Chapter 7 Case Study & Chapter 14 Case Study

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Introduction to Operations and Supply Chain Management

Fifth Edition

Chapter 7

Supply Management

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Chapter Objectives (1 of 2)

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.

Chapter Objectives (2 of 2)

Be able to:

Show how multicriteria decision models can be used to evaluate suppliers and interpret results.

Understand when negotiations should be used and the purpose of contracts.

Describe the major steps of the procure-to-pay cycle.

Discuss some of the longer-term trends in supply management and why they are important.

Introduction

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 Supply Management is Critical (1 of 5)

Global Sourcing

Firms do not compete only against global competitors, but against their competitors’ supply chains.

To keep up with global competition and tap into the abilities of world-class suppliers, many companies have put in place global sourcing systems.

Advances in information systems have served as a catalyst for global sourcing efforts.

Global sourcing applies to services and business processes, as well as manufactured goods.

Why Supply Management is Critical (2 of 5)

Table 7.1 Top 10 First-Tier Suppliers in Global Automotive Industry

Company	Home Country	2015 Sales ($ Billions)	Products
Bosch	Germany	$45	Gasoline & diesel systems, chassis system controls
Denso	Japan	36	Powertrain control, electronic & electric Systems
Magneti Marelli	Canada	32	Body, chassis, exterior, seating, powertrain, electronic, vision,
Continental	Germany	31	Driver assistance systems, electronic brakes, stability systems
ZF Friedrichshafen AG	Germany	39	Transmissions, chassis components and systems, steering
Hyundai Mobis	Korea	26	Chassis, cockpit & front-end modules; stability control steering
Aisin Seiki Co.	Japan	26	Body, brake & chassis systems, electronics, drivetrain,

Why Supply Management is Critical (3 of 5)

[Table 7.1 Continued]

Faurecia	France	23	Seating, emissions control technologies, interior systems
Johnson Controls Inc.	USA	20	Complete automotive seats & seat Components
Lear Corp.	USA	18	Seating & electrical distribution systems
Toyota	Japan	248	Blank
Volkswagen	Germany	213	Blank
GM	USA	152	Blank

Source: Based on Automotive News, “Top Suppliers,” June 20, 2016, www.autonews.com/assets/PDF/CA105764617.PDF.

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Why Supply Management is Critical (4 of 5)

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 generally defined as Earnings/Total Assets

Example 7.1 – Target Corporation (1 of 3)

Table 7.3 Selected Financial Data for Target Corporation (all figures in $ millions)

Earnings and Expenses, 2010	Blank
Sales	$65,786
Cost of goods sold (COGS)	$45,725
Pretax earnings	$4,629

Selected Balance Sheet Items (As of January 29, 2011)	Blank
Merchandise inventory	$7,596
Total assets	$17,213

Example 7.1 – Target Corporation (2 of 3)

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.

Example 7.1 – Target Corporation (3 of 3)

3% purchasing reduction in COGS

Earnings and Expenses	Current	Reflecting Savings
Sales	$65,786	$65,786
COGS	$45,725	$44,353
Pretax earnings	$4,629	$6,001
Selected Balance Sheet Items	Blank	Blank
Merchandise inventory	$7,596	$7,368
Total assets	$17,213	$16,985

Why Supply Management is Critical (5 of 5)

Performance Impact

Cost is not the only consideration.

Purchased goods and services can have a major effect on other performance dimensions including quality and delivery performance.

Example 7.2 – Springfield Hospital (1 of 3)

Springfield Hospital has two dialysis machines, each with a special valve that is normally replaced every two weeks when the machines are idle. As a result, Springfield uses about 50 valves per year. The hospital has two alternative sources for the valves. The purchase price and quality for these two suppliers are as follows:

Blank	Supplier A	Supplier B
Price per valve	$10	$2
% Good	99.8%	95%

Example 7.2 – Springfield Hospital (2 of 3)

Effect of defective valve

Interruption in patient treatment

Rescheduling difficulties

Reduction in the effective capacity for dialysis

Possible medical emergencies

Estimated cost of a failed valve = $1,000 per incident

Example 7.2 – Springfield Hospital (3 of 3)

Sourcing 50 dialysis machine valves (Total Costs)

Yearly Costs	Supplier A	Supplier B
Valves	50 × $10 = $500	50 × $2 = $100
Failure costs	0.2% of all valves fail: 0.2% × 50 valves × $1,000 = $100	5% of all valves fail: 5% × 50 valves × $1,000 = $2,500
Total cost	$600	$2,600

The Strategic Sourcing Process (1 of 17)

Strategic Sourcing

Identifying ways to improve long-term business performance by better understanding sourcing needs, developing long-term sourcing strategies, selecting suppliers, and managing the supply base.

Figure 7.1 The Strategic Sourcing Process

The Strategic Sourcing Process (2 of 17)

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.

What categories of products or services make up the bulk of company spending?

How much are we spending with various suppliers?

What are our spending patterns like across different locations?

The Strategic Sourcing Process (3 of 17)

Step 2: Profile Internally and Externally

Two approaches to creating profiles:

Category profile – Understanding all aspects of a particular sourcing category that could ultimately have an impact on the sourcing strategy.

Industry Analysis – Profiling the major forces and trends that are impacting an industry, including pricing, competition, regulatory forces, substitution, technology changes, and supply/demand trends.

The Strategic Sourcing Process (4 of 17)

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.

The Strategic Sourcing Process (5 of 17)

Table 7.7 Advantages and Disadvantages of Insourcing and Outsourcing

Insourcing	Blank
Advantages	Disadvantages
High degree of control	Reduced strategic flexibility
Ability to oversee the entire process	Required high investment
Economies of scale and/or scope	Potential suppliers may offer superior products and services

Outsourcing	Blank
Advantages	Disadvantages
High strategic flexibility	Possibility of choosing a bad supplier
Low investment risk	Loss of control over the process and core technologies
Improved cash flow	Communication/coordination challenges
Access to state-of-the-art products and services	Increased risk of supply chain disruption, corporate social responsibility (CSR) risks

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The Strategic Sourcing Process (6 of 17)

Table 7.8 Factors that Affect the Decision to Insource or Outsource

Blank	Favors Insourcing	Favors Outsourcing
Environmental uncertainty	Low	High
Competition in the supplier market	Low	High
Ability to monitor supplier’s performance	Low	High
Relationship of product/service to buying firm’s core competencies	High	Low

The Strategic Sourcing Process (7 of 17)

Step 3: 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.

The Strategic Sourcing Process (8 of 17)

Table 7.9 Insourcing and Outsourcing Costs

Blank	Insourcing	Outsourcing
Direct Costs	Direct material Direct labor Freight costs Variable overhead	Price (from invoice) Freight costs
Indirect Costs	Supervision Administrative support Supplies Maintenance costs Equipment depreciation Utilities Building lease Fixed overhead	Purchasing Receiving Quality control

The Strategic Sourcing Process (9 of 17)

Step 3: 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.

The Routine Quadrant – Readily available products or services representing a relatively small portion of a firm’s purchasing expenditures.

The Leverage Quadrant – Standardized and readily available products or services representing a significant portion of spend.

The Strategic Sourcing Process (10 of 17)

Step 3: Develop the Sourcing Strategy

The Bottleneck Quadrant – Products or services with unique or complex requirements that can be met only by a few potential suppliers.

The Critical Quadrant – Products or service with unique or complex requirements coupled with a limited supply base.

Single sourcing – The buying firm depends on a single company for all or nearly all of a particular item or service.

The Strategic Sourcing Process (11 of 17)

Step 3: Develop the Sourcing Strategy

Multiple sourcing – The buying firm shares its business across multiple suppliers.

Cross sourcing – The buying firm uses a single supplier for one particular part or service and another supplier with the same capabilities for a different part or service.

Dual sourcing – The buying firm uses two suppliers for the same purchased product or service.

The Strategic Sourcing Process (12 of 17)

Step 4: Screen Suppliers and Create Selection Criteria

Qualitative criteria to evaluate suppliers include:

Process and design capabilities

Management capability

Financial condition and cost structure

Longer-term relationship potential

The Strategic Sourcing Process (13 of 17)

Step 5: Conduct Supplier Selection

Weighted-point evaluation system

Assign weights to performance dimensions.

Rate the performance of each supplier with regard to each dimension.

Calculate the total score.

The Strategic Sourcing Process (14 of 17)

Step 5: Conduct Supplier Selection

Weighted-point evaluation system

Example 7.6 – Electra Company (1 of 5)

Electra Company is looking to award a new contract for 500,000 integrated circuit boards. The table below summarizes the expected performance of three possible suppliers with regard to price, quality, and delivery.

Table 7.12 Summary Data for Three Possible Suppliers

Performance Dimension	Aardvark Electronics	Beverly Hills Inc.	Conan the Electrician
Price	$4/unit	$5/unit	$2/unit
Quality	5% defects	1% defects	10% defects
Delivery Reliability	95% on-time	80% on-time	60% on-time

Example 7.6 – Electra Company (2 of 5)

Criteria Weights

WPrice = 0.3

WQuality = 0.4

WDelivery = 0.3

TOTAL = 1.0

Scoring Scheme

5 = excellent

4 = good

3 = average

2 = fair

1 = poor

Example 7.6 – Electra Company (3 of 5)

Table 7.14 Values for the Three Suppliers

Performance Dimension	Aardvark Electronics	Beverly Hills Inc.	Conan the Electrician
Price	4	3	5
Quality	3	5	1
Delivery Reliability	4	2	1

Example 7.6 – Electra Company (4 of 5)

Total Scores for Alternative Suppliers

Aardvark should improve their quality.

Beverly Hills should improve their delivery and price.

Conan is out of the running as a potential supplier.

Example 7.6 – Electra Company (5 of 5)

Options for choosing between Beverly Hills and Aardvark

Award the contract to Aardvark, after a detailed negotiation in which it asks Aardvark to provide details on how it will improve its quality.

Award the contract to Beverly Hills, after a detailed negotiation in which it asks Beverly Hills to reduce its price and explain how it will improve delivery performance.

Award a dual-source contract, in which the volumes are split between two suppliers. The contract might state that future volumes will be assigned according to which supplier improves its performance more quickly.

The Strategic Sourcing Process (15 of 17)

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

The Strategic Sourcing Process (16 of 17)

Step 6: Negotiate and Implement Agreements

Negotiating – A more costly, interactive approach to final supplier selection. This 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.

The Strategic Sourcing Process (17 of 17)

Step 6: Negotiate and Implement 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(s) or other economic factors.

The Procure-to-Pay Cycle (1 of 2)

Ordering

Purchase order – A document that authorizes a supplier to deliver a product or service and often includes key terms and conditions such as price, delivery, and quality requirements.

Follow-Up and Expediting

Receipt and Inspection

Statement of work (scope of work) – Terms and conditions for a purchased service that indicate, among other things, what services will be performed and how the service provider will be evaluated.

The Procure-to-Pay Cycle (2 of 2)

Settlement and Payment

May be paid through Electric Funds Transfer (EFT)

Records Maintenance

Trends in Supply Management (1 of 2)

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, and reducing costs while being good for the environment.

Trends in Supply Management (2 of 2)

Supply Chain Disruptions

Caused by natural disasters, economic or political events.

Cause a big threat to revenue streams.

Risk of disruptions has increased due to companies outsourcing processes to global suppliers.

Supply Management Case Study

Pagoda.com

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