Supply Management

Chapter 7

Chapter Objectives
Identify and describe the various steps of the strategic
sourcing process.
Use portfolio analysis to identify the appropriate sourcing
strategy for a particular good or service.

Describe the rationale for outsourcing and discuss

when it is appropriate.
Show how multi-criteria decision models can be used to
evaluate suppliers and interpret the results.
Discuss some of the longer-term trends in supply
management and why they are important.

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

analyze sourcing opportunities,

develop sourcing strategies,
select suppliers, and,
carry out all the activities required to procure
goods and services.

Why is Supply Management critical?

Global Sourcing
Competition against global competitors and their
supply chains.
Advances in information systems have helped.
Applies to services and manufacturing
environments.
Outsourcing routine business processes (e.g.
invoice processing, file checking, call centers).

Why is Supply Management critical?

Financial Impact

Table 1

Profit Leverage Example 1

Financial Impact
Selected Financial
Data for Target
Corporation
Table 2

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

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

Profit Leverage Example 1

Financial Impact
Every dollar saved in purchasing lowers COGS by
$1 and increases pretax profit by $1.
Profit leverage effect A term used to describe the
effect of $1 in cost savings increasing pretax profits by
$1 and a $1 increase in sales increasing pretax profits
only by $1 multiplied by the pretax profit margin.

Every dollar saved in purchasing lowers the

merchandise inventory figure and as a result,
total assets by $1.
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Profit Leverage Example 1

3% purchasing reduction in COGS
Earnings and Expenses

Sales
COGS
Pretax earnings

Current

Reflecting Savings

$65,786
$45,725
$4,629

$65,786
$44,353
$6,001

Selected Balance Sheet Items

Merchandise inventory
$7,596
Total assets
$17,213

$7,368
$16,985

Pretax earnings
increase by $1372
(30%)

ROA increases
from 26.9% to
35.3%

Why is Supply Management critical?

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

Performance Impact Example 2

Sourcing dialysis machine valves

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Performance Impact Example 2

Effect of defective dialysis machine

Interruption in patient treatment

Rescheduling difficulties
Reduction in the effective capacity for dialysis
Possible medical emergencies

Estimated cost of a failed valve = $1,000

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Performance Impact Example 2

Sourcing 50 dialysis machine valves
(Total Costs)

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The Strategic Sourcing Process

Figure 1

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Step 1: Assess Opportunities

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

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Assess Opportunities Example 3

Examine the trends and
impact of spending.

Table 3

Figure 2
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Step 2: Profile Internally and Externally

Two approaches to creating profiles:
Category profile An approach to understand all
aspects of a particular sourcing category that could
ultimately have an impact on the sourcing strategy.
Example: Breakdown of the total category spend by
subcategories, suppliers, and locations; how the purchased
components/services are used.

Industry Analysis An approach to provide a more

detailed understanding of the characteristics of the
external supply base. (Major forces or trends)
Example: Pricing, competition, regulatory forces, substitution,
technology changes, supply/demand trends.
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Step 3: Develop the Sourcing Strategy

The Make-or-Buy Decision
A high-level, often strategic, decision regarding
which products or services will be provided
internally and which will be provided by external
supply chain partners.
Insourcing The use of resources within the firm to
provide products or services.
Outsourcing The use of supply chain partners to
provide products or services.

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Develop the Sourcing Strategy

Advantages and Disadvantages of
Insourcing and Outsourcing

Table 6
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Develop the Sourcing Strategy

Factors that affect the decision
to Insource or Outsource.

Table 7

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Develop the Sourcing Strategy

Total cost analysis A process by which a firm seeks
to identify and quantify all of the major costs
associated with various sourcing options.
Direct costs Costs tied directly to the level of operations
or supply chain activities.
Indirect costs Costs that are not tied directly to the level
of operations or supply chain activity.

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Develop the Sourcing Strategy

Insourcing and Outsourcing Costs

Table 8
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Develop the Sourcing Strategy

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

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Portfolio Analysis Strategic Quadrants

The Routine Quadrant Readily available products or services (small %
of total expenditures) (e.g. office supplies, cleaning services)
Automating processes, reducing number of suppliers, using Electronic Data
Interchange.

The Leverage Quadrant Standardized and readily available products or

services (large % of total expenditures).
Leverage firms spending levels to get the most favorable terms, use
Preferred suppliers

The Bottleneck Quadrant Unique or complex products or services

supplied by few potential suppliers.
Dont run out, ensure supply continuity, carry extra inventory against
interruptions, contract multiple vendors.

The Critical Quadrant - Unique or complex products or services supplied

by a few suppliers, representing large % of total expenditures.
Negotiate favorable deals, build partnerships, prepare contingency plans

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Develop the Sourcing Strategy

Portfolio Analysis
High

Complexity
or Risk
Impact

Bottleneck

Critical

Routine

Leverage

Low

Low

High
Value Potential

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Develop the Sourcing Strategy

Single sourcing The buying firm depends on a single company
for all or nearly all of an item or service.
Multiple sourcing The buying firm shares its business across
multiple suppliers.
Cross sourcing Using a single supplier for one product or
service and another supplier with the same capabilities for
another, similar product or service.

Dual sourcing Using two suppliers for the same purchased

product or service.

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Step 4: Screen Suppliers and

Create Selection Criteria
Quantitative Criteria
Cost, on-time delivery, quality, etc.

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

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Step 5: Conduct Supplier Selection

Weighted-point evaluation system An evaluation
system to evaluate potential suppliers, track suppliers
performance over time, and rank current suppliers.
Method
Assign weights to performance dimensions.
Rate the performance of each supplier with regard to each
dimension.
Calculate the total score.
n

Score X Performanc e XY WY
Y 1

where X = Supplier X

Y = performance dimension Y

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Supplier Selection Example 6

Summary Data for Three Possible Suppliers

Table 11

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Supplier Selection Example 6

n

Score X Performanc e XY WY
Y 1

Criteria Weights
WPrice

= 0.3

Scoring Scheme
5 = excellent
4 = good

WQuality = 0.4

3 = average
2 = fair

WDelivery = 0.3

1 = poor
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Supplier Selection Example 6

Performance Values for Alternative Suppliers

Table 13

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Supplier Selection Example 6

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

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

Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2
Aardvark should improve their quality.
Beverly Hills should improve their delivery and price.
Conan is out of the running as a potential supplier.
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Step 6: Negotiate and Implement Agreements

Competitive bidding A request for bids from suppliers
with whom a buyer is willing to do business.
Request for quotation A formal request for the suppliers to
prepare bids, based on the terms and conditions set by the
buyer.

Description by market grade/industry standard

Description by brand
Description by specification
Description by performance characteristics

Competitive bidding is most effective when

The buying firm can provide qualified suppliers with clear descriptions of
the items or services to be purchased;
Volume is high enough to justify the cost and effort; and,
The buying firm does not have a preferred supplier.
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Negotiate and Implement Agreements

Negotiating A more costly, interactive approach to final
supplier selection.
Negotiation is used best when:
The item is a new or technically complex item with only vague
specifications.
The purchase requires agreement about a wide range of
performance factors.
The buyer requires the supplier to participate in the
development efforts.
The supplier cannot determine risks and costs without
additional input from the buyer.
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Negotiate and Implement Agreements

Contracting The process of creating a detailed
purchasing contract to formalize the buyersupplier relationship.
Fixed-price contract Stated price does not change.
Cost-based contract Price of the good or service is
tied to the cost of some other key input or
economic factor such as interest rates.

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The Procure-to-Pay Cycle

Ordering
Purchase order (PO) A document that authorizes a supplier to deliver
a product or service and includes the terms and conditions of the sale.

Follow-up and expediting

Monitor the status of open POs.

Receipt and inspection

Statement of work (scope of work) Terms and conditions for a
purchased service.

Settlement and payment

May be paid through Electric Funds Transfer (EFT)

Records maintenance
Record of critical events associated with the purchase.
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Trends in Supply Management

Sustainable Supply
Becoming more conscious of the importance of being
environmentally friendly and using environmental
performance in selecting suppliers.
Ensuring compliance with regulations.
Reducing packaging, promoting recycling, reducing costs.

Supply Chain Disruptions

Caused by natural disasters, economic/political events.
Cause a big threat to revenue streams.
Increased risk due to outsourcing to global suppliers.
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