1. Sourcing Decisions and the Purchasing Process

2. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 2 Introduction Why purchasing is critical The sourcing decision Sourcing strategies The purchasing process Multi criteria decision models in sourcing and purchasing Trends in purchasing management

3. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 3 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 Purchasing – The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance Sourcing decisions and purchasing activities serve to link a company with its upstream supply chain partners Focus

4. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 4 Why Purchasing is Critical – I To compete globally, you need to purchase globally Global purchasing efforts are supported by advances in information systems The Changing Global Competitive Landscape

5. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 5 For the average manufacturer, 52.5% of the value of shipments comes from materials Purchasing represents a major opportunity to increase profitability Financial Impact Why Purchasing is Critical – II

6. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 6 Why Purchasing is Critical Financial Impact - I Earnings and Expenses Sales $26,491 COGS $18,465 Pretax earnings $2,359 Selected Balance Sheet Items Merchandise inventory $3,968 Lowe’s Company Every dollar saved in purchasing increases pretax profit by one dollar Every dollar saved in purchasing lowers inventory (assets) by one dollar

7. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 7 Earnings and Expenses Current With 3% saving Sales $26,491$26,491 COGS $18,465$17,911 Pretax earnings $2,359 $2,913 Selected Balance Sheet Items Merchandise inventory $3,968 $3,849 3% purchasing reduction in COGS Pretax earnings increase by $554 (23.4%) ROA increases from 14.6% to 18.2% Why Purchasing is Critical Financial Impact - II

8. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 8 Quality Delivery Ability to exploit new technologies Performance Impact Why Purchasing is Critical – III

9. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 9 $10$2 99.8%95% Overnight delivery 1 day to 3 weeks Supplier A Supplier B Cost per valve % good Delivery lead time Sourcing dialysis machine valves Why Purchasing is Critical Performance Impact - I

10. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 10 Effect of defective dialysis machine valves Interruption in patient treatment Rescheduling difficulties Reduction in the effective capacity for dialysis Possible medical emergencies Estimated cost of a failed valve = $1,000 Why Purchasing is Critical Performance Impact - II

11. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 11 Supplier A Supplier B Valve costs Failure costs Backup inventory Total costs Sourcing dialysis machine valves (Total Costs) 50 x $10 = $50050 x $2 = $100 0.2% x 50 valves x $1,000 = $100 5% x 50 valves x $1,000 = $2,500 1 valve x $10 = $103 valves x $2 = $6 $610$2,606 Why Purchasing is Critical Performance Impact - III

12. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 12 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 Sourcing decisions are high-level, often strategic decisions that address:  Which will use resources within the firm  Which will be provided by supply chain partners The Sourcing Decision Make or Buy Decision

13. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 13 Advantages and Disadvantages of Insourcing Advantages High degree of control Ability to oversee the entire program Economies of scale and/or scope Disadvantages Required strategic flexibility Required high investment Loss of access to superior products and services offered by potential suppliers

14. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 14 Advantages and Disadvantages of Outsourcing Advantages High strategic flexibility Low investment risk Improved cash flow Access to state-of-the- art products and services Disadvantages Possibility of choosing a bad supplier Loss of control over the process and core technologies Communication and coordination challenges “Hollowing out” of the corporation

15. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 15 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

16. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 16 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 that are 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

17. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 17 Insourcing and Outsourcing Costs Direct material Direct labor Freight costs Variable overhead Price (from invoice) Freight costs Supervision Administrative support Supplies Maintenance costs Equipment depreciation Utilities Building lease Fixed overhead Purchasing Receiving Quality control Insourcing Outsourcing Direct costs Indirect costs

18. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 18 Single sourcing – The buying firm depends on a single company for all or nearly all of an item or service Multiple sourcing – The buying firm shares its business across multiple suppliers Cross sourcing – Using a single supplier for a certain part or service and another supplier with the same capabilities for a similar part Dual sourcing – Using two suppliers for the same purchased product or service Sourcing Strategies

19. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 19 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

20. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 20 The Purchasing Process Needs Identification Needs identification Purchase requisition – An internal document completed by a user that informs purchasing of a specific need Reorder point system – A method used to initiate the purchase of routine items. Typically, each item has a predetermined order point and order quantity

21. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 21 The Purchasing Process Description Description by market grade/industry standard Description by brand Description by specification Description by performance characteristics Description by prototypes or samples Description The communication of a user’s needs to potential suppliers in the most efficient and accurate way possible

22. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 22 The Purchasing Process Supplier Identification and Evaluation - I Supplier identification and evaluation The complexity of the product or service increases The amount of money that is committed increases The length of the proposed buyer-supplier relationship increases The amount of effort increases as:

23. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 23 Supplier identification and evaluation Process and design capabilities Management capability Financial condition and cost structures Planning and control systems Environmental regulation compliance Longer-term relationship potential Criteria for supplier assessment: The Purchasing Process Supplier Identification and Evaluation - II

24. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 24 Supplier selection Preferred supplier Competitive bidding Negotiation The Purchasing Process Supplier Selection - I

25. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 25 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

26. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 26 Supplier selection The buying firm can provide qualified suppliers with clear descriptions of the items or services Volume is high enough to justify the cost and effort The firm does not have a preferred supplier Competitive bidding is most effective when: The Purchasing Process Supplier Selection - III

27. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 27 Supplier selection The item is new or technically complex with only vague specifications The purchase requires agreement about a wide range of performance factors The supplier must participate in the development effort The supplier cannot determine risks and costs without input from the buyer Negotiation is most effective when: The Purchasing Process Supplier Selection - IV

28. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 28 Purchase order preparation Records maintenance Invoice clearing and payment Receipt and inspection Follow-up and expediting Purchase order preparation 74% of firms currently have electronic data interchange (EDI) with some part of their supply base Follow-up and expediting Receipt and inspection Invoice clearance and payment Records maintenance The Purchasing Process The Order Cycle

29. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 29 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)?

30. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 30 Weighted-Point Evaluation System - I Assign weights to performance dimensions Rate the performance of each supplier with regard to each dimension Calculate the total score Evaluating potential suppliers Tracking suppliers’ performance over time / ranking current suppliers Purpose: The Process:

31. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 31 $4/unit$5/unit$2/unit 5% defects1% defects10% defects 95% on time80% on time60% on time Aardvark Beverly Conan the Electronics Hills Inc. Electrician Performance Dimension Price Quality Delivery reliability Weighted-Point Evaluation System - II Summary Data for Alternative Suppliers

32. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 32 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

33. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 33 435 351 421 Aardvark Beverly Conan the Electronics Hills Inc. Electrician Performance Dimension Price Quality Delivery reliability Weighted-Point Evaluation System - IV Performance Values for Alternative Suppliers

34. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 34 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

35. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 35 Trends in Purchasing Management Long-term Contracts and Consolidation Supply Base Reduction Global Purchasing Supplier Performance Measurement Supplier Technology Information Technology Professionalism in Purchasing

36. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 36 Trends in Purchasing Management - I Contract length Competitive bidding, reviewed annually or semiannually Long-term contracts (> 2 years) with performance improvement clauses Purchase consolidation Products and services purchased by individual business units Purchases consolidated across business units to leverage volumes and purchasing efforts Number of suppliers Suppliers switched often, with many suppliers for each purchased item Firms more likely to single- source or dual-source in order to improve performance and reduce costs Area of Traditionally In the Future Purchasing

37. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 37 Trends in Purchasing Management - II Location of suppliers Primarily domestic or even local Global sourcing to access the best suppliers in the world Top management’s perception of purchasing Purchasing seen as a nuisance or non-value added activity Purchasing sees as a way to harness suppliers’ capabilities Importance of time Long cycle times tolerated; little involvement of suppliers in new product development Cycle times a critical order- winner; suppliers cooperate in new product development to reduce development time Area of Traditionally In the Future Purchasing

38. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 38 Trends in Purchasing Management - III Improvement of suppliers’ capabilities Suppliers expected to improve... or else! Buying organizations improving supplier performance through supplier development programs Supplier performance measurement Random or nonexistent monitoring of suppliers, quality, delivery, and price over time Detailed, formal performance measurement systems to track price, delivery, quality and other measures Supplier performance standards Low standards, if anyIncreasing levels of performance expected Area of Traditionally In the Future Purchasing

39. ©2006 Pearson Prentice Hall — Introduction to Operations and Supply Chain Management — Bozarth & Handfield Chapter 10, Slide 39 Trends in Purchasing Management – IV Reliance on supplier product and process technology Little to none; suppliers expected to deliver exactly what was asked for and no more Suppliers active in new product/process development Information systems linking buyers and suppliers Little or noneIncreasing use of EDI, B2Bs, Cad/CAM, and Web to link supply chain partners Purchasing responsibilities Primarily clerical – processing purchase orders Increased use of technology for routine activities; more time spent managing key supplier relationships Area of Traditionally In the Future Purchasing