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©2006 Pearson Prentice Hall — Introduction to Operations and ...


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©2006 Pearson Prentice Hall — Introduction to Operations and ...

  1. 1. Sourcing Decisions and the Purchasing Process
  2. 2. Introduction <ul><li>Why purchasing is critical </li></ul><ul><li>The sourcing decision </li></ul><ul><li>Sourcing strategies </li></ul><ul><li>The purchasing process </li></ul><ul><li>Multi criteria decision models in sourcing and purchasing </li></ul><ul><li>Trends in purchasing management </li></ul>
  3. 3. Strategic Sourcing <ul><li>Strategic Sourcing is the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of the business </li></ul>
  4. 4. Bullwhip Effect Order Quantity Time Retailer’s Orders Order Quantity Time Wholesaler’s Orders Order Quantity Time Manufacturer’s Orders The magnification of variability in orders in the supply-chain A lot of retailers each with little variability in their orders…. … can lead to greater variability for a fewer number of wholesalers, and… … can lead to even greater variability for a single manufacturer.
  5. 5. Hau Lee’s Concepts of Supply Chain Management <ul><li>Hau Lee’s approach to supply chain (SC) is one of aligning SC’s with the uncertainties revolving around the supply process side of the SC </li></ul><ul><li>A stable supply process has mature technologies and an evolving supply process has rapidly changing technologies </li></ul><ul><li>Types of SC’s </li></ul><ul><ul><li>Efficient SC’s </li></ul></ul><ul><ul><li>Risk-Hedging SC’s </li></ul></ul><ul><ul><li>Responsive SC’s </li></ul></ul><ul><ul><li>Agile SC’s </li></ul></ul>
  6. 6. What is Outsourcing? <ul><li>Outsourcing is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers </li></ul>
  7. 7. Reasons to Outsource <ul><li>Organizationally-driven </li></ul><ul><li>Improvement-driven </li></ul><ul><li>Financially-driven </li></ul>
  8. 8. Value Density <ul><li>Value density is defined as the value of an item per pound of weight </li></ul><ul><li>It is used as an important measure when deciding where items should be stocked geographically and how they should be shipped </li></ul>
  9. 9. Mass Customization <ul><li>Mass customization is a term used to describe the ability of a company to deliver highly customized products and services to different customers </li></ul><ul><li>The key to mass customization is effectively postponing the tasks of differentiating a product for a specific customer until the latest possible point in the supply-chain network </li></ul>
  10. 10. <ul><li>Sourcing decisions – High level, often strategic decisions regarding which products or services will be provided internally and which will be provided by external supply-chain partners </li></ul><ul><li>Purchasing – The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance </li></ul>Focus Sourcing decisions and purchasing activities serve to link a company with its upstream supply chain partners
  11. 11. Why Purchasing is Critical – I <ul><li>To compete globally, you need to purchase globally </li></ul><ul><li>Global purchasing efforts are supported by advances in information systems </li></ul>The Changing Global Competitive Landscape
  12. 12. <ul><li>For the average manufacturer, 52.5% of the value of shipments comes from materials </li></ul><ul><li>Purchasing represents a major opportunity to increase profitability </li></ul>Why Purchasing is Critical – II Financial Impact
  13. 13. <ul><li>Quality </li></ul><ul><li>Delivery </li></ul><ul><li>Ability to exploit new technologies </li></ul>Why Purchasing is Critical – III Performance Impact
  14. 14. Why Purchasing is Critical Performance Impact - I Supplier A Supplier B Cost per valve % good Delivery lead time Sourcing dialysis machine valves 1 day to 3 weeks Overnight delivery 95% 99.8% $2 $10
  15. 15. Why Purchasing is Critical Performance Impact - II Effect of defective dialysis machine valves <ul><li>Interruption in patient treatment </li></ul><ul><li>Rescheduling difficulties </li></ul><ul><li>Reduction in the effective capacity for dialysis </li></ul><ul><li>Possible medical emergencies Estimated cost of a failed valve = $1,000 </li></ul>
  16. 16. Why Purchasing is Critical Performance Impact - III Supplier A Supplier B Valve costs Failure costs Backup inventory Total costs Sourcing dialysis machine valves (Total Costs) $2,606 $610 3 valves x $2 = $6 1 valve x $10 = $10 5% x 50 valves x $1,000 = $2,500 0.2% x 50 valves x $1,000 = $100 50 x $2 = $100 50 x $10 = $500
  17. 17. <ul><li>Insourcing – The use of resources within the firm to provide products or services </li></ul><ul><li>Outsourcing – The use of supply chain partners to provide products or services </li></ul>The Sourcing Decision <ul><li>Sourcing decisions are high-level, often strategic decisions that address: </li></ul><ul><li>Which will use resources within the firm </li></ul><ul><li>Which will be provided by supply chain partners </li></ul>Make or Buy Decision
  18. 18. Advantages and Disadvantages of Insourcing <ul><li>Advantages </li></ul><ul><li>High degree of control </li></ul><ul><li>Ability to oversee the entire program </li></ul><ul><li>Economies of scale and/or scope </li></ul><ul><li>Disadvantages </li></ul><ul><li>Required strategic flexibility </li></ul><ul><li>Required high investment </li></ul><ul><li>Loss of access to superior products and services offered by potential suppliers </li></ul>
  19. 19. Advantages and Disadvantages of Outsourcing <ul><li>Advantages </li></ul><ul><li>High strategic flexibility </li></ul><ul><li>Low investment risk </li></ul><ul><li>Improved cash flow </li></ul><ul><li>Access to state-of-the-art products and services </li></ul><ul><li>Disadvantages </li></ul><ul><li>Possibility of choosing a bad supplier </li></ul><ul><li>Loss of control over the process and core technologies </li></ul><ul><li>Communication and coordination challenges </li></ul><ul><li>“ Hollowing out” of the corporation </li></ul>
  20. 20. Factors Affecting the Decision to Insource or Outsource Environmental uncertainty low high Competition in the supplier market low high Ability to monitor supplier performance low high Relationship of product/service to high low buying firm’s core competencies Factor Favors Insourcing Favors Outsourcing
  21. 21. Total Cost Analysis A process by which a firm seeks to identify and quantify all of the major costs associated with various sourcing options <ul><li>Direct costs – Costs that are tied directly to the level of operations or supply chain activities </li></ul><ul><li>Indirect costs – Costs that are not tied directly to the level of operations or supply chain activity </li></ul>
  22. 22. Insourcing and Outsourcing Costs Insourcing Outsourcing Direct costs Indirect costs <ul><li>Purchasing </li></ul><ul><li>Receiving </li></ul><ul><li>Quality control </li></ul><ul><li>Supervision </li></ul><ul><li>Administrative support </li></ul><ul><li>Supplies </li></ul><ul><li>Maintenance costs </li></ul><ul><li>Equipment depreciation </li></ul><ul><li>Utilities </li></ul><ul><li>Building lease </li></ul><ul><li>Fixed overhead </li></ul><ul><li>Price (from invoice) </li></ul><ul><li>Freight costs </li></ul><ul><li>Direct material </li></ul><ul><li>Direct labor </li></ul><ul><li>Freight costs </li></ul><ul><li>Variable overhead </li></ul>
  23. 23. <ul><li>Single sourcing – The buying firm depends on a single company for all or nearly all of an item or service </li></ul><ul><li>Multiple sourcing – The buying firm shares its business across multiple suppliers </li></ul><ul><li>Cross sourcing – Using a single supplier for a certain part or service and another supplier with the same capabilities for a similar part </li></ul><ul><li>Dual sourcing – Using two suppliers for the same purchased product or service </li></ul>Sourcing Strategies
  24. 24. Invoice clearance & payments Records maintenance Receipt and inspection Follow up and expediting Purchase order preparation Supplier selection Supplier identification and evaluation Description Needs identification Is there a preferred supplier? No Yes The Purchasing Process Order cycle
  25. 25. The Purchasing Process Needs Identification <ul><li>Purchase requisition – An internal document completed by a user that informs purchasing of a specific need </li></ul><ul><li>Reorder point system – A method used to initiate the purchase of routine items. Typically, each item has a predetermined order point and order quantity </li></ul>Needs identification
  26. 26. The Purchasing Process Description <ul><li>Description by market grade/industry standard </li></ul><ul><li>Description by brand </li></ul><ul><li>Description by specification </li></ul><ul><li>Description by performance characteristics </li></ul><ul><li>Description by prototypes or samples </li></ul>The communication of a user’s needs to potential suppliers in the most efficient and accurate way possible Description
  27. 27. The Purchasing Process Supplier Identification and Evaluation - I <ul><li>The complexity of the product or service increases </li></ul><ul><li>The amount of money that is committed increases </li></ul><ul><li>The length of the proposed buyer-supplier relationship increases </li></ul>The amount of effort increases as: Supplier identification and evaluation
  28. 28. <ul><li>Process and design capabilities </li></ul><ul><li>Management capability </li></ul><ul><li>Financial condition and cost structures </li></ul><ul><li>Planning and control systems </li></ul><ul><li>Environmental regulation compliance </li></ul><ul><li>Longer-term relationship potential </li></ul>Criteria for supplier assessment: The Purchasing Process Supplier Identification and Evaluation - II Supplier identification and evaluation
  29. 29. Supplier selection <ul><li>Preferred supplier </li></ul><ul><li>Competitive bidding </li></ul><ul><li>Negotiation </li></ul>The Purchasing Process Supplier Selection - I
  30. 30. Supplier selection Preferred supplier A supplier that has demonstrated its performance capabilities through previous purchase contracts and therefore receives preference during the supplier selection process The Purchasing Process Supplier Selection - II
  31. 31. Supplier selection <ul><li>The buying firm can provide qualified suppliers with clear descriptions of the items or services </li></ul><ul><li>Volume is high enough to justify the cost and effort </li></ul><ul><li>The firm does not have a preferred supplier </li></ul>Competitive bidding is most effective when: The Purchasing Process Supplier Selection - III
  32. 32. Supplier selection <ul><li>The item is new or technically complex with only vague specifications </li></ul><ul><li>The purchase requires agreement about a wide range of performance factors </li></ul><ul><li>The supplier must participate in the development effort </li></ul><ul><li>The supplier cannot determine risks and costs without input from the buyer </li></ul>Negotiation is most effective when: The Purchasing Process Supplier Selection - IV
  33. 33. <ul><li>Purchase order preparation 74% of firms currently have electronic data interchange (EDI) with some part of their supply base </li></ul><ul><li>Follow-up and expediting </li></ul><ul><li>Receipt and inspection </li></ul><ul><li>Invoice clearance and payment </li></ul><ul><li>Records maintenance </li></ul>The Purchasing Process The Order Cycle Purchase order preparation Records maintenance Invoice clearing and payment Receipt and inspection Follow-up and expediting
  34. 34. Multi-Criteria Decision Models in Sourcing and Purchasing How do we evaluate alternatives when criteria include both quantitative measures (such as costs and on-time delivery performance) and qualitative factors (such as management stability and trustworthiness)?
  35. 35. Weighted-Point Evaluation System - I <ul><li>Assign weights to performance dimensions </li></ul><ul><li>Rate the performance of each supplier with regard to each dimension </li></ul><ul><li>Calculate the total score </li></ul><ul><li>Evaluating potential suppliers </li></ul><ul><li>Tracking suppliers’ performance over time / ranking current suppliers </li></ul>Purpose: The Process:
  36. 36. Aardvark Beverly Conan the Electronics Hills Inc. Electrician Performance Dimension Price Quality Delivery reliability Weighted-Point Evaluation System - II Summary Data for Alternative Suppliers 60% on time 80% on time 95% on time 10% defects 1% defects 5% defects $2/unit $5/unit $4/unit
  37. 37. Weighted-Point Evaluation System - III 5 = excellent 4 = good 3 = average 2 = fair 1 = poor Scoring Scheme Criteria Weights W Price = 0.3 W Quality = 0.4 W Delivery = 0.3 reliability
  38. 38. Aardvark Beverly Conan the Electronics Hills Inc. Electrician Performance Dimension Price Quality Delivery reliability Weighted-Point Evaluation System - IV Performance Values for Alternative Suppliers 1 2 4 1 5 3 5 3 4
  39. 39. Weighted-Point Evaluation System - V 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 Beverly Hills should improve their delivery and price Conan is out of the running as a potential supplier
  40. 40. Trends in Purchasing Management <ul><li>Long-term Contracts and Consolidation </li></ul><ul><li>Supply Base Reduction </li></ul><ul><li>Global Purchasing </li></ul><ul><li>Supplier Performance Measurement </li></ul><ul><li>Supplier Technology </li></ul><ul><li>Information Technology </li></ul><ul><li>Professionalism in Purchasing </li></ul>
  41. 41. Trends in Purchasing Management - I Area of Traditionally In the Future Purchasing Firms more likely to single-source or dual-source in order to improve performance and reduce costs Suppliers switched often, with many suppliers for each purchased item Number of suppliers Purchases consolidated across business units to leverage volumes and purchasing efforts Products and services purchased by individual business units Purchase consolidation Long-term contracts (> 2 years) with performance improvement clauses Competitive bidding, reviewed annually or semiannually Contract length
  42. 42. Trends in Purchasing Management - II Area of Traditionally In the Future Purchasing Cycle times a critical order-winner; suppliers cooperate in new product development to reduce development time Long cycle times tolerated; little involvement of suppliers in new product development Importance of time Purchasing sees as a way to harness suppliers’ capabilities Purchasing seen as a nuisance or non-value added activity Top management’s perception of purchasing Global sourcing to access the best suppliers in the world Primarily domestic or even local Location of suppliers
  43. 43. Trends in Purchasing Management - III Area of Traditionally In the Future Purchasing Increasing levels of performance expected Low standards, if any Supplier performance standards Detailed, formal performance measurement systems to track price, delivery, quality and other measures Random or nonexistent monitoring of suppliers, quality, delivery, and price over time Supplier performance measurement Buying organizations improving supplier performance through supplier development programs Suppliers expected to improve . . . or else! Improvement of suppliers’ capabilities
  44. 44. Trends in Purchasing Management – IV Area of Traditionally In the Future Purchasing Increased use of technology for routine activities; more time spent managing key supplier relationships Primarily clerical – processing purchase orders Purchasing responsibilities Increasing use of EDI, B2Bs, Cad/CAM, and Web to link supply chain partners Little or none Information systems linking buyers and suppliers Suppliers active in new product/process development Little to none; suppliers expected to deliver exactly what was asked for and no more Reliance on supplier product and process technology
  45. 45. Logistics
  46. 46. Logistics <ul><li>Logistics defined </li></ul><ul><li>Logistics decision areas </li></ul><ul><li>Logistics strategies in action </li></ul><ul><ul><li>Kraft Foods, page 336. </li></ul></ul>
  47. 47. Logistics Planning, implementing, and controlling the effective flow and storage of goods and materials from the point of origin to the point of consumption (CLM)
  48. 48. Key Decision Areas <ul><li>Transportation </li></ul><ul><li>Warehousing (and more generally, location) </li></ul><ul><li>Packaging </li></ul><ul><li>Material handling </li></ul><ul><li>Logistics information systems </li></ul><ul><li>Logistics service providers </li></ul><ul><li>(And some would put inventory here as well!) </li></ul>
  49. 49. Why the Increasing Interest? <ul><li>Deregulation </li></ul><ul><li>Globalization </li></ul><ul><li>Technological breakthroughs </li></ul><ul><li>Environmental concerns </li></ul><ul><li>Performance impact </li></ul>
  50. 50. Deregulation <ul><li>Transportation providers </li></ul><ul><ul><li>Elimination of artificial barriers </li></ul></ul><ul><ul><li>Unrestricted markets </li></ul></ul><ul><ul><li>Multi-modal solutions </li></ul></ul><ul><ul><li>Price, schedule, and terms flexibility </li></ul></ul><ul><li>Buyers have greater freedom </li></ul><ul><ul><li>Negotiate prices, terms, and conditions </li></ul></ul><ul><ul><li>Ownership issues </li></ul></ul><ul><li>BUT… </li></ul>
  51. 51. Deregulation (continued) <ul><li>… With greater freedom comes new responsibilities </li></ul><ul><li>Key point </li></ul><ul><ul><li>Logistics has evolved from being a “tactical” area to a “strategic” one </li></ul></ul>
  52. 52. Globalization (US Statistics) What is driving this activity? +31% +49% Change $917 Billion $670 Billion 1998 $700 Billion $449 Billion 1992 Imports Exports Year
  53. 53. Technological Breakthroughs I <ul><li>Information Systems </li></ul><ul><li>Global positioning systems </li></ul><ul><li>Bar-coding applications </li></ul><ul><ul><li>RFID on the horizon as replacement </li></ul></ul><ul><li>Real-time simulation and optimization </li></ul><ul><li>Precise coordination of multi-modal solutions </li></ul>
  54. 54. Technological Breakthroughs II <ul><li>Transportation Systems </li></ul><ul><li>Standardized containers for ease of transfer </li></ul><ul><li>“ Roadrailers,” etc. </li></ul><ul><li>Multi-modal solutions </li></ul><ul><ul><li>Ship  Truck  Train  Truck  ? </li></ul></ul>
  55. 55. Environmental Concerns <ul><li>Even while certain aspects of logistics have been deregulated, other areas are being controlled more stringently </li></ul><ul><ul><li>Fuel efficiency </li></ul></ul><ul><ul><li>Pollution </li></ul></ul><ul><ul><li>Recovery, recycling, and reuse of packaging, containers, and products </li></ul></ul>
  56. 56. Performance Impact I Comparative GDP and Logistics Expenditures (billions of $, 1998) Source: D. Bowersox and R. Calantone, “Executive Insights: Global Statistics,” Journal of International Marketing , Vol. 8, no. 4, 1998, pp 83-93. 11.7 3,424 29,161 Total 12.9 916 7,080 Other 11.6 652 5,605 Pacific 11.8 941 7,981 Europe 10.8 915 8,495 North America Logistics % of GDP Logistics Expenditure Gross Domestic Product Region
  57. 57. Performance Impact II <ul><li>Customer “touch points” </li></ul><ul><ul><li>Delivery reliability </li></ul></ul><ul><ul><li>Delivery speed </li></ul></ul><ul><ul><li>Delivery tracking </li></ul></ul><ul><ul><li>Quality </li></ul></ul>
  58. 58. Performance Impact III Total time to the customer at WolfByte Computer 75% decrease in manufacturing time, but only 25% decrease in time to customer. Where is the leverage now? 4.5 days 6 days Total Time to the Customer 4 days 4 days Shipping Time 0.5 days 2 days Manufacturing Time 2004 2000
  59. 59. The Evolution of Logistics Strategy From functional silos to strategic positioning
  60. 60. Strategic Disconnect
  61. 61. Who “Owns” Logistics?
  62. 62. Logistics Decision Areas <ul><li>Transportation… </li></ul><ul><ul><li>Modes </li></ul></ul><ul><ul><li>Formats </li></ul></ul><ul><ul><li>Pricing </li></ul></ul><ul><li>Warehousing </li></ul><ul><ul><li>Consolidation </li></ul></ul><ul><ul><li>Cross Docking and Break-Bulk </li></ul></ul><ul><ul><li>Hub and Spoke </li></ul></ul><ul><ul><li>Inventory </li></ul></ul>
  63. 63. Major Transportation Modes <ul><li>Highway (truck) </li></ul><ul><li>Water </li></ul><ul><li>Rail </li></ul><ul><li>Air </li></ul><ul><li>Pipeline </li></ul>
  64. 64. Modal Shares of Shipments (within US, 1999) 6.7 5.5 5.5 Other/Unknown 17.6 13.7 4.2 Pipeline 0.2 0 2.7 Air 26.7 11.2 4.8 Rail 20.4 11.1 2.5 Water 28.4 58.5 80.3 Highway (trucking, parcel, postal, courier) Ton Miles (%) Tons (%) Value (%) Mode
  65. 65. Highway Mode <ul><li>Strengths </li></ul><ul><li>Flexibility to pick up and deliver where and when needed </li></ul><ul><li>Often the best balance between cost/flexibility and delivery reliability/speed </li></ul><ul><li>Can be available 24/7 </li></ul><ul><li>Weaknesses </li></ul><ul><li>Not the fastest </li></ul><ul><li>Not the cheapest </li></ul>
  66. 66. Water Mode <ul><li>Strengths </li></ul><ul><li>Highly cost effective for bulky items </li></ul><ul><li>Most effective when linked into multimodal system </li></ul><ul><li>Weaknesses </li></ul><ul><li>Limited locations </li></ul><ul><li>Relatively poor delivery reliability/speed </li></ul><ul><li>Often limited operating hours at docks </li></ul>
  67. 67. Rail Mode <ul><li>Strengths </li></ul><ul><li>Highly cost effective for bulky items </li></ul><ul><li>Can be most effective when linked into multimodal system </li></ul><ul><li>Weaknesses </li></ul><ul><li>Limited locations, but better than for water. </li></ul><ul><li>Better delivery reliability/speed than water </li></ul>
  68. 68. Air Mode <ul><li>Strengths </li></ul><ul><li>Quickest delivery over longer distances </li></ul><ul><li>Can be very flexible when linked to highway mode </li></ul><ul><li>Weaknesses </li></ul><ul><li>Often the most expensive, particularly on a per pound basis </li></ul>
  69. 69. Question How can businesses design solutions that exploit the strengths of each mode?
  70. 70. Transportation “Formats” <ul><li>Common carriers </li></ul><ul><ul><li>Published rates and schedules </li></ul></ul><ul><ul><li>“ Nondiscriminatory” pricing </li></ul></ul><ul><ul><li>Increased flexibility to partner </li></ul></ul><ul><li>Contract carriers </li></ul><ul><ul><li>Service for select customers </li></ul></ul><ul><ul><li>Unlimited number of customers </li></ul></ul><ul><li>Private carriers </li></ul>