Tradition

Traditionally, the main activities of a purchasing manager

Supply Chain Management

Chapter 4: Procurement & Sourcing

to beat up potential suppliers on price and then buy products from the lowest cost supplier that could be found.

BUT
there are other activities that are becoming equally important . The modern focus is on total spend and the development of relationship between buyer & sellers. As a result procurement & sourcing have been elevated to a strategic activity

Procurement - a Strategic Tool

Impact of Sourcing on Profits

100% ~ ~ 60%

A corporate strategy requires forming sub strategies such as product strategy, procurement strategy, marketing strategy, and so on. A corporations corporate strategy and procurement strategy must fit with each other or otherwise, both will fail

Purchased goods and services can be more than half of a firms total revenue Reduced spending falls right to the bottom line 25% 10% 5%

8%
Profit After

Total Revenue

Purchased Goods and Services

Salaries, Wages and Benefits

Taxes, Depreciation and Interest

Profit Before

How Does Strategic Sourcing Work?

Partnership Sourcing
Traditional Approach Emphasises competitiveness and self interest of both parties Partnership Approach Emphasises co-operation Emphasis on total acquisition cost Emphasis on long term relationship Emphasis on quality assurance based on TQM and zero defects Emphasis on single sourcing Emphasis on mutual trust between buyer and supplier

Buyer Buyer

Emphasis on lowest price Emphasis on short term Emphasis on quality checks and incoming inspection of goods Emphasis on multiple sourcing

Suppliers

Emphasis on uncertainty regarding supplier performance and integrity

Partnership Sourcing Advantages

To the purchaser
Purchasing Advantage through QA, reduced supplier base, assured supplies, long term planning improvements, JIT delivery, improved quality Lower costs through joint cost reduction programmes, lower inventory, improved logistics, reduced handling

To the supplier
Marketing advantage through stability, larger share of orders placed, better planning, ability to work with key customers, increase sales without increasing procurement overheads Lower costs through joint cost reduction programmes, lower inventory through better customer planning, improved logistics, simplification or elimination of processes, payment on time Strategic advantage through access to customers technology, a customer who recognises need to invest, shared problem solving and management

Definitions
Sourcing: The fundamental aspects of sourcing is:
supplier selection- identified by spend analysis using one of many negotiation techniques (such as RFx, tenders etc). Once the suppliers are selected the relationship with the selected suppliers is then managed through the negotiated contracts.

Strategic advantage through access to suppliers technology, a supplier who will invest, shared problem solving and management

RFX
The RFI (Request for Information), RFQ (Request for Quotation), and RFP (Request for Proposal) :
An RFx is a document with an associated process initiated by a buyer in order to solicit information, competitive quotes, or proposals from multiple suppliers.

Protocols (aka Auctions, Tenders & Bids)

A typical flow for negotiation is to get a bid response to the RFQ from the suppliers and choose the appropriate bid/s that satisfy the requirements of the purchase at minimum cost.

Outsourcing of Supplies
Firms today purchase not only raw materials and basic supplies but also complex fabricated components with high value-added content. The spin off functions to suppliers to focus internal resources on core competencies More focus required on how the organization interfaces and manages its supplies.

Procurement Perspectives
The emphasis has shifted from adversarial/ transactional relationship to a supplier supportive strategy. Emphasis is on:
Continuous Supply Minimizing Inventory Investment Quality Improvement Supplier Development Lowest Total Cost of Ownership

Procurement Perspectives-2
Core objective of procurement is to ensure continuous supply. One goal of procurement is to maintain supply continuity with minimum inventory. The ideal being the material arriving just when needed or just-in-time. Poor quality inputs will result in failing on customer requirement Locating suppliers, developing their capabilities and sharing information such as production schedule, POS info achieves better results

Procurement Perspectives-TCO
The focus in modern procurement is on Lowest Total Cost of Ownership (TCO). Purchase price is important but it is only one part of the TCO. Service costs and life cycle cost must also be considered.

Procurement Components
PURCHASE PRICE- TIP OF THE ICEBERG
Procurement does not deal with a single action or process, which is commonly assumed - just buying. It includes activities & events like:
Pre-contract activities such as planning, needs identification, analysis and sourcing. Post-contract activities such as contract management, supply chain management & disposal. General activities such as risk management & regulatory compliance.

TOTAL COST OF OWNERSHIP

Procurement Strategies
Pre-transaction components
1. Identifying need 2. Investigating sources 3. Qualifying sources 4. Adding supplier to internal systems 5. Educating Supplier in firms operations Firm in supplier operations

Transaction components
1. Price 2. Order placement/ preparation 3. Delivery/ transportation 4. Tariffs/duties 5. Billing/ payments 6. Inspection 7. Return of Parts 8. Follow-up and correction

Post-transaction components
1. Line fallout 2. Defective finished goods rejected before sale 3. Field failure 4. Repair/replacement in field 5. Customer goodwill/ reputation of firm 6. Cost of repair parts 7. Cost of maintenance & repairs

Effective procurement strategy to support the SC operations requires closer relationship between buyer and sellers than in traditional approach. Volume consolidation, supplier operational integration and value management have emerged as three important procurement strategies

Volume Consolidation
Consolidating volume with limited number of suppliers increases the share of buyer in suppliers business This way it can leverage its purchasing power with a few suppliers and get better prices in return for purchasing higher volumes of product. Supplier benefits due to economies of scale. Assured of a volume of purchases, supplier is more willing to invest in process or capacity improvements.

Volume Consolidation- Benefits not trivial

Estimated savings in purchase price and other elements range from 5% to 15%. If a typical firms spends 60% of its revenue on purchased items, a saving of 10% through volume consolidation can deliver Rs 6 million improvement on revenue of Rs100 million to the bottom line.

Volume Consolidation - single source supply risks

Screen supplier rigorously Develop strict selection procedures Develop preferred or certified suppliers When risks justify use more than one supplier (but still a few, two?) In case of a single source, have a contingency plan.

Supplier Operational Integration

Primary objective is to cut cost, reduce waste and develop a relationship that allows both buyers and sellers to achieve mutual improvements
Sharing sales and ordering information Redesigning processes to improve efficiency Achieving zero defects at suppliers Vendor managed inventory Reducing TCO

Value management
More intense aspect of supplier integration where buyer supplier operations develop into a comprehensive relationship. Early supplier involvement in NPD allows supplies to reduce TCO Teams representing procurement, engineering, manufacturing, marketing, logistics as well as key supplier personnel jointly seek solutions to lower cost and improved customer service.

Early Supplier Involvement reduction

Cost

Benefits of Effective Sourcing Decisions

Better economies of scale can be achieved if orders are aggregated More efficient procurement transactions can significantly reduce the overall cost of purchasing Design collaboration can result in products that are easier to manufacture and distribute, resulting in lower overall costs Good procurement processes can facilitate coordination with suppliers Appropriate supplier contracts can allow for the sharing of risk Firms can achieve a lower purchase price by increasing competition through the use of auctions

Pareto Principle
The Pareto principle (also known as the 80-20 rule, or the law of the vital few) states that, for many events, roughly 80% of the effects come from 20% of the causes

Purchase Requirement Segmentation

Pareto effect applies to purchasing too. A small percentage of the materials, items and services acquired account for a large percentage of cost spent We need to pay attention to segmented purchase requirements and prioritize resources and expertise to handle these requirements.

Purchase Requirement Segmentation

Portfolio Matrix

Supply Chain Management

Procurement & SRM

Overview of Supplier Relationship Management (SRM)

What is SRM?
Management operating system and practices to ensure alignment of suppliers and buyers

Supplier Relationship Management

SRM is a comprehensive approach to managing an enterprise's interactions with the organizations that supply the goods and services it uses. SRM includes both business practices and software and is part of the information flow component of SCM

Why use SRM?

Ensures TCO objectives forecasted are achieved, maintained and even surpassed Vehicle for continuous improvement

SRM-Strategic Sub-processes
Review Corporate, Manufacturing and Sourcing Strategies Identify Criteria for Categorizing Suppliers Provide Guidelines for the Degree of Customization in the Product/Service Agreement Develop Framework of Metrics Develop Guidelines for Sharing Process Improvement Benefits with Suppliers

SRM-Operational Sub-processes
Differentiate Suppliers Prepare the Supplier/Segment Management Team Internally Review the Supplier/Supplier Segment Identify Opportunities with the Suppliers Develop Product/Service Agreement and Communication Plan Implement the Product/Service Agreement Measure Performance and Generate Supplier Cost/Profitability Reports

Supplier Relationship Management

Strategic Sub-Processes
Review Corporate, Manufacturing and Sourcing Strategies

Process Interfaces
Customer Relationship Management

Operational Sub-Processes
Differentiate Suppliers

Customer Service Management Identify Criteria for Categorizing Suppliers Demand Management Provide Guidelines for the Degree of Customization in the Product/Service Agreement

Prepare the Supplier/Segment Management Team Internally Review the Supplier/ Supplier Segment

Order Fulfillment

Identify Opportunities with the Suppliers Develop Product/Service Agreement and Communication Plan Implement the Product/Service Agreement Measure Performance and Generate Supplier Cost/Profitability Reports

Manufacturing Flow Management Develop Framework of Metrics Product Development & Commercialization Develop Guidelines for Sharing Process Improvement Benefits with Suppliers

Returns Management

Source: Keely L. Croxton, Sebastin J. Garca-Dastugue, Douglas M. Lambert, and Dale S. Rogers, The Supply Chain Management Processes, The International Journal of Logistics Management, Vol. 12, No. 2, 2001, p. 25.

Reference
1. Supply Chain Logistics Management by Bowersox, D. J., Closs, D. J., and Cooper, M. B., Publishers: McGraw Hill International Edition, Asia

Questions
1. How does the contemporary view of procurement as a strategic activity differ from the more traditional view of purchasing? 2. How can strategic procurement contribute to the quality of produced by a manufacturing organization? 3. How does the total cost of ownership differs from the lowest purchase price? 4. Explain the rationale underlying volume consolidation. What are the risk associated with using a single supplier for an item? 5. What is the underlying rationale that explains why firms should segment their purchase requirements?