Chapter 6 Sourcing

Objectives After reading the chapter and reviewing the materials presented the students will be able to: Explain the difference between purchasing, strategic sourcing, and supply management Explain the impact of sourcing on the organization Explain different types of sourcing arrangements Explain how to measure sourcing performance

What is sourcing? Sourcing is the business function responsible for all activities and processes required to purchase goods and services from suppliers. Purchasing is a term that defines the process of buying goods and services. Strategic sourcing goes beyond focusing on just the price of goods to looking at sourcing function from a strategic and future oriented perspective.

Evolution of the sourcing function Sourcing moved from being a mere buying function to one responsible for cultivating suppliers and ensuring a large and continuous supply base. The importance of sourcing has continued as companies now compete globally for resources of supply. As a result, the role of the sourcing function has moved to the rank of vice president of purchasing and vice president of supply.

Commercial versus Consumer Sourcing In consumer buying, there are many suppliers of common items and the buyers are typically final consumers of the item they purchase. In commercial buying, the volumes purchased are on a much larger scale. The number of potential suppliers may be limited. The primary function of commercial buying is acquiring the right materials and services and making sure they are available in the right quantities, at the right price, at the right time. As a result commercial buying is much more complex than that of personal buying.

Impact on the Organization and the Supply Chain Shortages of materials can stop an organization from functioning. Too much inventory can mean tied up capital and financial losses. Finding the right balance is an enormous task. The savings that can result from the proper management of this function can have a huge impact on the organization. Another impact is minimizing risks of supply disruptions. This means evaluating suppliers to meet a range of performance standards, including legal and ethical. Sourcing is also continually gathering information on suppliers, prices, as well as new products and technology. This allows companies to incorporate new technologies in their products.

The Sourcing Process The sourcing function is responsible for acquiring goods and services ranging from potential suppliers to negotiating and awarding contracts, and ensuring contract standards are met. Sourcing typically maintains an acceptable list of suppliers for ongoing purchases, but also evaluate suppliers for new needs that occur on an ongoing basis. Supplier selection is important and business can be solicited either in the form of a request for quotation (RFQ), a request for proposal (RFP), or a request or invitation for bid (RFB).

Cost versus Price Cost is the sum of all costs incurred to produce the product. The total cost for producing a product or service is the sum of the fixed costs and variable costs. The price of an item is the amount at which it is being sold in the marketplace. Buyers understand that a supplier must make a profit in order to stay in business. The goal of developing purchasing contracts and negotiation is to find a fair price, which is the lowest price that can be paid while ensuring a continuous supply of quality goods. Total cost of ownership (TCO) includes transportation, administrative costs, follow-up, expediting, storage, inspection and testing, warranty, customer service, and handling returns.

Bidding or Negotiation? Competitive bidding has the objective of awarding the business to the most qualified bidder, once specific criteria have been identified, and can pit suppliers against one another. Negotiation on the other hand is a communication process between two parties that attempts to reach a mutual agreement.

Sourcing and SCM Supply chains have uncertainty on both the demand and supply side. Demand uncertainty occurs when product demand is unstable and difficult to predict. Supply uncertainty occurs when there is uncertainty regarding sources of supplies and their capabilities. Innovative products have highly unpredictable demand and short life cycles.

Single versus Multiple Sourcing Traditionally companies held the view that multiple sources of supply were best in order to increase cost competition and ensure supply security. Single sourcing focuses on building closer supplier relationships and cooperation between buyer and supplier. One strategy companies should consider is a small number of multiple suppliers. Some may be local for rapid deliveries, while other may be global but less expensive.

Domestic versus Global Sourcing Global sourcing has been on the rise as companies have been attracted to cheaper labor costs in other parts of the world. However with the rise in fuel prices, the labor savings are often negated by high transportation costs. Reasons for outsourcing include lower costs, access to technical skills, and the ability to free themselves of doing non-core activities.

Electronic Auctions (e-Auctions) Auctions have been used throughout history as a means of providing competition between suppliers. E-auctions include market transparency, decreased error rate, and simplified comparisons of sources of supply. This may potentially damage a good supplier relationship and is not the best strategy for building long term relationships.

Electronic Auctions (e-Auctions) In an open auction, suppliers can select the items they want to place competitive offers on, see the most competitive offers from other suppliers, and enter as many offers as they want until a specified closing time. In a sealed bid auction, sellers have a certain amount of time to submit one best and final bid, with bidders never having knowledge of what the other sellers are bidding. The most common type of e-auction is the reverse auction. Sellers place decreasing bids. The supplier with the lowest bid is usually awarded the business.

Measuring Sourcing Performance There are two common measures that can be used the performance of sourcing functions. Inventory turnover measures how quickly inventory moves. In general, the higher the inventory turnover rate, the better the company utilizes its inventory. Weeks of supply tells the manager how long the current on hand inventory will last based on current demand. As with inventory turnover, companies should benchmark this metric against industry best practices.

Summary Sourcing is the business function responsible for all activities and processes required to purchase goods and services from suppliers. Purchasing is a term that defines the process of buying goods and services. Strategic sourcing goes beyond focusing on just the price of goods to looking at sourcing function from a strategic and future oriented perspective. The sourcing function is responsible for acquiring goods and services ranging from potential suppliers to negotiating and awarding contracts, and ensuring contract standards are met. Cost is the sum of all costs incurred to produce the product. The price of an item is the amount at which it is being sold in the marketplace. The goal of developing purchasing contracts and negotiation is to find a fair price, which is the lowest price that can be paid while ensuring a continuous supply of quality goods. Total cost of ownership (TCO) includes transportation, administrative costs, follow-up, expediting, storage, inspection and testing, warranty, customer service, and handling returns. In an open auction, suppliers can select the items they want to place competitive offers on, see the most competitive offers from other suppliers, and enter as many offers as they want until a specified closing time. In a sealed bid auction, sellers have a certain amount of time to submit one best and final bid, with bidders never having knowledge of what the other sellers are bidding. The most common type of e-auction is the reverse auction. Sellers place decreasing bids. The supplier with the lowest bid is usually awarded the business. Inventory turnover measures how quickly inventory moves. In general, the higher the inventory turnover rate, the better the company utilizes its inventory. Weeks of supply tells the manager how long the current on hand inventory will last based on current demand. As with inventory turnover, companies should benchmark this metric against industry best practices.

Home Work 1. What is strategic sourcing? 2. What is the difference between cost and price? 3. What is the advantage of the reverse auction?