Supplier Selection &

Evaluation
Preparing a Prospective Supplier List
 You can search for the potential vendors by
looking at several information sources:
 Past experiences
 Interviewing with the salesperson of the
supplier
 Catalogs published by the vendors
 Trade Directories
 Classifies suppliers according to the products
they make
 Includes names of company personnel,
financial status, and location of sales offices
2
Information sources…

 Trade Journals or Business Magazines

 These are oriented towards specific industries

 Fairs and Trade shows

 Specific to industry. Ex: Computer, textile, etc.

3
Types of Suppliers
 In the search for suppliers, all available types (that is,
distributors, manufacturers, and foreign sources)
should be considered.

 The number of suppliers to be used should also be

considered.

 Trade-offs between price, delivery, and service and

community relations and goodwill must be weighed
when selecting various types of vendors.

4
Local vs. National Suppliers
 There are inherent natural advantages to buying from
local suppliers whenever possible.

 Among the most significant are the following:

1. There is usually a freight savings when the distance
between firms is relatively short.
2. Local vendors tend to share the same political and
tax concerns as the purchaser.
3. Close proximity permits many possibilities for
communication and service; shorter lead times, and
exchanges.

5
Local vs. National Suppliers…
 There are also considerations that favor national
suppliers:
1. National concerns may offer lower prices because of
their ability to produce in mass quantities for large
numbers of customers.
2. Technical assistance may be better from large firms
that provide extensive research and development
support.
3. Continuity of supply may be more certain with larger-
volume producers, which exercise considerable raw
material purchasing power and maintain large in-
process and raw materials inventories.
6
Distributor vs. Direct
 The buyer will often have to choose between buying
through a distributor or direct from a manufacturer.

 Both options have their advantages and

disadvantages.

 The manufacturer often offers lower prices than the

distributor; this difference usually depends on the
volume of business.

 Manufacturers generally prefer large-quantity orders.

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Distributor vs. Direct…
 Manufacturers often find small-quantity purchases
unprofitable, considering the expenses involved, and
charge a premium price to compensate.

 Thus, a distributor may offer lower prices on purchases

of smaller quantities.

 Since distributors are generally local firms, they are

often able to provide better service than manufacturers.

 For instance, distributors are able to ship quickly and

handle rush orders as well as visit the buyer's facility
frequently and provide personal services.
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Distributor vs. Direct…
 Another factor in the decision concerns
inventory levels.

 Buying direct usually means buying in large

quantities, and the purchaser must hold these
quantities in inventory.

 In contrast, the distributor maintains a local

inventory, and the buyer can utilize it, making
smaller, more frequent buys.
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Foreign Sources
 The increasing industrialization of third-world
countries, coupled with lower labor costs, has made
foreign purchasing increasingly attractive in recent
years.

 The quality problems formerly associated with foreign

goods have in many instances been transformed into
quality standards that challenge domestic firms.

 However, the drawbacks of foreign sources

sometimes negate the cost savings.
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Foreign Sources…
 The first problem is long lead times.

 In addition to the actual travel time of the goods, time

is spent in customs.

 A large volume of paperwork is necessary to import

goods, and there is a lack of service.

 When a source has no domestic facilities, there are

few avenues of recourse if the supplier makes a
mistake.

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Foreign Sources…
 Another problem is currency fluctuation.

 With such long lead times, the price agreed upon may
rise or fall between purchase and payment simply
because the foreign currency exchange rate fluctuates
against the buyer country’s currency.

 These problems can be dealt with in many ways, and

the supplier will often handIe most of the import details.

 Information about foreign sources can be obtained from

embassies or trade offices operated by various
countries in major cities.
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Looking at Suppliers in Developing
Countries
 Often, you will be investigating suppliers in low-cost,
developing countries.

 Countries tend to develop in a structured way.

 First, a major multinational will move into a

developing country and set up a factory.

 This factory will be mainly an assembly plant and will

do very little local purchasing.

 The components will be imported.

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Country Development
 Next, and with varying degrees of speed, supporting
suppliers will grow up around the multinational and
replace the imports.

 Eventually local employees will leave the

multinational and start their own competing
companies.

 At this point, the country has what Michael Porter

calls a "cluster," and the potential for world-class
competitive industries.
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Buying from Developing Countries…
 When a major multinational moves into a less-
developed country, there is good chance that the
multinational may be able to offer lower prices quickly.

 If you are buying from the company already, you should

know and explore these possibilities.

 Later, when the supporting industry starts to develop, it

becomes attractive to buyers of the supporting
products.

 You should start checking early and be prepared to

move to be the supporting company's customer.
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Single vs. Multiple Sourcing
 Because of quantity discounts or low shipping rates, it
may be more economical to concentrate purchases with
a single supplier.

 JIT and blanket orders lead to single sourcing.

 In other instances the total amount needed may be too

small to justify splitting the order among suppliers
because it would increase per-unit handling and
processing costs.

 Other purchases that encourage the use of a single

supplier are those of parts made by processes
employing expensive tools or dies.
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Single vs. Multiple Sourcing…

 In most cases, however, the buyer who utilizes

multiple suppliers has greater assurance of
uninterrupted supply in the event of fire, flood, or
strikes, which might disrupt the operations of a single
plant.

 Multiple sourcing also stimulates competition among

vendors in price, quality, delivery, and service.

 Therefore, many buyers use multiple sources for

most of the items purchased.

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How many suppliers?
 The decision to use multiple sources prompts
questions about how many suppliers to use and on
what basis to allocate the business.

 Although these questions cannot be answered

universally, these decisions are influenced primarily
by the amounts required, the relative size of the
suppliers, and their past performances.

 Most buyers split orders between two or three

suppliers.
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Supplier Evaluation Factors
 After potential suppliers have been determined and
located, a qualitative evaluation and elimination
process is used.

 This process compares suppliers in terms of their

ability to provide the desired quality, quantity, price,
and service.

 In purchasing parlance, quantity has a somewhat

specialized meaning, referring not only to the total
amount required but also to the schedule according
to which the goods must be received.
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Supplier Evaluation Factors…
 Thus, a supplier who might be able to supply the
desired quantity during the specified period, but could
not supply this quantity on specified dates, would not
be a satisfactory supplier.

 In purchasing, price is meaningless when considered

in isolation from other factors.

 A price is good only if the item supplied has the

desired quality and quantity and is accompanied by
sufficient useful services.
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Location
 The geographical location of the supplier is an important
consideration in evaluating service.

 Shipments from distant suppliers are subject to more

and greater risks of interruption by accidents, strikes,
and acts of nature.

 The possibility of using substitute modes of

transportation is also lessened as distance increases.

 Companies may overcome some of their geographical

disadvantages by providing pool car shipments, branch
warehouses, and make-and-hold services.
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Managing the Disadvantages of
Location
 “Pool car shipment" refers to the practice of collecting a
number of small orders from a given geographical region
and combining them into one shipment, thereby
economizing on freight by obtaining the full-car rate rather
than the much higher less-than-carload (LCL) rate.

 Pool car shipments may be used in conjunction with

“branch warehouses” that act as distributing points for
shipments originating at the home plant.

 In “make-and-hold” service, the seller produces in

anticipation of a buyer's needs and stores the
merchandise.

 The seller is then ready to ship immediately upon word

from the buyer, minimizing total order time.
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Reserve Capacity
 The reserve facilities of a supplier are another
consideration in evaluating service.

 This issue is of special importance during

business booms.

 A supplier with an adequate reserve of

productive facilities can respond to increased
customer requirements.
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Technological capabilities
 The stage of a supplier's technological development
and its ability to keep up with current methods are
other considerations affecting service.

 Technological capabilities give the buyer access to

outreach research.

 Buyers rely on vendors to suggest design and

material changes as new concepts are perfected.

 The buying firm often relies on the provision of such

service as an extension of its own research and
development facilities.
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Inspection
 The inspection methods and quality control
procedures used by the prospective supplier are also
considered.

 A supplier who is careless about inspecting finished

goods will ship items that must eventually be rejected
and returned as unsatisfactory for their purpose.

 If such a supplier is also careless in controlling

production quality, the problem is aggravated,
because some imperfections may not be discovered
until the item has been incorporated into the finished
product.

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Labor Relations
 Another source of interference with the continuity of
production in a supplier's plant may be the workers
themselves.

 If relations of the supplier with its workers are poor,

there may be strikes or slowdowns in production.

 The possibility of such delays can sometimes be

projected by determining the morale of the workforce,
and reviewing the labor policies as expressed by
general management.

 The history of strikes and the length of the union

contract also reflects the labor management climate.
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Warranties
 Service also includes the kind and form of warranties
that accompany a supplier's products.

 Relevant considerations include a vendor's ability to

provide installation wherever necessary and to
provide replacement parts as needed.

 The supplier should assure the buyer that the product

delivered will be maintained throughout its normal
life.

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Vendor Sources
 Vendor relations also influence a supplier's service rating.

 A good supplier has well-developed sources of raw

materials and components that will ensure continuity of
production during periods of fluctuating business
conditions.

 The volume of raw materials carried in inventory and the

relationship between direct and distributor sources affect
this evaluation.

 To the degree that the supplier has well-developed

sources of supply, the firm will be able to produce
effectively during business booms.
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Plant visitations
 Buyers perceive risk when deciding upon a choice
among alternative market offerings.

 The uncertainty about the consequences of any given

selection heightens the anxiety or stress.

 Hawes and Barnhouse examined how purchasing

executives handle personal risk.

 They found nine important tactics in use for handling

perceived personal risk.

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Visit the supplier
 The foremost tactic mentioned consisted in "Visit the
operations of the potential vendor, to observe its
viability firsthand."

 In addition to reducing buyer stress, visits to the

plants of suppliers are an important means of initial
evaluation and periodic examination of existing
vendors.

 It is often desirable for a representative of the

production or engineering departments to accompany
the buyer on such visits, especially if the products are
highly technical.

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Financial Status of Supplier
 The financial status of the supplier directly affects its
ability to serve and should be carefully evaluated.

 One way to perform this evaluation is through the

analysis of credit reports.

 Credit reports contain information about suppliers'

financial standings.

 These reports also provide information on the

experience, management, and facilities of the
potential vendor.
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Financial Status of the Supplier…

 A related supplementary procedure is

independent analysis of the vendor's financial
statements.

 The purchasing official can obtain information

regarding the vendor's financial stability,
pricing policies, and general operating
efficiency by applying the tools of ratio
analysis to the vendor's balance sheet and
income statements.
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Financial Status …Popular Ratios
 The current ratio relates current assets to current
liabilities.

 The usual rule-of-thumb acceptable ratio is two to one.

 Because current assets and liabilities are those that can

be turned into cash within a short period of time (a year
or less), this ratio measures the financial ability of the
firm to continue in the short run.

 However, because in recent years companies have

often maintained current ratios less than two to one to
avoid idle and unproductive assets, this ratio should not
be overemphasized. 33
Financial Status …Popular Ratios…
 The acid test ratio is a variant of the current ratio in
that it relates current assets, excluding inventories, to
current liabilities.

 Inventories are omitted from current assets because

they are often difficult to liquidate.

 An acceptable ratio here is one to one.

 Like the current ratio, it is a reflection of a company's

short-term functioning ability.

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Financial Status …Popular Ratios…
 The sales-receivable ratio represents sales divided by
accounts receivable.

 It indicates whether customers are paying their bills promptly

or whether too much of the vendor's assets are tied up in
receivables.

 This ratio is related to the seller's standard terms of payment.

 For example, if the terms are 90 days, not much more than
this amount of total sales should be in receivables.
 A firm with annual sales of $6 million and 90-day terms
should not have much more than $1.5 million in accounts
receivable.
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Financial Status …Popular Ratios…
 Net profit to sales is an overall measure of
the firm's profitability after all expenses have
been deducted.

 The size of the profits gives an indication of

the possibility of successful price
negotiations.

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Financial Status …Popular Ratios…
 Cash flow is obtained by adding net profit after taxes
to depreciation charges, which are allocations against
profits that do not reflect actual cash outflow.

 It measures the amount of dollars the firm is

receiving.

 Cash flow assists profit evaluation because it is a

measure of how much cash a company is likely to
require for meeting short-term expenses.

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Financial Status …Popular Ratios…
 The inventory turnover ratio is the cost of goods
sold divided by the average inventory.

 It indicates the degree of efficiency in inventory

management and the freshness and sale-ability of
the inventory.

 If the ratio is low, the firm is either over-inventoried or

undersold.

 A high turnover ratio is usually preferable to a low

one.
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Supplier Goodwill

 Developing supplier goodwill is a vital part of

purchasing personnel's strategic planning.

 Goodwill benefits the organization in

emergencies and helps ensure adequate
levels of supply during periods of shortages.

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Quality Management
 Quality is the last, but the most important, factor on the
evaluation list.

 Without good quality, the lowest-cost supplier in the world will

not be acceptable.

 The ISO series (ISO 9001, 9002, 9003) of quality standards

is becoming more and more a requirement worldwide.

 However, it is a quality systems and documentation

specification, not a quality requirement.

 A company produces a set of operating specifications that

guarantee consistency in its processes and its production.
40
ISO Quality Standards
 If the operating specifications meet ISO requirements and the
company passes an audit showing it follows the
specifications, it can obtain an ISO certification.

 This reduces, but does not eliminate, the need to survey a

quality system.

 There are two problems to consider.

 First, the specification guarantees consistency, not quality.

 The specification could state that a defined level of quality

that you regard as mediocre (moderate quality) would be
acceptable.
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ISO Quality Standards…Problems
 If the potential supplier follows the operating specification
consistently, they will produce to that quality level
consistently.

 It may not be good enough for you.

 Second, once granted an ISO certification, the supplier may

not follow the specification consistently.

 There can be years between auditors' visits.

 For these reasons, even an ISO-qualified supplier needs

some quality auditing.

 You should check the quality level produced.

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Acceptable Quality Level, (AQL)
 You should ask what a supplier's outgoing quality level is.

 What you are really looking for here is the attitude toward
shipping faulty parts.

 There are still suppliers who ship to acceptable quality levels,

or AQLs.

 An AQL of 0.4, for example, means that a lot with 4,000 parts
per million (0.4 percent) faulty parts has a 95 percent chance
of being shipped.

 This AQL is measured by sample inspection, and there are

sample plans that allow a lot with known rejects in it to ship.
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Supplier Evaluation Methods
 The measure of a supplier's value is expressed in its
performance record.

 In recent years buyers have emphasized the setting

of objective standards and procedures for evaluating
and comparing existing suppliers.

 The least precise evaluation technique is the

categorical method.

 It relies heavily on the experience and ability of the

individual buyer.
44
The Categorical Method
 Basically, it is a procedure whereby the buyer relies on a
historical record of supplier performance.

 Initially, a list of evaluation criteria is identified.

 The buyer then assigns a grade to each supplier, for each

criterion, based on past experience.

 A simple marking system of plus, minus, and neutral grades

may be used.

 Evaluation lists are often provided to other departments

involved, such as quality control, engineering, production,
and receiving.
45
The Categorical Method…
 Vendors with composite high or low ratings are noted, and
future supply decisions are influenced by them.

 Although this system is non-quantitative, it is a means of

keeping systematic records of performance.

 It is also inexpensive and requires a minimum of

performance data.

 However, the process relies heavily on the memory and

judgment of the individuals providing the ratings, and the
ratings may become routinely performed without much
critical thought.
46
The Weighted Point Method
 Weighted-point method quantifies the evaluation criteria.

 A number of evaluation factors can be included, and their

relative weights can be expressed in numerical terms so
that a composite performance index can be determined
and supplier comparisons made.

 For example, following evaluation criteria have been

chosen: quality of shipments, accuracy of delivery, and
price.

 Assuming that quality and delivery are the most

significant, a point rating system such as the following
might be used:
 quality, 40 points; delivery, 40 points, and price, 20
points. 47
 Weighted Point Method…

% Perf. (A) % Perf. (B) %Perf. (C) (A+B+C)

Vendor Quality %40 Delivery %40 Price %20 Total Score
A 90 36 70 28 60 12 76
B 80 32 60 24 80 16 72
C 70 28 80 32 90 18 78

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Weighted Point Method…

 The advantage of the weighted-point plan is that a

number of evaluation factors can be used with
relative weights corresponding to the needs of the
firm, thereby minimizing subjective evaluation.

 If this individually assigned plan is used in

conjunction with the categorical method, suppliers
can be evaluated on a quantifiable basis and many of
the intangible aspects of service can still be
considered.

49
The Cost-Ratio Method
 The cost-ratio method relates all identifiable
purchasing costs to the value of the shipments
received from the respective suppliers.

 The higher the ratio of costs to shipments, the lower

the rating for that supplier.

 What cost categories are used depends on the

products involved.

 Quality, delivery, service, and price are the overall

categories, and respective costs are accumulated for
each.
50
The Cost-Ratio Method…

 For example, costs associated with quality

normally include
 the costs of unusual visits to a vendor's
plants,
 unusual inspection costs of incoming
shipments, and
 all costs associated with defective products,
including rejected parts and the resulting
manufacturing losses.
51
The Cost-Ratio Method…
Quality Cost Ratio
Vendor__________________________ January, 20__

Visit to vendor plant 200

Sample approval 300
Incoming inspection 75
Manufacturing losses 0
Reworking costs 0
Value of rejected parts 425
Other 9
Total costs 1,000
Total value of purchases 100,000
Quality cost ratio:
(total cost / purchases) %1

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