Chapter 7 Supply Management Guide

Chapter Objectives
Be able to:
 Discuss the rise of global sourcing and the important financial and operational
performance impacts of supply management activities.
 Identify and describe the various steps of the strategic sourcing process, and
apply some of the more common analytical tools, including spend analysis,
portfolio analysis, and total cost analysis.
 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.
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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
 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.

 Financial Impact
Table 7.1

 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
Profit Margin = 100% X (Earnings/Sales)
Return on Assets = 100% X ($4,629 / $17,213) = 26.9%
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Profit Margin = 100% X ($4,629 / $65,786) = 7%
Return on Assets = 100% X (Earnings/Assets)
7-7

1. 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.
2. Every dollar saved in purchasing lowers the merchandise inventory figure
– and as a result, total assets – by $1.

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
Merchandise inventory $7,596 $7,368
Total assets $17,213 $16,985

 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.

The Strategic Sourcing Process
 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.
Copyright © 2016 Pearson Education, Inc.
Figure 7.1
7-11

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?

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.

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.

Advantages and Disadvantages of
Insourcing and Outsourcing
Table 7.6

Factors that Affect the Decision
to Insource or Outsource
Table 7.7

 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.

Insourcing and Outsourcing Costs
Table 7.8

 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 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.
 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.

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

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.

Step 5: Conduct Supplier Selection
 Weighted-point evaluation system

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

 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.

 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
 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.
 Settlement and Payment
 May be paid through Electric Funds Transfer (EFT)
 Records Maintenance

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, and reducing costs while being
good for the environment.

Trends in Supply Management
 Supply Chain Disruptions
 Caused by natural disasters, economic or political events.
 Cause a big threat to revenue streams.
 Lead to increased risk due to outsourcing to global suppliers.

Chapter 7 Supply Management Guide

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