Supply Management

Chapter 7
 7
Chapter Objectives
Be able to:
Identify and describe the various steps of the strategic
sourcing process.
Perform and interpret the results of a simple spend
analysis.
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.
Perform a simple total cost analysis.
Show how multicriteria decision models can be used to
evaluate suppliers and interpret the results.
Understand when negotiations should be used and the
purpose of contracts.
Describe the major steps of the procure-to-pay cycle.
DiscussCopyright
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7
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.

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Why is
7
Supply Management critical?
Global Sourcing
Competition against global competitors
and their supply chains.
Advances in information systems have
helped.

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Why is
7
Supply Management critical?
Financial Impact

Table
7.1

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Why is
7
Supply Management critical?
Financial Impact
Cost of goods sold The purchased cost of
goods from outside suppliers.
Merchandise inventory A balance sheet item
that shows the amount a company paid for the
inventory it has on hand at a particular point in
time.
Profit margin The ratio of earnings to sales for
a given time period.
Return on assets (ROA) A measure of
financial performance defined as Earnings/Total
Assets
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 7 Leverage Example 7.1
Profit

Financial Impact

Selected
Financial Data
for Target
Corporation

Table 7.2

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

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

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 7 Leverage Example 7.1
Profit

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
theCopyright
merchandise inventory
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 7 Leverage Example 7.1
Profit

3% purchasing reduction in
COGS
Earnings and Expenses Current Pretax
Reflecting Savings earnings
Sales $65,786 $65,786 increase by
$1372 (30%)
COGS $45,725 $44,353
Pretax earnings $4,629 $6,001
ROA
increases
Selected Balance Sheet Items from 26.9%
Merchandise inventory $7,596 $7,368 to 35.3%
Total assets $17,213 $16,985

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Why is
7
Supply Management critical?
Performance Impact
Purchased goods can have a major
effect on other dimensions such as
quality and delivery performance.

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Performance Impact Example
7
7.2

Sourcing dialysis machine valves

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Performance Impact Example
7
7.2
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
7
7.2

Sourcing 50 dialysis
machine valves (Total
Costs)

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The Strategic Sourcing
7
Process

Figure
7.1

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7
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
7
Example 7.3
Examine the trends
and impact of
spending.

Table 7.3

Figure 7.2
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Profile Internally and
7
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.
Industry Analysis An approach to
provide a more detailed understanding
of the characteristics of the external
supply base.
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7
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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7
Develop the Sourcing Strategy

Advantages and Disadvantages of

Insourcing and Outsourcing

Table
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7
Develop the Sourcing Strategy

Factors that affect the decision

to Insource or Outsource.

Table
7.7

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7
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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7 - 21
7
Develop the Sourcing Strategy

Insourcing and Outsourcing Costs

Table
7.8
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7
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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7
Develop the Sourcing Strategy

Portfolio Analysis
The Routine Quadrant Readily available products or
services (small % of total).
Electronic Data Interchange
The Leverage Quadrant Standardized and readily
available products or services (large % of total).
Preferred suppliers
The Bottleneck Quadrant Unique or complex products
or services supplied by few suppliers.
The Critical Quadrant - Unique or complex products or
services supplied by few suppliers, representing large %
of total.

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 7
Develop the Sourcing Strategy

Portfolio
Analysis
High

Bottleneck Critical
Complexi
ty or Risk
Impact

Routine Leverage
Low
Low High
Value Potential

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7
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
a certain part or service and another
supplier with the same capabilities for a
similar part.
Dual sourcing Using two suppliers for the
same purchased product or service.

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Screen Suppliers and
7
Create Selection Criteria
Criteria to evaluate suppliers

Process and design capabilities

Management capability

Financial condition and cost structure

Longer-term relationship potential

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Conduct Supplier
7
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.
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Supplier Selection Example
7
7.6
Summary Data for Three
Possible Suppliers

Table 7.11

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Supplier Selection Example
7
7.6
n
Score X Performance XY WY
Y 1

Criteria Weights Scoring Scheme

WPrice = 0.3 5 = excellent

4 = good
WQuality = 0.4 3 = average
2 = fair
WDelivery = 0.3 1 = poor

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Supplier Selection Example
7
7.6

Performance Values for

Alternative Suppliers

Table
7.13

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Supplier Selection Example
7
7.6

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.

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Beverly
PrenticeHills
Hall should improve their delivery
Negotiate and Implement
7
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
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Description
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Negotiate and Implement
7
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
7
Agreements
Contracting The process of
creating a detailed purchasing
contract to formalize the buyer-
supplier 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.

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7 Procure-to-Pay Cycle
The
Ordering
Purchase order 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
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

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Trends in Supply
7
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.

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Trends in Supply
7
Management
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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Supply Management
Case Study
Pagoda.com

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Printed in the United States of America.

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