supply chain2- discussion- due in 6 hours

CHAPTER 5 SOURCING MATERIALS AND SERVICES

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.

· 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.

· Six Sigma—Similar to TQM in its focus on techniques for solving problems and using statistical methods to improve processes.

· 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.