simple rating scheme for service, such as outstanding, acceptable, and poor, along with explanations regarding specific incidents to explain these ratings. Efforts should be made to create objective assessments of service performance including clearly defined service levels and metrics. A key driver in satisfactory service performance is clear and unambiguous descriptions of the required service level included in statement of work. It is even more difficult to establish metrics to assess supplier performance or projected performance in areas of strategic importance such as innovation. Measures of innovation at an organizational level might include the percentage of sales attributable to new products or services, the number of new patents or new products successfully introduced, or gross margins from new products compared to gross margins from existing products. Measuring supply and suppliers’ direct and indirect contribution to these metrics is an ongoing challenge.
Weighted Point Evaluation Systems Many organizations rate suppliers by assigning points and scales to each factor and each rating. Where several sources supply the same goods or services, such schemes permit cross-comparisons. Outstanding performance of a supplier can then be rewarded with additional business, while poor performance may result in the development and implementation of a performance improvement plan, or lead to less business with the supplier, or possibly dropping a supplier altogether.
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The APC case at the end of this chapter provides a good example of a weighted point evaluation system and how it applies to a specific supplier. Several issues are of concern with weighted point evaluation systems. The typical process for developing a weighted point evaluation system is to (1) identify the factors or criteria for evaluation, (2) determine the importance of each factor, and (3) establish a system for rating each supplier on each factor. The relevant factors or decision criteria should be determined in the context of the purchase and the sourcing strategy for that item. Clearly, most organizations track major suppliers more closely than those sources deemed to have less impact on organizational performance. Some organizations use annual dollar volume as a guide toward such categorization, for example, identifying A, B, and C sources, much the same as inventories can be classified using the Pareto distribution. Some organizations add a special category of “critical” or “strategic” goods or services regardless of dollar volume, in which unsatisfactory performance by a supplier might result in serious problems for the organization and good supplier performance provides strategic opportunities. The purpose of such categorization is to fit each category with an appropriate supplier rating scheme. For example, for a high-value, high-volume purchase over a long-term contract, the buyer may include factors such as the supplier’s management, human resources, and information systems fit. For a C-item (low dollar value, high volume), the critical factors may be delivery, availability, convenience, and price. There are a number of ways to assign weight to the factors. One is to assign percentages to each factor for a total of 100 percent. Obviously, the selection of the factors, weights, and form of measurement will require considerable thought to ensure congruence between the organization’s priorities for this product class and the rating scheme’s ability to identify superior suppliers correctly. For different product classes, different factors, weights, and measures should be used to reflect varying impact on the organization. In a fully computerized system, all supplier performance data would be entered as orders were received, and the buyer (and the supplier in some cases) should have online access to be able to discuss the supplier’s performance at any time. Suppliers need to be informed about how they stand on the rating scale. Improved performance on the part of the supplier often results from the knowledge that its rating is lower than some competitor’s or falls short of a set target.
SUPPLIER RANKING If supplier performance is measured fairly and regularly, it is possible to rank suppliers on a scale from unacceptable to exceptional.
Unacceptable Suppliers Unacceptable suppliers fail to meet operational and strategic needs of the buying organization. Discontinuing business with unacceptable suppliers and substituting better ones is the normal action required. A special case exists when such a discontinuance may create even greater problems for the purchasing organization. A typical example is
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a sole-supply situation as in the case of a patented or OEM part where the supplier takes undue advantage of its privileged position. Even then, when discontinuance in the short term may not be feasible, in the long term it may be, if the supply organization has diligently worked on finding an appropriate substitute or developing another source of supply. Another exception is a new source of supply that is still learning how to satisfy the purchasing organization’s requirements and is assiduously working to achieve significant improvement.
Acceptable Suppliers Acceptable suppliers meet current operational needs as required by contract. Acceptable suppliers provide a performance that other purchasers could easily match and, hence, acceptable suppliers provide no basis for competitive edge.
Preferred Suppliers Purchasers have a system or process orientation with preferred suppliers and this integration avoids unnecessary duplication and speeds up transactions that normally are handled on an electronic basis. Both parties work toward mutual improvements to eliminate nonvalue-adding activities. Preferred suppliers meet all operational and some of the strategic needs of the buying organization. Preferred suppliers react positively to initiatives of the purchaser to improve the current situation.
Exceptional Suppliers Exceptional suppliers anticipate operational and strategic needs of the purchaser and are capable of meeting and exceeding them. With exceptional suppliers, mutual breakthroughs may be a source of significant competitive advantage. Exceptional suppliers, like exceptional customers, need to be treasured. They can serve as an example of what is possible: an opportunity to experiment with new and different approaches to supply base management and as an early indicator of future supply management and supplier relationship direction and goals. It requires a substantial amount of work on the part of both the supplier and the purchaser to obtain the big rewards of mutual breakthrough. Patience and persistence are required to sustain the investment in relationship building. The lack of evidence of substantial reward in the earlier stages may be disappointing for those who are interested only in the short haul. A similarity exists in athletic training. World and Olympic records are seldom obtained by those not willing to commit fully beforehand to the intensive training and developmental program. Leslie Monroe, contract coordinator at Disneyland in Anaheim, California, reports that the innovation that is most common at Disneyland isn’t about systems or processes or contracts; the true innovation is in the relationships we are building with key suppliers of goods and services. I need to understand my supplier’s business as much as he or she needs to understand mine. We are working together to identify cost savings and value creating opportunities, including alternative products, process changes, or any number of areas that positively impact the bottom line without sacrificing quality, safety, or the environment.1 1
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Leslie R. Monroe, “The Relationships We Build,” Purchasing Today, February 1999, p. 68.
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SUPPLIER RELATIONS The key strategic decisions in supply management center on which supplier to pursue and what kinds of relations to maintain with suppliers. Strategic supply management is founded on the conviction that a significant competitive edge can be gained from the suppliers an organization has developed and its supply systems and supplier relations. Any organization’s desire to satisfy its customers and to provide continuing improvement in its customer service is dependent on its suppliers to help it accomplish this goal. (See Figure 13–1.) Supplier performance has a greater impact on the productivity, quality, and competitiveness of the organization than most managers realize. Recent trends to buy instead of make, to outsource instead of continuing to make, to improve quality, to lower inventories, to integrate supplier and purchaser systems, and to create cooperative relations such as partnerships have underlined the need for outstanding supplier performance. In the supply chain management perspective, the link between the buying organization and its direct suppliers is obviously one of the two primary external ones. The other link, between the buying organization and its customers, continues the chain on the exit, or distribution, side. The ability of any organization to connect these two external links through its internal organization will, to a large extent, determine the effectiveness of its supply chain. Figure 13–2 provides a simplified overview of these links. Since, in any chain, the weakest link determines the strength of the whole chain, it is important that the strength of each link be equal and congruent. It is also a relatively simple perspective that greater strength in any one link can create a customer-dominant, internally dominant, or supplierdominant chain. The prime objective in supplier relations is, therefore, to develop a supply link that will provide a short- and long-term strategic competitive advantage. FIGURE 13–1 Customer Satisfaction Depends on Supplier Performances
Customer Satisfaction
Strategic Needs
Traditional Needs
Other Additional Needs
Suppliers
FIGURE 13–2 Simplified Supply Chain Perspective Showing the Three Core Links
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Supply Link
Internal Link
Customer Link
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Supplier Relations Context Depending on the nature of the purchase, whether it is a repeat, a modified repeat, or a new requirement, the size of the dollar amount involved, and the market conditions, the criticality or impact of the supplier choice may vary and the acquisition process and final decision may change. Whereas in the past most buyers felt that the supplier selection decision should be purchasing’s domain, today’s trend to team procurement recognizes that it is necessary to bring together key organizational resources outside and inside of the supply area to achieve sound supplier choices. Moreover, the trend to fewer suppliers, longer-term contracts, e-procurement, and continuing improvement in quality, delivery, price, and service requires much closer coordination and communication between various people in both the buying and selling organizations. Therefore, improving buyer–seller relationships is a key concern. Outstanding supplier performance normally requires extensive communication and cooperation between various representatives of the buying organization and the selling organization over a long period of time. In full recognition of this, progressive supply organizations are pursuing ways and means of limiting their total number of suppliers and maximizing the results from fewer key suppliers. Bringing new suppliers onstream is expensive and is often accompanied by a period of learning and aggravation for both sides. Frequent supplier switching for the sake of a seemingly lower price may not result in obtaining the best long-term value. As quality improvement programs and lean production efforts take hold, proximity of the supplier’s premises to those of the purchaser becomes a significant consideration. An imaginative and aggressive supplier development effort, both with existing and new sources, holds high promise as a review of existing suppliers discloses gaps and as new technology evolves into new requirements. System and philosophical compatibility between purchaser and supplier has become more vital as ways and means are found to shorten the time taken from requisition to actual receipt of the order. These exciting new approaches to supplier choice and relationships between suppliers and purchasers are in stark contrast to the old-fashioned, hard-nosed way of procurement. It used to be reasonably common that suppliers were dropped with little notice when they failed to provide the lowest quote on an annual contract. The ideas of sharing information and assisting suppliers to improve their performance are no longer seen as novel, but more as a necessity for world-class performance. When one organization supplies another with goods or services, the nature of the relationship between the two organizations is a major influencer of the ultimate value and customer satisfaction achievable. Supply management is, therefore, not simply engaged in the exchange of money for goods and services, but also in the management of the buyer– seller relationship. In this section, the nature of supplier goodwill is discussed along with the qualifications of good and preferred suppliers, partnerships, and strategic alliances.
Supplier Goodwill Good sources of supply are one assurance of good quality today, and progressive thinking and planning is a further assurance of improved quality tomorrow. Superior sources of supply, therefore, are an important asset to any organization. It has long been considered sound marketing policy to develop goodwill on the part of customers toward the seller. This goodwill has been cultivated through the development of trademarks and brands, through extensive advertising, through missionary efforts as well as through
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regular calls by sales personnel, and through the many other devices that have appealed to the imaginations of marketing managers. These days these efforts are often lumped together under the term relationship marketing. Sellers are jealous of this goodwill, considering it one of their major assets. It has real commercial value and is so recognized by courts of law. Goodwill between a purchasing organization and its suppliers needs to be just as carefully cultivated and just as jealously guarded. When purchasers are as aggressive in their attempts to maintain proper and friendly relations with suppliers as marketing managers are in their relations with customers, congruence in supply chain linkage may be achieved. Since strategic plans are so often based on the assumption that supply sources will be cooperative, it makes sense to ensure that such cooperation will be forthcoming. Progressive companies have started to measure supplier goodwill on a regular basis using third-party research organizations to conduct surveys. The president of one electronics firm flatly stated, “No company can be world class if it does not measure on a regular basis the satisfaction level of its key suppliers and try to improve constantly on its relations with its suppliers.” One of the interesting outcomes of supplier satisfaction surveys is the general finding that suppliers believe that the best purchasers are those who know more about the supplier’s business than the supplier’s own employees.
The Purchaser–Supplier Satisfaction Matrix One of the major assessments a purchaser must make is whether the current relationship with a supplier is a satisfactory one or not. This relationship is highly complex, and different people inside the purchasing organization may have different perceptions of it. In the simplest form, with a new supplier just after a relatively small order has been placed but no deliveries have yet been made, it may consist only of an assessment of the agreement just reached and the buyer’s quick impression of the sales representative. For a long-term supplier of major needs, the assessment will be based on past and current performance, personal relationships with a number of personnel in both organizations, and even future expectations. Such assessments may well change as a result of competitive action in the marketplace. What may look like a good price deal today may not look so attractive when information comes to light that a fully competent competitor could have supplied the same materials or services for substantially less. The matrix in Figure 13–3 provides a simple framework for clarifying the current purchaser–supplier relationship in terms of satisfaction and stability. The assumptions behind it are 1. That satisfaction with a current supplier relationship can be assessed, whether it is satisfactory or not. 2. That an unsatisfied party (seller or purchaser or both) will attempt to move to a more satisfactory situation. 3. That attempts to move may affect the stability of the relationship. 4. That attempts to move may fall in the win-lose, as well as the lose-lose, lose-win, and win-win categories. 5. That purchaser and seller may well have different perceptions of the same relationship. 6. That many tools and techniques and approaches exist that will assist either party in moving positions and improving stability.
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FIGURE 13–3
Complete (0, 10) satisfaction
(5, 10)
(10, 10)
Desirable region
SUPPLIER'S SATISFACTION
A Simple PurchaserSupplier Satisfaction Matrix
C
A
Purchaser dissatisfied Supplier satisfied
Purchaser satisfied Supplier satisfied
(0, 5) Marginal satisfaction
(10, 5) (5, 5) D
B
Purchaser dissatisfied Supplier dissatisfied
Purchaser satisfied Supplier dissatisfied
(0, 0)
(5, 0)
(10, 0)
Total dissatisfaction
Marginal satisfaction
Complete satisfaction
PURCHASER'S SATISFACTION
Obviously, any purchaser–supplier relationship could fall into any of the four quadrants in the matrix. However, only quadrant A represents a desirable region in which a reasonably stable relationship can be maintained. In each of the other quadrants attempts by purchaser or supplier or both to increase satisfaction may worsen the satisfaction of the other, thereby lowering stability in the relationship. Clearly, quadrant D, with both parties dissatisfied, represents a highly undesirable and unstable relationship. The diagonal in the diagram may be seen as a “fairness or stability” line. As long as positions move along this line, both purchaser and supplier are at least equally well off. Its end points of (0, 0) and (10, 10) represent two extremes. The (0, 0) position is completely undesirable from either standpoint. The (10, 10) position represents a utopian view rarely found in reality. It requires a degree of mutual trust and sharing and respect that is difficult to achieve in our society of “buyer beware” and where competition and the price mechanism are supposed to work freely. However, in some partnerships, a relationship close to the (10, 10) state has been developed. Buyers are willing to share risks and information with the seller, and the seller is willing to open the books for buyer inspection. Problems are ironed out in an amicable and mutually acceptable manner, and both parties benefit from the relationship. The middle position of (5, 5) should really be considered as a minimum acceptable goal for both sides, and few agreements should be reached by the purchaser without achieving at least this place. Adjustments in positions should, hopefully, travel along the diagonal and toward the (10, 10) corner. Substantial departures from the diagonal raise the difficulty that the agreement may be seen as less beneficial to one party than the other, with the
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possibility of jealousy and the attempt by the less-satisfied party to bring the other down to a more common denominator. The region of greatest stability will, therefore, lie close to the (5, 5)–(10, 10) portion of the diagonal line. This model becomes more complex when the perceptions of both parties are considered, both with respect to their own position and the other side’s. For example, the purchaser’s perception may be that the relationship is in the A region. The supplier’s perception may or may not match this view. From a supply point of view, it is possible to assess the total package of current supplier relationships and to determine how many fall inside the desirable region and how many outside. A significant percentage of unsatisfactory or marginal situations will mean a substantial amount of work to restructure current arrangements. The supply perception of a relationship may be shared with a supplier to check on congruence and as a starting point for mutual diagnosis and plan for change. Even the process of attempting to assess contracts and suppliers against the model’s framework may be useful in establishing the key variables that are relevant for the particular requirement under study. Furthermore, the severity of the situation is a good indicator of the need for action and the tools and techniques that might be applied. For example, a purchaser may wish to work harder at a (1, 5) than a (5, 5) situation of equal dollar value and corporate impact.
Tools and Techniques for Moving Positions A number of supply management and marketing means may be used to shift positions on the satisfaction chart. The use of some of these will adversely affect the perceptions of the other party, and these might be called “crunch” tools or negative measures. Others are likely to be viewed in less severe terms and might be considered “stroking” methods or positive approaches. For example, crunch tools for the purchaser include 1. Complete severance of purchases without advance notice. 2. Refusal to pay bills. 3. Refusal to accept shipments. 4. Use or threat of legal action. For the supplier, examples would include 1. Refusal to send shipments as promised. 2. Unilateral price increase without notice. 3. Insistence on unreasonable length of contract, take or pay commitments, onerous escalation clauses, or other unreasonable terms and conditions and use of take it or leave it propositions. “Stroking” techniques by the purchaser would include 1. Granting of substantial volumes of business, long-run commitments, or 100 percent requirements contracts. 2. Sharing of internal information on forecasts, problems, and opportunities to invite a mutual search for alternatives. 3. Evidence of willingness and ability to work toward changed behavior in the purchasing organization to improve the seller’s position.
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4. Rapid positive response to requests from suppliers for discussions and adjustments in price, quality, delivery, and service. On the supplier side, examples could be 1. Willingness and ability to make rapid price, delivery, and quality adjustments in response to purchase requests without a major hassle. 2. Invitation to the purchaser to discuss mutual problems and opportunities. 3. The giving of notice substantially in advance of pending changes in price, lead times, and availability to allow the purchaser maximum time to plan ahead. It is interesting that “stroking” techniques are more likely to be used in the A region, further strengthening the stability of the relationship, whereas the use of crunch tools may well accomplish short-term objectives but may impair future chances of a desirable stable relationship. The perception of a relationship is based on both the results obtained and the process by which they have been achieved. For example, a price concession grudgingly granted by a supplier and continually negatively referred to by supplier’s personnel may create less satisfaction for the purchaser than one more amicably reached. Crunch methods pleasantly applied may be far more palatable than the same tool used in a hard-nosed way. For example, an unavoidable price increase can be explained in person by a supplier’s sales manager well in advance more palatably than by a circular letter after the increase has been put into effect. A supply manager can visit a supplier’s plant to determine ways and means of solving a quality problem and explain that no deliveries can be accepted until the problem is solved, instead of sending back shipment after shipment as unacceptable. The results–process combination puts a heavy emphasis on managerial judgment and capability to accomplish change effectively.
Supplier Relationship Management The satisfaction-stability matrix underlines the need for extensive communications between both parties in the buying–selling relationship. The whole art of supplier relationship management from a supply perspective is to bring both sides into an effective working relationship. This will require substantial coordination work inside the purchaser’s organization to ensure that the people most vitally concerned with a particular supplier’s performance are fully involved in the planning and execution of a program leading to the desired long-term relationship. Therefore, the team approach to long-term supplier relations is probably the only reasonable option. In such team acquisition, the buyer or supply manager usually plays the coordination and project manager role. Without internal cooperation and a congruent strategic internal approach to the improvement of supplier relations, supplier relationship management is impossible. The members of the internal team are the ones who have to deal directly with their appropriate counterparts on the supplier side. The necessity for good management of this interface is obvious. Immediate and concerted action needs to be taken when either side detects problems or sees opportunities. Awareness of the full details of each side’s situation, aspirations, strengths, and weaknesses is necessary for any team member to be able to assess the impact of changes, problems, or opportunities on the other side. Simply stated, the seller’s and purchaser’s personnel need to understand their own and the other’s organization very well so that both sides
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can work on continuing improvement for mutual benefit. Such understanding can come only through exposure, discussion, mutual problem solving, and willingness to investigate every aspect of a meaningful relationship frankly. Given that in many organizations it is difficult for individual employees in different functional areas to work well together toward a common goal, it is easy to appreciate the challenge posed by adding the supplier’s organization to this set. It may well be that the development of superior supplier relations will be the most critical challenge for supply managers in the decades ahead. Moreover, the ability to develop effective working relationships with suppliers will be dependent on supply’s ability to develop effective working relationships internally. Thus, supply’s status within the organization and the availability of qualified and credible supply personnel will be key determinants of the organization’s ability to get the most out of its supplier force.
PARTNERSHIPS In the last three decades, a large number of organizations have started to create “partnerships” with their suppliers. The term partnership gives lawyers discomfort, because in the legal sense it has certain obligations that are not necessarily part of a standard purchaser– seller partnership. Unfortunately, considerable confusion exists regarding the meaning of partnership, and the selling community has further compounded these difficulties by making it part of a standard sales pitch to any customer. To avoid some of this confusion, some purchasers have chosen the term preferred suppliers. The interest in supplier partnerships was fanned in the 1980s by the study of Japanese companies that maintained very close relationships with their suppliers. This was seen as one of the key elements in the achievement of quality, fast delivery, and continuous improvement. Early adopters in North America included companies like Xerox, Honeywell, Polaroid, Motorola, and IBM, to name just a few. This move into a partnership mode really represents a substantial shift from the traditional buying–selling mode. A summary of some of the key differences is shown in Figure 13–4. In the late 1990s, buying organizations continued to develop closer relationships or partnerships with suppliers. For example, CompUSA initially formed a partnership with Wallace, a large printing company, to print and replenish forms to 210 retail stores. Next, CompUSA consolidated its requirements for other supplies and purchased them from Wallace at a lower cost. Wallace prints a quarterly catalog of supplies it provides to CompuUSA as well as some items it replenishes from other suppliers. In the first year, supply expenditures were reduced by 32 percent.2
SEMATECH’s Partnering Perspective SEMATECH was originally created through a joint effort of the American electronics industry giants and the American government to assist the electronics industry and its suppliers to be world class. It has evolved into an international consortium though which member companies cooperate precompetitively in key areas of semiconductor technology to accelerate the development of advanced manufacturing technologies needed to build powerful 2
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Becky S. Moore, “Increased Service,” Purchasing Today, February 1999, p. 68.
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FIGURE 13–4
Partnership
Traditional
View of Buyer-Supplier Relationship
Lowest price Specification-driven Short term, reacts to market Trouble avoidance Purchasing’s responsibility Tactical Little sharing of information on both sides
Total cost of ownership End customer-driven Long term Opportunity maximization Cross-functional teams and top management involvement Strategic Both supplier and buyer share short- and long-term plans Share risk and opportunity Standardization Joint ventures Share data
semiconductors.3 SEMATECH identified quality as the key driver of competitiveness and partnering as the means to achieve quality. Their interpretation of partnering extends to customers, employees, and suppliers. On the supplier side, SEMATECH identified two classes of partnership. Every supplier should be treated as a “basic partner” with mutual respect, honesty, trust, open and frequent communication, and understanding of each other as the minimum guidelines governing the relationship. SEMATECH identified the need for an “expanded partnership” with selected key suppliers. Expanded partnering builds on basic partnering, is a long-term relationship process, provides focus on mutual strategic and tactical goals, and may include customer/supplier team support to promote mutual success and profitability. Therefore, in addition to basic partnering guidelines, expanded partnering has a long-term view, must have continuing improvement as an objective, and evidence of it must exist. The partners must have a passion to help each other succeed; place a high priority on the relationship; and include shared risks, opportunities, strategies, and technology road maps. It is expected that most organizations would have a limited number (6 to 20) of expanded partnerships. An expanded partnership would normally have a top executive assigned to it. This executive would meet at least two to four times per year with his or her counterpart in the selling organization who would monitor internal progress on joint projects and smooth the way for changes necessary for success. In addition, there should be regular monthly meetings planned for buyer–seller representatives and daily and weekly contact on project teams and other activities, involving a substantial number of people from various functions in the buying and selling organizations.
Early Supplier/Supply Involvement (ESI) The opportunity to affect value in the acquisition process is significantly greater in the early stages (need recognition and description) than in the later ones. Involving the supplier and the buyer in these early stages can lead to improvements in processes, design, redesign, or value analysis activities. The drive to cut cycle time, improve competitiveness, and 3
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Corporate Information, International SEMATECH, www.sematech.org, April 17, 2001.
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reduce cost compels some organizations to include supplier(s) on cross-functional teams. A supplier may participate with the hope of securing the business, or as part of an ongoing partnering/alliance relationship. Confidentiality issues often must be dealt with up front, and it must be clear to the supplier(s) if involvement guarantees the business or not. The benefits from partnering come from intercorporate closeness. The philosophy is similar to design for manufacturability or design for assembly, in which internal barriers are removed between design, marketing, manufacturing engineering, quality assurance, procurement, and operations to avoid functional suboptimization. The removal of functional barriers, avoiding “throwing the design over the wall,” helps speed the introduction of new designs and achieve significant quality and cost improvements. The same idea extended makes supply and suppliers part of the process—it could be called “design for procurability.” Others call it “early supply/supplier involvement” or ESI. Moreover, if suppliers involve their suppliers in the process, the purchasing organization has access to a wide pool of talent all focused on the needs of its customers. When the supplier is making investment decisions, hiring decisions, new product or process or system decisions, these can be made keeping the customer–partner’s future needs in mind. It is this latent potential for improvement that the partnership tries to tap. Partnerships may be seen as an alternate solution for the make option in the make-orbuy decision. Similarly, a partnership could be a substitute for vertical integration. A partnership attempts to unlock the benefits from shared information without the disadvantages of ownership. Partnerships require hard work on both sides to make them effective. They require a tolerance toward mistakes and a real commitment to make the relationship work. The key idea is that each partner might enhance its own competitive position through the knowledge and resources shared by the other.
Partner Selection From a supplier selection perspective, what is interesting about selecting potential partners is the focus on soft as well as hard factors. All of the traditional hard factors of quality, delivery, cost, environment, safety and continuing improvement, financial and management stability, risk reduction, and technological accomplishment still continue. But, for potential partners, soft factors also become important: for example, congruence of management values on issues like customer satisfaction, concern for quality, employee involvement, supplier relationships, and personal compatibility between functional counterparts. Vital questions are, Can we work well together? Can we respect and trust each other? Do we like each other? Questions like these are not answered easily and quickly. It is, therefore, more likely that potential partners are found among the organization’s best current suppliers. (See Figure 13–5.) Developing partnering-type relationships takes time and some organizations may be ill prepared for the amount of time it does take before seeing the desired results.
The Longer Time Perspective Another interesting question is what happens over a longer period of time. Do benefits continue to accelerate, or does the law of diminishing returns set in? Companies like Honda that have maintained partnering-type relationships with some suppliers since the late 1970s have clearly found a way to continue generating benefits for both parties. Whether all
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FIGURE 13–5 Some Indicators of a Successful Partnering Effort
• • • • • • • • • •
Formal communication processes Commitment to our suppliers’ success Mutual profitability Stable relationships, not dependent on a few personalities Consistent and specific feedback on supplier performance Realistic expectations Employee accountability for ethical business conduct Meaningful information sharing Guidance to supplier in defining improvement efforts Nonadversarial negotiations and decisions based on total cost of ownership
Source: SEMATECH.
companies can sustain the relationship over the long term probably depends on many variables, including what the original goals of the partnership were, the level of commitment of both sides to continuing to develop the relationships, and the specific situation of the companies and industry. Thinking about the longer term at the initial stages of the relationship may help to prevent dissatisfaction in the long run.
Co-location/In-plants One potential outcome of a partnering effort may be co-location as a supplier in-plant. As organizations look for ways to do more work with fewer people and achieve the productivity and competitiveness goals of the firm, they are increasingly looking to suppliers for expertise and assistance. Having a key supplier locate personnel in a department in the buying organization who can function as buyer, planner, and salesperson can improve buyer–seller communications and processes, absorb work typically done by the firm’s employees, and reduce administrative and sales costs.
Concerns about Partnerships There are serious concerns about the idea of partnerships. Not all supply professionals believe that cooperative relationships are better than the competition-based culture upon which most traditional procurements tools and techniques are based. The idea that at least one partner might wish to take advantage of the preferred status and let the commitment and relationship slide is a serious concern. In a technology-driven world, intellectual rights to new technology are extremely valuable and the preservation of secrecy a vital concern. Whether purchasers or suppliers, or either, can be trusted with information that might shape competitive strategy in years to come needs to be weighed carefully. Similarly, whether cutting off the option to “shop around” is in the best long-term interest of the purchaser will depend on its customer-satisfaction-driven strategies. Clearly, the decision to enter into a partnership mode is an organizational commitment, not just a procurement one, and is of key strategic importance. Often partnerships or strategic alliances involve single or sole sourcing a particular requirement. The danger in single sourcing lies in becoming puppets of suppliers. Suppliers know that customers depend on them, and they may charge excessively or let quality or delivery slip, or slow down or stop continuing improvement programs. This is where careful supplier relationship management becomes important. It requires an understanding and identification of value. Value is the ultimate long-term life-cycle cost and benefit to the
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user of the product or service acquired. It does not necessarily mean lowest purchase price, or lowest investment in inventory, or fastest delivery time, or lowest delivery cost, or longest life, or highest disposal value, or even the highest attainable quality; it is an optimal amount cutting across all of these. The purchase price frequently is one important part of this total. It is the duty of the supply manager to make sure that the purchase represents exceptional long-term value. Moreover, in the establishment of preferred suppliers or partnerships, it is normal to agree on future quality, delivery, and price goals, in full recognition of learning curve theory and the commitment of both buyer and seller to continuous improvement. At Alberto Culver, a personal-care products company, partnerships consist of multiyear contracts with key suppliers that include goals for the contract term and a performancebased incentive rebate. A target level for quality and on-time delivery performance is negotiated and performance is measured monthly. The rebate is adjusted accordingly and paid annually. When targets are exceeded, Alberto Culver encourages their supplier partners to return the rebate to its employees as bonuses. The two companies work jointly toward continuous improvement and agree to higher performance targets each year with the ultimate goal of attaining a specific goal by the end of the contract period.
STRATEGIC ALLIANCES Strategic alliances in a supply sense represent special arrangements with key suppliers that make a strategic difference to both buyer and seller and attempt to seek sustainable competitive advantage. The term “expanded partnership” used by SEMATECH fits this category. Strategic alliance arises from the conviction of both buyer and seller that it is in the interest of both to formalize the relationship beyond the standard mode of trade. Strategic alliances are often technology based and require substantial investment of both buyer and seller to achieve major market breakthroughs. Obviously, as cornerstones of corporate strategy, these alliances are of major concern to top management and reinforce the perspective that suppliers and supplier relationships are of strategic concern to any organization. In their breakthrough research on problems in alliances, Stuart and McCutcheon identified three “prior conditions scales”: (1) outlook, (2) power, (3) gains, and two “alliance building process scales”: info share and help gap.4 They found that “to enhance the prospects for success,” 1. Identify supplier firms in which a philosophical match exists between the two firms’ managements on such issues as views toward quality and productivity improvement. Such a fit is possible despite differences in the parties’ size and power. 2. Create an interorganizational task force to establish clear expectations of the information required for successful problem identification and resolution, the level of technical expertise available from both parties, and how the benefits from such improvements are to be measured and then shared in a mutually agreeable manner. 3. Slightly exceed the expectations established in item 2 above.
F. Ian Stuart and David McCutcheon, “Problem Sources in Establishing Strategic Supplier Alliances,” International Journal of Purchasing Materials Management, Winter 1995, pp. 6–8.
4
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Conclusion
Supplier evaluation is an integral part of the acquisition process. There has to be a check to ensure that the contractual arrangement is adhered to by the supplier. Methods for evaluation range from informal to formal and have to suit the criteria established for supplier selection. Suppliers may be ranked from unacceptable to acceptable, preferred, and exceptional. Supplier relationship management is just as important to the organization as customer relationship management. Therefore, although supplier relations are a prime responsibility for supply professionals, they also represent a responsibility for other functions and top management. To gain satisfaction for each side, it is the goal of relationship management to assure long-term stability. Partnerships require a high degree of satisfaction and a degree of closeness and the cooperation among purchaser and seller not present in normal supplier relation. Strategic alliances represent a special form of partnership in which both parties exploit an opportunity that may provide a sustainable competitive advantage.
Questions for Review and Discussion
1. What is a weighted point evaluation system? Why is it used? 2. When might it be appropriate to conduct an informal, rather than a formal, supplier evaluation? 3. What are the similarities and differences between evaluating new and existing sources of supply? 4. Why is purchasing focusing more attention on a supplier’s management as part of the evaluation process? How might this evaluation be conducted? 5. Why are buyer–supplier relationships important? 6. Why create a partnership? 7. What is a strategic alliance and why is it used? 8. What are the goals of early supplier involvement (ESI)? How does ESI fit in with cross-functional teams? 9. Might there be anything unique about a strategic alliance? 10. What is the relationship between satisfaction and stability in buyer–supplier relations?
References
Barringer, B. R., and J. S. Harrison. “Walking a Tightrope: Creating Value through Interorganizational Relationships.” Journal of Management 26, no. 3 (2000), pp. 367–403. Bovert, David, and Martha Joseph. Value Nets. New York: Wiley, 2000. Forrest, W. “McDonald’s Applies SRM Strategy to Global Technology Buy.” Purchasing 135, no. 12 (2006), pp. 16–17. Kerr, J. “The Changing Complexion of Supplier Diversity.” Supply Chain Management Review 10, no. 2 (2006), pp. 38–45. Krause, D. R.; R. B. Handfield; and B. B. Tyler. “The Relationship Between Supplier Development, Commitment, Social Capital Accumulation and Performance Improvement.” Journal of Operations Management 25, no. 2 (2007), pp. 528–545. Liker, J. K., and T.Y. Choi. “Building Deep Supplier Relationships.” Harvard Business Review 83, no. 1 (2004), pp. 104–113.
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Nix, N. W.; R. F. Lusch; Z. G. Zacharia; and W. Bridges. “The Hand That Feeds You: What Makes Some Collaborations with Suppliers Succeed, Why So Many Fail?” The Wall Street Journal, October 27–28, 2007, p. R8. “Performance Measurement: Why It’s Important to Measure Suppliers Well.” Purchasing 128, no. 7 (2000), pp. 36–39. Prokopets, L., and R. Tabibzadeh. Supplier Relationship Management: Maximizing the Value of Your Supply Base. Stamford, CT: Archstone Consulting. Robitaille, D. Managing Supplier-Related Processes. Chico, CA: Paton Professional, 2007. Teague, P. E. “How to Improve Supplier Performance.” Purchasing 136, no. 4 (2007), pp. 1–32.
Case 13–1
APC Europe On Thursday, October 5, Maggie Agnelli, the packaging purchasing manager for APC’s European division in Utrecht, the Netherlands, wondered what she should say in the next day’s meeting with the plant manager of Branco, a custom packaging supplier. In the last three quarters, Branco’s quality performance rating had shown a steady decline. Maggie believed it was essential to get the plant manager’s cooperation to avoid future problems.
APC APC, a diversified international manufacturing organization headquartered in the United States, offered a wide range of products to both industrial and consumer markets. Its Utrecht plant employed approximately 400 people. European sales were €150 million a year and the company had a long-standing track record of successful business performance. Each division operated within a set of corporate guidelines and was responsible for its own financial performance.
QUALITY CONTROL Contributing to the success of APC was a commitment to strict quality standards in purchasing. Coordination between each supplier and APC’s plant was crucial to avoid production slowdowns. Contact was maintained directly between plant personnel and sales representatives. When
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a problem in the manufacturing plant arose due to the supplier’s product, the appropriate sales representative was immediately notified by fax via a standard form called “Nonconformance Action Report” completed by the plant operator closest to the problem. The sales representative was required to return, by fax, a standard “Feedback Form” to acknowledge the problem and explain how it was to be solved. Supplier deviations from standard, as reported on the Nonconformance Action Report, were also forwarded to each purchasing manager. The supply assistant compiled these forms, together with information collected on a number of other supplier performance criteria, such as accuracy of the quantity delivered, shipments on time, and accuracy of paperwork (see Exhibit 1). Each quarter, each purchasing manager used the information collected to compute a “Supplier Performance Rating.” Suppliers were all rated on the same scoring criteria. The criteria and scoring system implemented by APC (Europe) had been developed by the headquarters supply group in North America several years earlier and reflected the key aspects of supplier performance deemed to be important by APC management. Suppliers received a copy of the scoring criteria so that they were fully aware of how they were evaluated. At the end of each quarter, they were advised of their rating. APC (Europe) maintained detailed documentation of supplier activity and variance from norms.
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372 Purchasing and Supply Management
EXHIBIT 1 Supplier Performance Scoring Criteria Quality Item
Grade
Criteria
Rejected and Nonconforming
4 3 2 1 0
No rejected or nonconforming shipments. Up to 5% of shipments nonconforming. ⬎5–10% of shipments nonconforming. ⬎10–20% of shipments nonconforming. ⬎20% of shipments nonconforming.
Process Capability, Data/Samples
4
Less than 1% outside control limits and samples/data received for all shipments. Up to 5% outside limits and 90–99% of shipments have samples/data. 5–10% outside limits and 80–90% of shipments have samples/data. 10–20% outside limits and 70–80% of shipments have samples/data. More than 20% outside limits and