CH-5 Sourcing Materials and Services – Supply Chain Management: A Logistics Perspective : Book Guide

CHAPTER 5 SOURCING MATERIALS AND SERVICES LEARNING OBJECTIVES After reading this chapter, you should be able to do the following: • Understand the role and nature of purchasing, procurement, and strategic sourcing in a supply chain context. • Consider the importance of types and of items and services purchased to the sourcing and procurement processes. • Understand the strategic sourcing process. • Recognize principles and approaches for the effective management of sourcing and procurement activities. • Appreciate the importance of companies having effective relationships with suppliers and for developing meaningful processes for evaluating suppliers. • Examine the concept of Total Landed Cost (TLC) and its value to the procurement process. • Be aware of contemporary advances in the areas of e-sourcing and e-procurement, and appreciate the roles played by various types of e-commerce models. CHAPTER OVERVIEW Introduction Logistics and supply chain managers are looking for ways to drive more value from their purchasing and procurement operations. As a result, the topics of purchasing, procurement, and strategic sourcing are all receiving considerable attention as organizations try to improve the overall efficiency and effectiveness of their supply chains. • Purchasing: The transactional function of buying products and services. • Procurement: Refers to the process of managing a broad range of processes that are associated with a company’s need to procure goods and services. • Strategic sourcing: Essentially, the strategic sourcing process is broader and more comprehensive than the procurement process, and it represents a very useful means to make sure that procurement priorities are well-aligned and goals and objectives of the supply chain and of the overall organizations Five examples of ways in which strategic sourcing is different: (1) consolidation and leveraging of purchasing power—to concentrate larger volumes of purchases into fewer suppliers or fewer purchasing transactions; (2) emphasis on value—rather than acquisition cost alone; (3) more meaningful supplier relationships; (4) attention directed to process improvement; and (5) enhanced teamwork and professionalism—to include suppliers and customers, as appropriate. Types and Importance of Items and Service Purchased The quadrant technique enables the supply chain manager to assess the importance of each product or service being purchased. The quadrant technique utilizes a two-by-two matrix to determine a procured item’s relative importance on the basis of value and risk. The criteria used to delineate importance are value or profit potential and risk or uniqueness. The value criterion examines product or service features that enhance profits for the final product and the firm’s ability to maintain a competitive advantage in the marketplace. A value risk quadrant and categorizes item importance and classifies items. Generics are low-risk, low-value items and services that typically do not enter the final product. Items such as office supplies and maintenance, repair, and operating items (MRO) are examples of generics. Commodities are items or services that are low in risk but high in value. Basic production materials (bolts), basic packaging (exterior box), and transportation services are examples of commodities that enhance the profitability of the company but pose a low risk. Distinctives are high-risk, low-value items and services such as engineered items, parts that are available from only a limited number of suppliers, or items that have a long lead time. The company’s customers are unaware of or do not care about the uniqueness of distinctives, but these products pose a threat to continued operation and/ or high procurement cost. A stockout of distinctives results in stopping the production line or changing the production schedule to work around a stocked-out item; both tactics increase production costs. Criticals are high-risk, high-value items that give the final product a competitive advantage in the marketplace. Criticals, in part, determine the customer’s ultimate cost of using the finished product. The procurement strategy for criticals is to strengthen their value through use of new technologies, simplification, close supplier relations, and/or value-added alterations. The focus of critical procurement is on innovation to make the critical item provide greater market value to the finished product. There are three types of buy situations that may occur: First is that of capital goods that may represent a longer-term investment for an organization that may require significant financial planning. The second is rebuys, which are repeat purchases that may either be identical to historical purchases (standard) or some variation thereof (modified). The third is that of maintenance, repair, operations items that are needed for the continuing operation of the company and its supply chain activities. Strategic Sourcing Process “Managing Strategic Sourcing Process” (MSSP) is a strategic sourcing process. Beginning with development of a strategic plan for the strategic sourcing process, this model recognizes several elements, each of which contributes significantly to a comprehensive MSSP process. To help guide the strategic sourcing process, five core principles are recognized as key drivers to achieve the desired levels of value. These principles are: • Assess the total value—Emphasis must go beyond acquisition cost and evaluate total cost of ownership and the value of the supplier relationship. • Develop individual sourcing strategies—Individual spend categories need customized sourcing strategies. • Evaluate internal requirements—Requirements and specifications must be thoroughly assessed and rationalized as part of the sourcing process. • Focus on supplier economics—Need to understand suppliers’ economics before identifying buying tactics such as volume leveraging, rice unbundling, or price adjustment mechanisms. • Drive continuous improvement—Strategic sourcing initiatives should be a subset of the continuous improvement process for the overall procurement and sourcing organizations. Seven key steps are included in the overall strategic sourcing methodology Step 1: Develop Strategic Plan – The most effective way to initiate a MSSP process is to take the time to map out a formal plan for the design and implementation of the process itself. Step 2: Understand Spend – The planning group needs to develop a baseline understanding of what products and services are being procured, what purpose they serve, and the financial implications of these purchases. Included in this step will be the need to refine understanding of the sourcing needs. Step 3: Evaluate Supply Source - This is a very critical step in the strategic sourcing process, as it involves making sure that all potential sources of supply are identified and that useful mechanisms are in place for meaningful comparisons of alternative supply sources. Step 4: Finalize Sourcing Strategy - Prior to embarking on the task of supplier selection, it is important to fully develop a sourcing strategy that defines the parameters of the process and the steps to be followed. The sourcing strategy should include supplier selection criteria and a process for evaluating submissions from multiple suppliers. The selection criteria should relate directly to the previously established objectives to be met by the formal strategic sourcing process. • Important factors in supplier selection - Typically the most important factor in supplier selection is quality. Over time, several techniques and approaches have been developed that address issues relating to soundness of processes, results achieved, and continuous improvement. A few of the well-recognized approaches are discussed below. o Total Quality Management—TQM represented a strategy in which entire organizations were focused on an examination of process variability and continuous improvement. This approach was heavily dependent on the use of statistical process control (SPC), and employee involvement to produce desired results. o Six Sigma—Similar to TQM in its focus on techniques for solving problems and using statistical methods to improve processes. o ISO 9000 - Started in 1987 by the International Organization for Standardization, a primary objective is to make sure that companies have standard processes in place that follow: “Document what you do and do what you document.” • Reliability. Time-definite and on-time deliveries are among the top-ranked factors relating to reliability. The importance relates to avoiding production line shutdowns, unavailability of finished products due to lack of materials, and ultimately to successfully fulfill customers’ orders in the marketplace. • Risk. There are many types of risks, including service reliability. Other types may include potentials for supply uncertainty, lead time uncertainty, and cost uncertainty. • Capability. This criterion considers potential suppliers’ production facilities and capacity, technical capability, management and organizational capabilities, and operating controls. These factors indicate the supplier’s ability to provide a needed quality and quantity of material in a timely manner. • Financial. In addition to price, buying firms are wise to consider the financial positions of potential suppliers. Financially unstable suppliers pose possible disruptions in a long-run continued supply of material. • Desirable Qualities. The types of concerns here may be extensive, but some of those likely to be relevant include: cultural compatibility and supplier attitude; locations of key supplier facilities; packaging capabilities; repair and return services; and others such as availability of training aids, etc. • Sustainability. This factor is “last but not least,” in the sense that a commitment to sustainability is regarded as essential in many leading supply chains. Step 5: Implementing Sourcing Strategy - Clearly, the most important part of this step is to choose a supplier (or suppliers, depending on the objectives of the sourcing decision). The choice of supplier also determines the relationship that will exist between the buying and supplying firms and how the mechanics of this relationship will be structured and implemented. Step 6: Onboarding and Transitioning - Important elements of this step are the finalization of the contractual agreement, planning the transition process, and receipt or delivery of the product or service. This activity commences with the first attempt by the supplier or suppliers to satisfy the user’s needs. The completion of this activity also begins the generation of performance data to be used for the next step in the strategic sourcing process. Step 7: Collaborative Process Improvement - A very important step in the MSSP process is to establish procedures for regular feedback and communication between suppliers and customers. Once the product has been delivered or the service performed, the supplier’s performance must be evaluated to determine whether it has truly satisfied the user’s needs. Supplier Evaluations and Relationships Many successful companies have recognized the key role that sourcing and procurement play in supply chain management and that supplier/ relationships are a vital part of successful procurement strategies. An important factor in achieving efficiency and effectiveness in this area is the development of successful supplier relationships. When suppliers are “partners,” companies tend to rely more upon them to provide input into processes such as product design, engineering assistance, quality control, etc. Evaluation of suppliers should be done regularly and on a formal basis. Essentially, the three most important question include: 1) did the supplier succeed in meeting the customer’s needs; 2) what elements of the relationship, both strategic and tactical/operational may benefit from modification and improvement; and 3) did the investments by both customer and supplier produce measurable benefits that justified the time and effort of the relationship? Another important dimension of the supplier relationship is the extent to which the customer-supplier relationship contributes to the competitive advantage of the company, whether the advantage is one of low cost, differentiation, or a niche orientation (using Porter’s generic strategies). Total Landed Cost (TLC) This perspective brings into play all of the costs associated with making and delivering products to the point where they are needed. Examples of such costs include life cycle costs, inventory costs, strategic sourcing costs, transaction costs, quality costs, technology costs, and management costs. e-Sourcing and e-Procurement Procurement was found to the greatest early application of e-commerce. However, EDI technology has proven to be more costly than desired and requires special technology to implement. The advent of the Internet has eliminated the investment and technology problems associated with EDI and opened the door to increased application of e-commerce techniques to the areas of procurement and sourcing. e-procurement and e-sourcing will refer to the use of electronic capabilities to conduct activities and processes relating to procurement and sourcing. Which of These Solutions Should Be Considered Strategic sourcing solutions should be considered for any entity that has a significant amount (over $50 million total) of spending with outside suppliers. The spend should also be segmented into categories and sorted in descending dollars to identify the top dollar spend. Transactional procurement systems are typically used to reduce the time and effort associated with the tactical aspects of procurement, such as requisition and purchase order creation, as well as the approval and payment processes. Advantages An obvious advantage is the lowering of procurement operating costs. The reduction of paperwork and the associated cost of paper processing, filing, and storing is a major cost-saving area of e-commerce. Another paper reduction innovation that has become a reality with e-commerce is electronic funds transfer (ETF). Paying supplier invoices electronically eliminates the cost of preparing, mailing, filing, and storage of the checks. Estimates of the cost of writing a check vary from a low of $10 to a high of $85, the majority of this cost being the cost of accounts payable personnel. Reduced sourcing time means increased productivity because a procurement specialist spends less time per order and can place more orders in a given time period. Likewise, the seller utilizing e-commerce can increase the productivity of customer service representatives. Many of the questions asked by the buyer can be answered online, thereby saving time for both the buyer and seller personnel. Given the real-time nature of e-commerce information, sellers have up-to-date information on demand and can adjust production/purchases to meet the current demand level. This same real-time information enables the buyer to establish controls that will coordinate purchase quantities with requirement quantities and monitor spending levels. Electronic procurement affords efficiency in the process by utilizing fewer resources to produce a given level of purchases. A significant efficiency factor of e-commerce is improved communications. The buyer can secure information from the supplier’s company—product line, prices, and product availability. The seller can obtain information regarding requests for proposals, blueprints, technical specifications, and purchase requirements from the buyer. Also, the seller can improve customer service by communicating the status of the order, giving the buyer advance notice of any delays in order fulfillment such as stockout situations, transportation delays, etc. Reduced procurement prices have resulted from the ability of a buyer to gain access to pricing information from more potential suppliers. With more suppliers bidding for the business, the buyers are finding lower prices forthcoming. In addition, the procurement manager has the ability to view online the qualities of different supplier products and services, making comparison much easier. The overall effect of increased comparison shopping and increased number of potential suppliers is lower prices. Concerns Although there are some reported concerns about e-commerce, many of them are in the process of being neutralized or eliminated. The most frequently voiced concern about using the Internet for sourcing and procurement activities is that of “cyber-security.” This refers to the increasing threat of the use of electronic technologies to hack into databases and information depositories of all types. Another problem may the lack of face-to-face contact between the buyer and seller. Buying and selling via e-commerce many times reduces the ability to build close supplier relationships. Other concerns deal with technology. More specifically, there are concerns with the lack of standard protocols, system reliability, and technology problems. Lastly, there is reluctance on the part of some to invest the time and money to learn the new technology. For the most part, these concerns are diminishing daily as new and improved technology is developed and the business community demands the use of e-commerce capabilities. e-Commerce Model The four basic types of e-commerce business models used in procurement and sourcing are sell-side system, electronic marketplace, buy-side system, and online trading community. The following comments and examples clarify each of their roles: 1. Sell-side system: Online businesses selling to individual companies or consumers. 2. Electronic marketplace: A seller-operated service that consists of a number of electronic catalogs from suppliers within a market. The electronic marketplace provides a one-stop sourcing site for buyers who can examine the offerings of multiple suppliers at one Internet location. 3. Buy-side system: A buyer-controlled e-procurement or e-commerce service that is housed on the buyer’s system and is administered by the buyer, who typically pre-approves the suppliers who have access to the system, and the process of the suppliers’ products and services that have been pre-negotiated. These systems permit tracking and controlling procurement spending and help to reduce unauthorized purchases. However, the cost of buy-side systems is frequently high due to the cost of developing and administering the system with a large number of suppliers. 4. Online trading community: A system maintained by a third-party technology supplier where multiple buyers and multiple sellers in a given market can conduct business. The difference between the online trading community and the electronic marketplace is that the electronic marketplace is focused on providing information about sellers, whereas the online community permits the buyers and sellers to conduct business transactions. Overall, electronic procurement is here and is quickly establishing itself as the direction for the future. It will not replace all procurement activities, but it could reach 80 percent or more of a company’s total purchase order activity. Electronic procurement focuses on the processing of orders and maintaining a source of real-time information for better decision making. Procurement specialists focus on selecting suppliers, negotiating prices, monitoring quality, and developing supplier relations. SUMMARY • Expertise in the areas of purchasing, procurement, and strategic sourcing is essential to the success of supply chain management. • Different procurement and sourcing strategies are related to the risk and value or profit potential from needed products and services. Not all purchased items are of equal importance. Using the criteria of risk and value, the quadrant technique classifies items into four importance categories: generics, commodities, distinctives, and criticals. Generics have low risk, low value; commodities have low risk, high value; distinctives have high risk, low value; and criticals have high risk, high value. • The strategic sourcing process consists of seven steps that include project planning and kickoff, profile spend, assess supply market, develop sourcing strategy, execute sourcing strategy, transition and integrate, and measure and improve performance. • Keys to effective management of the procurement and sourcing processes include determining the type of purchase, determining the necessary levels of investment, performing the procurement process, and evaluating the effectiveness of the process. • A number of key factors should be considered in the supplier selection and evaluation process, including certifications and registrations such as TQM, Six Sigma, and ISO 9000. • Extensive effort should be expended to research and understand procurement price and total landed cost (TLC). • e-sourcing and e-procurement practices and technologies are helping to enhance the effectiveness and efficiency of traditional buying processes. In addition, a number of e-commerce model types have been developed and are becoming very popular: sellside, electronic marketplace, buy-side, and online trading community systems. Overall, the advantages of e-sourcing and e-procurement include lower operating costs, improved efficiency, and reduced prices. ANSWERS TO STUDY QUESTIONS 1. Describe and discuss the differences and relationships between purchasing, procurement, and strategic sourcing. How have these concepts evolved? Purchasing: This function is responsible for managing an organization’s acquisition procedures and standards. In a business setting this is a largely transactional activity that consists of the buying of products and services. This is facilitated by the placement and processing of a purchase order. Typically, this activity follows conduct of a formal sourcing process. •Procurement: Essentially, this refers to managing a broad range of processes that are associated with an organization’s need to procure goods and services that are needed throughout the supply chain and the overall organization. Example activities within the procurement process include product/service sourcing, supplier selection, price negotiation, contract management, transaction management, and supplier performance management. •Strategic sourcing: This is a significantly broader process than procurement, and it represents a very useful means to make sure that procurement priorities are well-aligned with goals and objectives of the supply chain and of the overall organization. Also, reliance on a capable strategic sourcing process facilitates the objective of achieving alignment and collaboration among the supply chain and other areas of the organization such as marketing, manufacturing, R&D, etc. Based on a review of these definitions, it is important to consider purchasing simply as an activity (albeit an important one), while procurement and strategic sourcing are best described as processes. Figure 5.1 identifies five examples of ways in which strategic sourcing is a more comprehensive concept: (1) consolidation and leveraging of purchasing power—to concentrate larger volumes of purchases into fewer suppliers or fewer purchasing transactions; (2) emphasis on value—rather than acquisition cost alone; (3) more meaningful supplier relationships; (4) attention directed to process improvement; and (5) enhanced teamwork and professionalism—to include suppliers and customers, as appropriate. Figure 5.2 suggests a strategic evolution to the sourcing process. This diagram highlights not only the trend from traditional/tactical sourcing to strategic sourcing, but ultimately to e-enabled procurement and integration of sourcing and supply chain. Regardless of the terminology used to describe the future state, it is clear there is a high priority on developing and enhancing approaches to procurement and sourcing that create additional value for organizations, their customers, and their suppliers. Michael Porter, in his value chain, identified the strategic importance of procurement, since it includes such activities as qualifying new suppliers, procuring different types of inputs, and monitoring supplier performance. As such, procurement serves as a critical link between members of the supply chain. 2. Using the risk/value technique, categorize the importance of the following items for an automobile manufacturer: engine, tires, gasoline, paper for the employee newsletter, a uniquely designed and engineered muffler, and rail car service to dealers. Describe the rationale you used to ascertain each categorization. • Engine – Engine would be categorized in the critical quadrant. It is high risk and high value. Customers buy cars specifically for the types of engines. Customers are definitely aware of the distinctiveness qualities of an engines, and therefore engines increase the value. It is high risk because if the product isn’t available it poses a threat to continued operations. • Tires – Tires would be categorized as a commodity. It is low in risk but high in value. Tires are not unique and there is little brand distinction and plenty of suppliers. It enhances the profitability of the company because the tires are fundamental to the company’s finished product, however risk is low because tires are not unique. • Gasoline – Gasoline would be categorized as a commodity. It is low in risk but high in value. Gasoline is not unique and there is little brand distinction and plenty of gas stations. It enhances the profitability of the product because if the car can’t move, the customer is not going to purchase it, therefore it is fundamental to the company’s finished product. • Paper for the employee newsletter - Paper would be categorized in the generics quadrant. Paper is low-risk and a low-value item. Risk is low because paper is not a unique items and there are many sources of supply. Also, there is very little brand distinction, and price is a significant distinguishing factor. Value is low because it has nothing to do with the final product. • A uniquely designed and engineered muffler – This item would fit in the distinctive quadrant. It is high-risk and low value. The company’s customers are unaware of the unique design of the muffler or do not care about the uniqueness, but these products pose a threat to continued operation and/or high procurement cost. A stockout of this item results in stopping the production line or changing the production schedule to work around a stocked-out item; both tactics increase production costs. • Rail car service to dealers – This would be categorized in the commodity quadrant. It is a low-risk, high-value items. It enhances the profitability, because getting the car to the dealer is fundamental to profitability, thus making the value high. Risk is low because transportation is not unique and there are many sources of supply. 3. The MSSP process can be described in terms of a series of elements that should be used in the purchase of goods and services. Briefly discuss these elements. To help guide the strategic sourcing process, five core principles are recognized as key drivers to achieve the desired levels of value. These principles are: •Assess the total value—Emphasis must go beyond acquisition cost and evaluate total cost of ownership and the value of the supplier relationship. •Develop individual sourcing strategies—Individual spend categories need customized sourcing strategies. •Evaluate internal requirements—Requirements and specifications must be thoroughly assessed and rationalized as part of the sourcing process. •Focus on supplier economics—Need to understand suppliers’ economics before identifying buying tactics such as volume leveraging, rice unbundling, or price adjustment mechanisms. •Drive continuous improvement—Strategic sourcing initiatives should be a subset of the continuous improvement process for the overall procurement and sourcing organizations. 4. Maximizing the effectiveness of the procurement process is a major goal of an organization. What steps can be taken to help ensure that the process is maximized? Managing the sourcing and procurement process can be difficult for a multitude of reasons, ranging from inflexible organizational structures to inflexible organizational cultures. However, most firms should find the process relatively straightforward. What must be remembered when dealing with these activities is that all firms are different and will have different requirements for the procurement process. A four-step approach can be used and adapted to a firm’s particular needs. To maximize effectiveness, the following steps may be considered: 1. Determine the type of purchase. In the strategic sourcing process, identifying the type of purchase will many times dictate the complexity of the entire process. Of the three types of purchasing activity, for example, the straight rebuy situation would involve only minimal additional effort in terms of procurement activities. Alternatively, the modified rebuy, and certainly the new buy situations, would involve significantly more effort. 2. Determine the necessary levels of investment. The strategic sourcing process requires two major types of investments by the firm: time and information. Time is expended by the individuals involved in making the purchase; the more complex and important the purchase, the more time must be spent on it, especially if it is a new buy. Information can be both internal and external to the firm. Internal information is gathered concerning user requirements and the implications that the purchase will have for the firm. External information concerning the input to be purchased may be gathered from supply chain members, potential suppliers, and others. The more complex and important the purchase, the more information is needed for the procurement process to be effective. By determining the type of purchase (which is also a function of the user’s needs), the procurement professional can determine the levels of investment necessary in the procurement process. Problems can occur when not enough or too much investment is made to satisfy a particular user’s needs. Determining the level of investment needed in time and information to adequately meet a user’s requirements is a firm-specific process. Once the level of investment is decided, the strategic sourcing process can take place. 3. Perform the procurement process. This is a relatively easy step to describe but can be a complex step to perform, depending on the situation. It includes performing those activities necessary to effectively make a purchase and satisfy the user’s requirements. This step also allows the procurement professional to collect data on the time and information actually used in making a specific purchase. The ability to measure the actual investment and how well a user’s needs were satisfied is important to the final step in managing the strategic sourcing process. 4. Evaluate the effectiveness of the strategic sourcing process. This is a control step that asks two questions: (1) Were the user’s needs satisfied? and (2) Was the investment necessary? Remember, the goal is to invest only enough time and information to exactly satisfy the user’s needs. If the process was not effective, the cause could be traced to not enough investment, not performing the proper activities, or mistakes made in performing one or more of the activities. In any case, when the strategic sourcing process is less effective than would be desired, the cause(s) must be identified and corrective actions taken to make sure that future sourcing strategies will prove to be effective. If the purchase satisfied the user’s needs at the proper level of investment, the strategic sourcing process may be deemed to be effective and can serve as a reference for future purchases. Thus, although the procurement process is complex, it can be managed effectively as long as the manager develops some systematic approach for implementing it. A key factor in achieving efficiency and effectiveness in this area is the development of successful supplier (vendor) relationships. In fact, many professional procurement/materials managers agree that today’s global marketplace requires developing strong supplier relationships in order to create and sustain a competitive advantage. Companies such as NCR and Motorola go so far as to refer to suppliers (vendors) as partners and/or stakeholders in their company. When vendors are “partners,” companies tend to rely more upon them to provide input into product design, engineering assistance, quality control, and so on. 5. A key part of the procurement process is the selection of suppliers. What criteria are commonly used in this selection process? Which criteria should be given the highest priority? Why? The most important factor in vendor selection is usually quality. As was indicated earlier, quality often refers to the specifications that a user desires in an item (technical specifications, chemical or physical properties, or design, for example). The procurement professional compares the actual quality of a supplier’s product with the specifications the user desires. In actuality, quality includes additional factors such as life of the product, ease of repair, maintenance requirements, ease of use, and dependability. In today’s total quality management (TQM) environment, not only are quality standards higher, but the supplier may also have to assume the major responsibility for quality. Reliability comprises on-time delivery and performance history, the second- and third-ranked factors for most procurement professionals. To prevent production line shutdowns resulting from longer-than-expected lead times, the buyer requires consistent, on-time deliveries. Also, the performance life of the procured product directly affects the quality of the final product, the manufacturer’s warranty claims, and repeat sales. Finally, in cases of material malfunction, the buying firm considers the supplier’s warranty and claim procedure a reliability measure. Reliability is often considered a part of a total quality management program. It should also be noted that the growing reliance upon foreign suppliers presents some special challenges to the achievement of reliability because of the distances involved. A factor of great, contemporary relevance is risk. One way this may occur is if there is likely variability in the cost of purchased products or services that may result in higher prices. Other ways in which risk may occur include supply uncertainties and unusual variation in delivery lead times. In either case, the result may be that the purchased products or services are not available when and where they are needed, thus introducing additional cost to develop appropriate countermeasures. The fourth major supplier selection criterion, capability, considers the potential supplier’s production facilities and capacity, technical capability, management and organizational capabilities, and operating controls. These factors indicate the supplier’s ability to provide a needed quality and quantity of material in a timely manner. The evaluation includes not only the supplier’s physical capability to provide the material the user needs, but also the supplier’s capability to do so consistently over an extended time period. The buying firm may answer this long-run supply concern by considering the supplier’s labor relations record. A record of supplier-labor unrest resulting in strikes may indicate that the supplier is unable to provide the material quantity the user desires over a long time period. A firm that buys from this supplier will incur increased inventory costs for storing material in preparation for likely disruptions in the supplier’s business due to labor strife. Again, sourcing from global suppliers makes this assessment more challenging. Financial considerations constitute the fifth major supplier selection criterion. In addition to price, the buying firm considers the supplier’s financial position. Financially unstable suppliers pose possible disruptions in a long-run continued supply of material. By declaring bankruptcy, a supplier that supplies materials critical to a final product could stop a buyer’s production. This criterion has become especially important in purchasing transportation service from truckload motor carriers. With the trend toward companies utilizing a smaller number of carriers, the financial failure of such a supplier is a major problem and source of disruption in a supply chain. The remaining supplier selection factors may be grouped into a miscellaneous category of desirable, but not always necessary, criteria. Although the buyer might find the supplier’s attitude difficult to quantify, attitude does affect the supplier selection decision. A negative attitude, for example, may eliminate a supplier for a buyer’s consideration. The impression or image that the supplier projects has a similar effect on supplier selection. The importance of training aids and packaging will depend on the material the buyer is purchasing. For example, packaging is important to buyers of easily damaged material, such as glass, but not important to buyers purchasing a commodity that is not easily damaged, such as coal. Training aids would be significant to a firm selecting suppliers to supply technical machinery such as computers and robots but not to a firm seeking office supplies. Likewise, a buyer would consider the availability of repair service more important when buying technical machinery. Another supplier selection factor is geographical location. This factor addresses the issue of whether to buy from local or distant suppliers. Transportation cost is one obvious aspect of this issue. Other factors, such as the ability to fill rush orders, meet delivery dates, provide shorter delivery times, and utilize greater supplier-buyer cooperation, favor the use of local suppliers. However, distant suppliers may provide lower prices, greater technical ability, greater supply reliability, and higher quality. This is again a choice faced more frequently in today’s global environment. The relative importance of the supplier selection factors will depend upon the material the buyer is purchasing. When a buyer purchases a computer, for example, technical capability and training aids may be more important than price, delivery, and warranties. Conversely, a buyer of office supplies would probably emphasize price and delivery more than other factors. All of the criteria just discussed are important or can be important in certain procurement situations. However, the one criterion that generates the most discussion and/or frustration for procurement specialists is price or cost. Therefore, some extended discussion of this criterion is necessary. 6. How should companies evaluate suppliers? Evaluation of suppliers should be done regularly and on a formal basis. Essentially, the three most important question include: 1) did the supplier succeed in meeting the customer’s needs; 2) what elements of the relationship, both strategic and tactical/operational may benefit from modification and improvement; and 3) did the investments by both customer and supplier produce measurable benefits that justified the time and effort of the relationship? If the process was not effective, the cause could be traced to not enough investment, not performing the proper activities, or mistakes made in performing one or more of the activities. In any case, when the strategic sourcing process is less effective than would be desired, the cause(s) must be identified and corrective actions taken to make sure that future sourcing strategies will prove to be effective. If the purchase satisfied the user’s needs at the proper level of investment, the strategic sourcing process may be deemed to be effective and can serve as a reference for future purchases. Another important dimension of the supplier relationship is the extent to which the customer-supplier relationship contributes to the competitive advantage of the company, whether the advantage is one of low cost, differentiation, or a niche orientation (using Porter’s generic strategies). Therefore, the goals of the strategic sourcing process must be consistent with the overall competitive advantage that a company is seeking to attain in the marketplace. An example of this would be L Brands (Limited, Inc.), which considers its supply chain capabilities to be a key differentiator of the entire organization in the marketplace. L Brands is viewed as a global leader on this capability, and their partnerships with their suppliers of all types focus on achieving the overall goals of the organization. 7. What are the components of total landed cost? Is it realistic to expect companies to consider all of these components? As indicated in Figure 5.8, purchase or acquisition cost is only the tip of the iceberg when the analysis is broadened to encompass factors that would better relate to the total landed cost (TLC). This concept represents the sum of all costs associated with making and delivering products to the point where they are needed. In effect, this perspective brings into play a few considerations that are helpful to the supplier selection process. Among those that are highlighted are life cycle costs, inventory costs, strategic sourcing costs, transaction costs, quality costs, technology costs, and management costs. Figure 5.9 illustrates how important it is to consider types of cost that are in addition to the purchase price for needed product. Interestingly, the product prices are lowest in Vietnam and highest in the EU, but after transportation, customs, and VAT costs are included, sourcing from the EU is the least expensive and from Vietnam the most expensive. Although this is a relatively straightforward example, it reinforces the importance of looking beyond the price of the products themselves when trying to make a cost-effective sourcing decision. • Traditional Basic Input Costs This is the primary price of the product or materials as paid by the firm • Direct Transaction Costs These are the costs of detecting, transmitting the need for, and processing the material flow in order to acquire the goods. The use of blanket or systems contracting can also reduce transaction costs. These include direct ordering by users to suppliers, single consolidated billing, and user inspection and checking. • Supplier Relational Costs These are the costs of creating and maintaining a relationship with a supplier. They include travel, supplier education, and the establishment of planning and operational links between purchasing and the supplier’s order-entry operation, as well as other links, including ones to traffic, engineering, research, and product development in both firms. • Landed Costs The inbound transportation flow includes two key cost elements: the actual transportation cost and the sales/FOB terms. • Quality Costs/Factors Quality pertains to the conformance of goods to a desired specification. It includes the cost of conformance, nonconformance, appraisal, and ultimate use costs. • Operations Logistics Costs include four key areas: receiving and make-ready costs, lot-size costs, production costs and logistics costs. It is realistic to expect companies to consider all of these components. 8. Discuss the advantages and disadvantages of using e-commerce in the procurement process. The computer and Internet have created some dramatic changes in the business world and in the everyday activities of consumers. According to a current five-year eCommerce forecast by Forrester Research, US online retail sales were expected to reach $334 billion in 2015 and $480 billion by 2019. At the time of the forecasts, 69% of the US online population regularly purchased products online, with clothing, consumer electronics, and computers generating about a third of all online shopping dollars in the US. Procurement was found to be the business process that made the greatest early application of e-commerce. Initially, companies utilized electronic data interchange (EDI) technology to connect with their major customers to process purchase orders, send notifications of shipment, and transfer funds. Aside from the significant popularity of EDI over a long period of time, use of the Internet has gained significant traction due to its greater convenience, lower costs, and less need for special technology to implement. This has opened the door to increased application of e-commerce techniques to the areas of procurement and sourcing The advantages of e-commerce procurement are shown in Figure 5.11. An obvious advantage is the lowering of procurement operating costs. The reduction of paperwork and the associated cost of paper processing, filing, and storing is a major cost-saving area of e-commerce. Another paper reduction innovation that has become a reality with e-commerce is electronic funds transfer (ETF). Paying supplier invoices electronically eliminates the cost of preparing, mailing, filing, and storage of the checks. Estimates of the cost of writing a check vary from a low of $10 to a high of $85, the majority of this cost being the cost of accounts payable personnel. Experience has shown that the costs of ETF capabilities are significantly less than those of writing checks, and the overall experience is greatly enhanced for both customers and suppliers. Reduced sourcing time means increased productivity because a procurement specialist spends less time per order and can place more orders in a given time period. Likewise, the seller utilizing e-commerce can increase the productivity of customer service representatives. Many of the questions asked by the buyer can be answered online, thereby saving time for both the buyer and seller personnel. Given the real-time nature of e-commerce information, sellers have up-to-date information on demand and can adjust production/purchases to meet the current demand level. This same real-time information enables the buyer to establish controls that will coordinate purchase quantities with requirement quantities and monitor spending levels. That is, the buyer is now in the position of monitoring the quantity of an item ordered, received, and on hand; comparing it to the amount needed; and doing this in a real-time mode. The same is true for monitoring spending activities against budgeted amounts. Electronic procurement affords efficiency in the process by utilizing fewer resources to produce a given level of purchases. With a click of the mouse, a purchasing manager can search the world for alternative supply sources of a product or service. With another click, the manager can then ascertain information about the sources identified through the electronic search. All of this research is done in the office without phone calls, additional personnel, or outside sources. A significant efficiency factor of e-commerce is improved communications. The buyer can secure information from the supplier’s company—product line, prices, and product availability. The seller can obtain information regarding requests for proposals, blueprints, technical specifications, and purchase requirements from the buyer. Also, the seller can improve customer service by communicating the status of the order, giving the buyer advance notice of any delays in order fulfillment such as stockout situations, transportation delays, etc. As noted earlier, e-commerce permits the seller to gain real-time information to more accurately predict demand and anticipate problems before they occur. Better use of procurement personnel is made possible by relieving them of the clerical tasks associated with processing the order, such as manually preparing purchase orders, mailing them to the supplier, and checking the status of the order via phone. The procurement manager is now free to focus attention on the long-term strategic procurement issues such as long-term item availability, opportunities for supply chain efficiencies, innovative products, and so on. Reduced procurement prices have resulted from the ability of a buyer to gain access to pricing information from more potential suppliers. With more suppliers bidding for the business, the buyers are finding lower prices forthcoming. In addition, the procurement manager has the ability to view online the qualities of different supplier products and services, making comparison much easier. The overall effect of increased comparison and increased number of potential suppliers is lower prices. Although there are some reported concerns about e-commerce, many of them are in the process of being neutralized or eliminated. The most frequently voiced concern about using the Internet for sourcing and procurement activities is that of “cyber-security.” This refers to the increasing threat of the use of electronic technologies to hack into databases and information depositories of all types. Whether it be in the form of cyber-attacks that result in the electronic theft of personal information (e.g., credit card numbers, social security numbers, bank transactions, etc.) or disruptions to manufacturing or other supply chain activities, the threat is a real one, and is receiving significant attention by businesses worldwide. Another problem may the lack of face-to-face contact between the buyer and seller. Buying and selling via e-commerce many times reduces the ability to build close supplier relationships. This can be overcome by making a concerted effort to develop and enhance personal communications with the supplier. Other concerns deal with technology. More specifically, there are concerns with the lack of standard protocols, system reliability, and technology problems. Lastly, there is reluctance on the part of some to invest the time and money to learn the new technology. For the most part, these concerns are diminishing daily as new and improved technology is developed and the business community demands the use of e-commerce capabilities. Shopping and increased number of potential suppliers is lower prices. 9. Describe the different types of e-commerce business models available for procurement and point out their respective benefits and disadvantages. The four basic types of e-commerce business models used in procurement and sourcing are sell-side system, electronic marketplace, buy-side system, and online trading community. The following comments and examples clarify each of their roles: Sell-side system: Online businesses selling to individual companies or consumers. Examples include Office Depot and OfficeMax (www.officedepot.com), Staples (www.staples.com), Xpedx (www.xpedx.com), Best Buy (www.bestbuy.com), Wal-Mart (www.walmart.com), and CNET (www.cnet.com). An increasing number of sell-side Web sites provide buyer login capabilities that allow storing of information concerning buying preferences, buying history, etc., for future reference. Electronic marketplace: A seller-operated service that consists of a number of electronic catalogs from suppliers within a market. The electronic marketplace provides a one-stop sourcing site for buyers who can examine the offerings of multiple suppliers at one Internet location. Examples include Expedia.com (www.expedia.com), PlasticsNet (www.plasticsnet.com), ThomasNet (www.thomasnet.com), Froogle (www.froogle.google.com), Amazon (www.amazon.com), eBay (www.ebay.com), and Hotwire (www.hotwire.com). Buy-side system: A buyer-controlled e-procurement or e-commerce service that is housed on the buyer’s system and is administered by the buyer, who typically pre-approves the suppliers who have access to the system, and the process of the suppliers’ products and services that have been pre-negotiated. These systems permit tracking and controlling procurement spending and help to reduce unauthorized purchases. However, the cost of buy-side systems is frequently high due to the cost of developing and administering the system with a large number of suppliers. For this reason, most buy-side systems are usually in the domain of large companies. An interesting example of a buy-side system is Elemica (elemica.com), a supply chain operating network that provides integrated messaging, applications, and analytics across a network of trading partners. Online trading community: A system maintained by a third-party technology supplier where multiple buyers and multiple sellers in a given market can conduct business. The difference between the online trading community and the electronic marketplace is that the electronic marketplace is focused on providing information about sellers, whereas the online community permits the buyers and sellers to conduct business transactions. The online trading community also may be viewed as an electronic auction. In such instances, the buyer indicates the type of product, quantity, and so on, desired; and the sellers respond. In a downward auction, the buyer states a maximum time period to receive the best bid from potential suppliers. At the end of the time period, the buyer selects the supplier(s) with the lowest price and will conduct negotiations, if necessary, to finalize the transaction. Examples of online trading companies include Travelocity (www.travelocity.com), Priceline (www.priceline.com), eBay (www.ebay.com), and NTE (www.nteinc.com). Other examples of online trading communities are E2open (www.e2open.com), which focuses on high-tech and electronics, and AGENTics (www.agentics.com), a global retail industry. Gartner defines strategic sourcing application suites as a set related, integrated solutions that support “upstream” procurement activities. Used primarily by large companies, there are four main components to these suites: spend analysis; e-sourcing; contract management; and supply base (SBM) applications. Also, Gartner evaluates the strengths and cautions of providers of these types of technologies using the Gartner Magic QuadrantTM, which focuses on the ability to execute and the completeness of vision for the companies under consideration. Overall, electronic procurement is here and is quickly establishing itself as the direction for the future. It will not replace all procurement activities, but it could reach 80 percent or more of a company’s total purchase order activity. Electronic procurement focuses on the processing of orders and maintaining a source of real-time information for better decision making. Procurement specialists focus on selecting suppliers, negotiating prices, monitoring quality, and developing supplier relations. Case Studies CASE 5.1 Alligator, Inc 1. Based on your knowledge of the global business environment and the positioning of Alligator with regard to its markets and supply sources, what do you think are some of the major global issues that will be relevant to the area of strategic sourcing? This case provides an opportunity for students to integrate some of the material from Chapter 4 relating to managing supply chains on a global scale. Of particular interest may be Section 4-2-2 pertaining to changes in global trade patterns, and Section 4-4 on the topic of major locational determinants. Categorically, it may be helpful to consider the relevance of risk factors such as trade risk, political risk, geophysical risk, economic risk, and operational risk. 2. What are the impacts of less-than-perfect demand forecasts for Alligator products, including GatorsTM, and of volatility in the length and cost the supply chain services needed to move components from suppliers to manufacturing sites, and the subsequent movement of finished products to market? What should be done to mitigate these problem areas? Obviously, most demand forecasts are less-than-perfect, and so this situation is not unique to GatorsTM. Referring to Figure 5.3 on the quadrant technique, it appears that GatorsTM would be described as a relatively low value, but high-profit product. Also likely is that risk would be somewhat low in the short term and possibly higher in the long-term. Thus, GatorsTM is generally a type of product that needs to be in-stock to realize the high levels of profit, which would exceed any extra costs of carrying additional inventory. Thus, the design and functioning of the supply chain should focus on having sufficient product available to meet likely demand, and minimizing the likelihood of stockouts. 3. What elements of the strategic sourcing process do you feel are the top candidates for improvement at Alligator, and why? Aside from the comment that all elements of the strategic sourcing process are important, a few notes below on those that may be more relevant and critical for improvement at Alligator: •MSSP #1 – Develop strategic plan – global operations place greater emphasis on a coherent and effect plan for Alligator’s global supply chains •MSSP #3 – Evaluate Supply Sources – essential to make sure that product quality will be maintained and that sources will be sufficiently capable and flexible to meet the sometimes changing demand patterns for Alligator products •MSSP #4 – Finalize Sourcing Strategy – given the longer-term risk with products such as GatorsTM, a preferred sourcing strategy would be for Alligator to work with contract manufacturers instead of building and operating company-owned facilities. In the event of an economic downturn, having fixed investment in proprietary manufacturing operations could be financially disastrous •MSSP #7 – Collaborative Process Improvement – an important step in sustaining and improving relationships both internal to Alligator and with suppliers and customers 4. How would you respond to the assertion that some of your contract manufacturers are involved in producing illegal merchandise (i.e., GatorsTM “knock-offs”) that ends up competing with the branded merchandise of Alligator? Considering the relative simplicity of manufacturing the basic GatorsTM product, there is a great likelihood that illegal merchandise may appear on the market. The idea of pursuing legal alternatives is something that may be considered, but the manufacture of “fake” merchandise is typically difficult to control. Given that the availability of one-size-fits-all orthotics are a critical part of the GatorsTM product, there may be patent protection steps that may be taken to lessen the threat of illegal merchandise becoming available on the market. CHAPTER CASE 5.2 Trans-Global, Inc. Case Notes: 1. Assuming that you are SVP supply chain at a leading merchandiser of fashion apparel, what do you feel would be the benefits and drawbacks of developing a business relationship with Trans-Global for the sourcing, manufacturing and distribution of your products? Example Benefits: •Recognition by the fashion apparel manufacturer of its corporate core competencies and the realization that it may be better to outsource or transfer ownership of sourcing operations to a company that specializes in such. •Streamlining and integration of administrative activities needed to assure the effective and efficient functioning of the fashion apparel merchandiser’s supply network. •Transference of some of the business risks to Trans-Global, but introduces possibility of the fashion apparel merchandiser losing control over certain aspects of its supply chain. Example Drawbacks: •Potential loss of control (although there is a possibility that use of Trans-Global may result in improvements in control) •Lack of flexibility •Potential problems with integrating information systems of Trans-Global and fashion apparel merchandiser •Cost and service considerations, including recognizing the critical importance of speed in supply chains supporting fashion apparel merchandisers 2. Where does consideration of a relationship with Trans-Global fit into the steps of the MSSP sourcing methodology that was discussed in this chapter? •MSSP #1 – Develop Strategic Plan – plan needs to identify the potential outsourcing or transfer of certain supply chain operations to external parties •MSSP #2 – Understand Spend – provides basis for comparison with costs associated with Trans-Global relationship •MSSP #3 – Evaluate Supply Sources – external sources need to be considered •MSSP #4 – Finalize Sourcing Strategy – confirmation of using a company such as Trans-Global •MSSP #5 – Implement Sourcing Strategy – first, formal involvement of Trans-Global as supply chain partner with fashion apparel merchandiser •MSSP #6 – Onboarding and Transitioning – joint effort to include Trans-Global and fashion apparel merchandiser to see that new relationship begins smoothly and that needed capabilities by both parties are identified and available •MSSP #7 – Collaborative Process Improvement – to help assure ongoing success of the relationship 3. Since a logical objective of a relationship with Trans-Global should be to create benefits to both parties over time, what do you think are some of the very critical “external” factors that could impact the success or failure of this relationship? Response here could include a broad range of external factors that potentially may impact overall supply chain and business operations. A few examples are listed below: •Overall business success of Trans-Global – includes ability to continue a base of business that helps to create economies of scale, etc. •Global economic conditions •Shifting economics of global logistics services (e.g., transportation; warehousing; manufacturing; etc.) •Tax and regulatory conditions •Changing global trade patterns and concepts such as off-shoring, near-shoring, etc. Solution Manual for Supply Chain Management: A Logistics Perspective John J. Coyle, John C. Langley, Robert A. Novack, Brian J. Gibson 9781305859975