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POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

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Chapter 4: Procurement

Natangcop, Sittie Farhannah

Zoleta, Alexandra Paula

Baldovizo, Kristine Joy N.

BSBA HRM 2-1

Prof. Noel Fabella

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Reporter: Natangcop, Sittie Farhannah

CHAPTER 4

Procurement
Procurement involves the process of selecting vendors, establishing payment terms, strategic
vetting, selection, the negotiation of contracts and actual purchasing of goods. Procurement is
concerned with acquiring (procuring) all of the goods, services, and work that is vital to an
organization. Procurement is, essentially, the overarching or umbrella term within which
purchasing can be found.

Procurement deals with the sourcing activities, negotiation and strategic selection of goods and
services that are usually of importance to an organization. Purchasing is the process of how goods
and services are ordered. Purchasing can usually be described as the transactional function of
procurement for goods or services.

Procurement Objectives

The emphasis has shifted from adversarial, transaction-focused negotiation with suppliers to
ensuring that the firm is positioned to implement its operations and marketing strategies with
support from its supply base. In particular, considerable focus is placed on ensuring continuous
supply, inventory minimization, quality improvement, supplier development, gaining access to
technology and innovation, and lowest total cost of ownership.

Continuous Supply

Stockouts of raw materials or component parts can shut down or force and change in production
plans, resulting in unexpected cost. Downtime due to production stoppage increases operating
costs and may result in an inability to provide finished goods as promised to the customers.

Minimize Inventory Investment

Downtime due to material shortages was minimized by maintaining large inventories of materials
and components to protect against potential disruption in supply. However, maintaining inventory
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is expensive and requires scarce capital. This requires balancing the costs of carrying material
against the possibility of production stoppage. The ideal is to have needed materials arrive just at
the moment they are scheduled to be used in the production process, in other words, just in time.

Quality Improvement

The quality of finished goods and services is dependent upon the quality of the materials and
components used. Both a firm and its suppliers need to be likely committed to a continuous quality
improvement initiative.

Supplier Development

Successful procurement depends on locating or developing suppliers, analyzing their capabilities,

and selecting and working with those suppliers to achieve continuous improvement. Developing
supply relationships with firms that are committed to buying the organization’s success in critical
in supplier development. It is important to develop close relationships with those suppliers in order
to share information and resources to achieve better results. This perspective on effective
procurement stands in stark contrast to the traditional focus on price alone, which inherently
created adversarial relationships between firm and its suppliers.

Access to Technology and Innovation

Firms look to suppliers as sources of innovation and new technology to aid in the design of new
products and improvement of the existing ones. The firm uses its firm uses its procurement
organization as a major source of outreach to suppliers for that innovation.

Lowest Total Cost of Ownership

Ultimately, the difference in perspective between a traditional adversarial and more contemporary
collaborative procurement strategy can be summarized as a focus on Total Cost of Ownership
(TCO) as contrasted to the focus of purchase price. Procurement professionals recognize that,
although the purchase price of a material or item remains important, it is only one part of the total
cost for their organization. Service costs and life cycle costs must also be considered. Supplier
terms of sale and cash discount structures also impact the total cost of ownership. A supplier
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offering more favorable credit terms is, in effect, impacting the purchase price from the buyer’s
perspective.

Sellers typically offer a number of standard services that must be considered in procurement.
Additionally, available value-added services must be considered as organizations seek to identify
the lowest TCO. Many of these services involve logistical operations and the logistical interface
between buyers and sellers. A key aspect of determining the TCO for purchased requirements is
to consider the trade-offs involved in terms of value added versus cost and price of an item must
be debundled from the price of services under consideration.

The final aspect of lowest TCO includes numerous elements known as life cycle costs. The total
cost of materials, items or other inputs extends beyond the purchase price and value added service
to include the lifetime costs of such items. Some of these costs are incurred before the actual receipt
of the items, others are incurred while the item is being used, and some occur long after the buyer
has actually used the item. One aspect of life cycle costs involves the administrative expense
associated with procurement. Expenses relating to screening potential suppliers, negotiation, order
preparation, and transmission are just few procurement administrative costs. Receiving,
inspecting, and payment are also important.

Total cost of Ownership

Transaction Components Post transation

Pretransaction Componets
1. Identifying need
2. Investigating sources
3. Qualifying sources
4. Adding supplier to internal
systems
5. Educating:
-supplier in firm's operations
-firm in supplier's opreations
Components
1. Price
1. Line fallout
2. Order placement/
preparation 2. Defective finished
goods rejected before
3.Transportation sale
4. Duties
3. Field failures
5. Billing/payment 4. Repair/replacement
6. Inspection 5. Reputation of firm
7. Return of parts 6. Cost of repair parts
8. Follow-up and correction 7. Cost of maintenance
and repairs
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The figure above presents a model of various elements that TCO compromises. When each of
these elements is considered in procurement, it is clear that numerous opportunities for
improvement exist in most companies.

Reporter: Zoleta, Alexandra Paula

Procurement Strategy

Developing effective procurement strategy is a complex process, considerable analysis of the

most appropriate means to accomplish its many different objectives. Fist, decisions must be
made regarding which products and services to produce or perform internally and which should
be purchased from outside suppliers. Next, alternative strategic approaches to dealing with
external suppliers must be developed. Finally, the appropriate strategic approach must be
determined for the different types of products and services the organization buys, resulting in
procurement portfolio.

Insourcing versus Outsourcing

Insourcing is the assignment of a project to a person or department within a company rather than
to a third party.

Outsourcing means that the firm has decided not to produce an item or service internally. This
process underlying the decision is commonly called “make- buy” decision. In the past, managers
tended to focus on a relatively narrow set of financial criteria. However, the make- buy decision
is an extraordinarily complex strategic decision for a firm and involves consideration of
numerous variables. Therefore, it typically involves executives from across the organization
working in cross- functional team to ensure comprehensive analysis of both quantitative and
qualitative issues involved.

Make – buy analysis should begin with an evaluation of a product or service relationship
to the firm’s core competencies. Outsourcing core competency capabilities raises substantial
risks. To reduce these risks and maintain control, firms typically insource those processes that
are core competencies even if outsourcing may be a lower- cost alternative. An advantage of
outsourcing non- core activities is that the financial resources that would be spent on performing
those activities internally can be devoted instead to the firm’s capabilities. This is the primary
reason that many manufacturing firms in recent years have decided to outsource logistics
processes and concentrate resources on new product development, manufacturing technology,
and marketing efforts.
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When it its determined that a product or service is a candidate for outsourcing, make- buy
analysis requires examination of the costs highlight the relative financial advantages and
disadvantages for organization.

Cost analysis reveals the quantitative cost a firm will incur to product needed product or
service internally or to buy it from a supplier. This information may identify the lower- cost
option, but thorough make- buy analysis also investigates qualitative factors, since it is not
always possible to quantify all factors affecting the decision. While there are numerous
qualitative factors to consider, two critical issues relate to loss control and supply risk. Deciding
to outsource requires the firm to relinquish control to supplier. The organization is dependent on
a supplier’s ability to provide the necessary quality and delivery performance to meet its
requirements. Supply risk refers to the possibility of unplanned event in acquisition, delivery, or
use the negatively effects a firm’s ability to serve its customers.

Alternative Procurement Strategy

Four Strategic Approaches to Procurement:

 User buy
 Volume consolidation
 Supplier operational integration
 Value management

User Buy

The simplest approach to procurement is to allow users in the organization to determine

their ow purchase needs, evaluate sources of supply, and execute the purchasing process. In fact,
even in organizations that have a centralized procurement function, user buy is still common for
at least some items.

Volume Consolidation

As important step in developing procurement strategy is volume consolidation, a

procurement strategy accomplished through deduction in the number of suppliers. Beginning in
the 1980s many firms faced the reality that they dealt with a larger number of suppliers for
almost every material or input used. In fact, purchasing literature prior to that time emphasized
the multiple sources of supply constituted best procurement practice. First, potential suppliers
were continually bidding for a buyer’s business, ensuring constant pressure to quote low prices.
Second, maintaining multiple sources reduced the buyer’s dependence on any supplier. This in
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turn served to reduce the buyer’s risk should a specific supplier encounter supply disruption such
as strike, a fire, or internal quality problems.

By consolidating volumes with a limited number of suppliers, procurement is also

positioned to leverage its share of supplier’s business. At the very least, it increases the buyer’s
negotiating strength in relationship to the supplier. More important, volume consolidation with a
reduced number of suppliers provides a number of advantages for those suppliers. The most
obvious advantage of concentrating a larger volume of purchases with a supplier is that it allows
the supplier to improve economies of scale by spreading fixed cost over a larger volume output.
Additionally, assured of a larger volume of purchases, service. When a buyer is constantly
switching suppliers, no one firm has an incentive to make such an investment.

Clearly, when a single source of supply is used, risk increases. Even when a single
source is chosen, it is essential to have a contingency plan.

Supplier Operational Integration

Operational integration occurs when buyers and sellers begin to integrate their processes
and activities in an attempt to achieve substantial performance improvement. Such integration
typically involves alliances or partnerships with selected suppliers to reduce total cost and
improve operational integration.

Example: The buyer may allow the supplier to have access to sales and ordering information,
thereby giving the supplier to have access to sales and ordering information, thereby giving the
supplier continuous knowledge of which products are selling. Detailed sales information allows
the supplier to be better positioned to effectively meet buyer requirements at a reduced cost. Cost
reduction occurs because the supplier has more information available to support planning and
can reliance on inefficient practices, such as forecasting and expediting.

Further operational integration can result for buyers and suppliers working together to
identify process involved in maintaining supply and searching for ways to redesign those
processes. Establishing direct communication linkages to reduce order time and eliminate
communication errors is a common benefit of such integration. More sophisticated integrative
efforts may involve eliminating redundant activities that both parties perform.

Example: In some sophisticated relationships, activities such as buyer counting and inspection of
incoming deliveries have been eliminated as greater reliance and responsibility are assumed by
suppliers. Many firms have achieved operational integration focused on logistical arrangements,
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such as continuous replenishment programs and vendor- managed inventory. Such integration
has considerable potential for reducing TCO.

Some of the efforts in operational integration strive to reduce total cost through two- way
learning.

Example: Honda of America works closely with its suppliers to improve their quality
management. Honda visit supplier facilities and helps identify ways to increase quality. Such
improvements ultimately benefit Honda by reducing the supplier’s cost of rework and by
providing Honda with higher levels of quality materials.

The primary objective of operational integration is to cut waste, reduce cost, and develop
a relationship that allows both buyer and seller to achieve mutual improvements.

Value Management

Value management is an even more intense aspect of supplier integration, going beyond a
focus on buyer- seller operations to a more comprehensive and sustainable relationship. Value
engineering, reduced complexity and early supplies to reduce TCO.

Value engineering is a concept that involves closely examining material and component
requirements at the early stage of product design to ensure that a balance of lowest total cost and
quality and incorporated into new product design. Figure 4.2 shows how early supplier
involvement can be critical in achieving cost reductions.
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Figure 4.2

Flexibility and Cost of Design and Changes

Idea Concept
Asses-
gener- develop- Design Prototype
ment ment
ation

High

Cost of design

changes

Flexibility in
design

Low

Time

As a firm’s new product development process proceeds from idea generation through the
various stages to commercialization, the company’s flexibility in making design changes
decreases. Design changes are easily accommodated in the early stages, but by the time
prototypes have been developed, a design process, the more likely an organization is to capitalize
on the supplier’s knowledge and capabilities.

Clearly, value management extends beyond procurement in an organization and requires

cooperation between numerous participants, both internal and external. Teams representing
procurement, engineering, manufacturing, marketing, and logistics as well as key supplier
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personnel jointly seek solutions to lower total cost, improve performance, or improved
accommodation of customer requirements.

Procurement Strategy Portfolio

In procurement, it can be stated simply: A small percentage of the materials, items, and
services acquired account for a large percentage of the dollars spent. The point is that all
procured inputs are not equal. A key step in determining procurement strategies, then, is to
understand exactly what the firm is currently buying (or planning to buy) and how much is
actually being spent on each purchased item or service. Spend analysis is a tool that identifies
how much is being spent on each type of product or service across all locations in the firm.
Spend analysis is an important step in determining the appropriate procurement strategy for each
of the products and services required by the buying firm.

One approach to determining an approximate procurement strategy for a product is

provided in Figure 4.3. This portfolio matrix, which is similar in concept to the customer strategy
matrix in chapter 3, is based on two criteria: potential supply risk in procuring an item from a
supplier and the value of the item to the firm.

Routine Purchase

Routine purchases are typically items that involve a low percentage of a firm’s totally
spend and involve very little supply risk. Additionally, they typically are non- critical to the
organization and have little impact on its overall performance.

Bottleneck Purchases

Bottleneck purchases represent a unique procurement problem. While such items involve
a small percentage of a firm’s spend, supply risk is high and lack of availability can cause
significant operational problems for the buyer. These items are frequently only available from a
small number of alternative suppliers. The appropriate strategic focus in this situation is to
maintain multiple source of supply and, if feasible, use long- term contracts to assure continuity
of supply.

Leverage Purchases

Like routine purchases, leverage purchases involve little supply risk. The items are
generally commodities where many alternative sources of supply exist.
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Critical Purchases

Critical purchases are typically the strategic items and services that involves a high level
of success. Because of their importance and the risk, involved, there is strong emphasis in
concentrating purchases with a strategic preferred supplier.

Figure 4.3 Procurement Strategy Matrix

Bottleneck Critical Purchases

Purchases
(Integrate with
(Multipl
Suppliers) Suppliers)

Routine Leverage
Purchases Purchases
(Reduce Buying (Concentrate
Effort) Purchases)
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Reporter: Baldovizo, Kristine Joy N.

SUPPLIER SELECTION AND ASSESSMENT

Implementing and executing procurement strategy depends on the organization’s supply

base. Potential suppliers must be identified and their capabilities to meet the buying organization’s
requirements must be assessed. The time and effort required for this differ for different types of
purchases. For routine purchases and items that have been purchased over time, the selection and
assessment process is relatively. However, there may even be situations in which no potential
supplier meets all of the buyer’s requirements and the buyer undertakes a process known as
supplier development in addition, effective procurement practice also requires an ongoing process
for monitoring performance and providing feedback to suppliers. Ultimately, some suppliers may
be designated as certified suppliers.

Supplier Audits

In supplier audit programs, the buying organization attempts to develop a detailed

understanding of a supplier’s organization and capabilities. Typically, cross-functional teams from
the buying firm visit supplier facilities to conduct extensive audits of processes and systems,
thereby evaluating their ability to consistently generate quality products in a timely fashion. For
example, representatives from purchasing, manufacturing, quality control, and logistics visit the
supplier’s facilities and study the processes firsthand. Supplier audit procedures are used to
document the degree to which all of a supplier’s processes are under tight management control.

While visiting supplier locations, the audit team examines in detail the supplier’s
equipment, facilities, and personnel. Supplier quality management and continuous improvement
processes are a particular area of investigation. The objective of this assessment is not only to
ensure that the supplier currently has the desired product and delivery quality required, but also
that these critical capabilities will be maintained. The audit team may even look closely at a
supplier’s efforts to conduct similar assessments of its ow suppliers.
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Another area of concern for the audit team is an assessment of the overall corporate culture
and willingness of its management to commit to the buying firm. While this is a subjective
judgement, these characteristics may be crucial in assessing supplier suitability for bottleneck and
critical purchase requirements.

Supplier Development

There are situation that arise in which a firm is unable to identify a supplier capable of
meeting its requirement and must develop a supplier that will have these capabilities. This means
that the buying organization must invest in improving the capabilities and performance of potential
suppliers. This development process becomes necessary when:

 The firm needs a new product that no supplier currently provides

 The firm wants a more convenient and less costly source of a supply
 The firm wants to avoid overreliance on a single supplier
 A current supplier lacks sufficient capacity to meet the firm’s demand
 The firm finds a supplier with compatible attitudes toward quality, timeliness, or flexibility
that does not currently make the desired input
 The firm becomes dissatisfied with continuing poor performance by current suppliers, but
no other potential supplier exists

Monitoring Performance

For ongoing supplier relationships, it is important to set formal goals for suppliers and to
measure performance against these goals on a regular basis. Procurement must identify the key
supplier performance characteristics and develop a process to collect and analyze actual day-to-
day performance information. Suppliers should receive regular feedback regarding their
performance. Many organizations use a supplier “scorecard” for this purpose.

Key supplier performance characteristics that are captured in a typical scorecard include
terms of product quality, delivery performance, cost reduction, service, and other performance
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attributes that are important for their firm. Often, supplier scorecards weight each attribute, and a
rating scale for each attribute is defined. An overall supplier score is calculated for each supplier
using a weighted-average approach. Figure 4.4 provides a simple example of a supplier scorecard
that includes criteria related to specific purchases as well as more subjective criteria that might be
assessed over a period of time. In developing the data for such a scorecard, procurement must
ensure that all of the internal personnel ensure that all of internal personnel who have contact with
the supplier have an opportunity to provide input to the criteria, weights, and actual scores.

Supplier scorecards are used in several ways. To provide feedback, scorecards should be
reviewed with suppliers at periodic intervals. By providing this feedback, suppliers have the
opportunity to respond to and improve their performance. Frequently, procurement organizations
even show relative comparisons to competing suppliers. Some companies categorize suppliers as
preferred, acceptable, and developmental. Firms give preferred suppliers the opportunity to
participate in product development and to win new business. Acceptable suppliers must be develop
a plan for improving their performance to the preferred level. Development suppliers must improve
performance or are targeted to be replaced.

Score
Category Weight (100 Maximum Weighted Score
points)
Correct Quantities .15 95 14.25
No defectives items .10 100 10.00
All shipments on time .15 80 12
Correct documentation .10 95 9.50
No damage .05 90 4.50
Flexibility .10 80 8.00
Responsiveness .20 90 18.00
Communication .15 90 13.50
Total 1.0 89.75
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FIGURE 4.4 Example Supplier Scorecard

ADT Security Services, a division of Tyco International, sources finished equipment from
numerous suppliers to include in the security systems it sells to its customers. Such equipment
ranges from card readers that control access to facilities to video products that record images for
surveillance and security purposes. In dealing with suppliers, part of ADT’s strategy is to form
long-term relationship with key suppliers and rate them quarterly on such criteria as quality,
delivery, and cost. But the criterion that receives the greatest weight is the supplier’s “account
management,” defined as “how well the supplier works with us and responds to our requests and
concerns”, Thus, suppliers are rated on responsiveness to ADT’s need, timely communication, and
reliability in meeting commitments.

Another aspect of the scorecard deals with how well a supplier helps the company meet its
cost savings goals. They are specifically graded on “the magnitude of the cost savings” that they
bring to ADT. Suppliers are even rated on their technology innovation and are awarded points on
how well they respond to technology trends. Suppliers are rewarded for excellent performance but
scorecard is not simply grading system. It is also used to help firms that are underachieving to
pinpoint areas where they need to improve. many of the criteria in ADT’s scorecard clearly require
subjective assessment. It is important to note that the procurement organization solicits input from
across the organization solicits input from across the organizations to develop its ratings. All
internal activities, including engineering, marketing, sales, and product support, as well as
receiving and manufacturing, provide input to the scoring process.

Supplier Certification

A supplier that consistently meets performance standards set by the organization may be
designated as a certified supplier. In these instances, the buying organizations may eliminate many
of the processes that result in duplication of effort and wasted time in dealing with the supplier.
For example, certified supplier may be given access to information that other suppliers are not
allowed. Certified suppliers are most likely to be those who participate in vendor-managed
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inventory that has substantial advantages for both the buying organizations and the supplier
(discussed in Chapter 7). Detailed counting and inspections that characterize typical receiving dock
and reducing inventories. Of course, certification can also be revoked if a supplier fails to maintain
its performance or if problems are discovered in a re-audit of its processes.

E-Commerce and Procurement

The explosion in technology and information systems is having a major impact on the
procurement activity of most organization. Much of the actual day-to-day work in procurement
has traditionally been accomplished manually with significant amount of paperwork, resulting in
slow processes subject to considerable human error. Applying technology to procurement has
considerable potential to speed up the process while simultaneously reducing errors.

Probably the most common technology used in procurement is Electronic Data

Interchange (EDI). EDI involves the electronic transmission of data between a firm and its
suppliers. This allows two or more companies to obtain and provide timely and accurate
information. Using EDI there are many types of data being directly transmitted, including
purchases requisitions, purchase orders, purchase order acknowledgement, order status, advanced
shipment notification and track and trace information. The explosion in EDI usage is a direct
recognition of associated benefits. Including standardization of data, more accurate information,
more timely information, shortening of lead tines with associated reductions in inventories, and
reduced TCO.

Another procurement application of electronic commerce is the development of electronic

catalogs. In fact, making information available about products and who can supply them is a
natural application for Internet-based communications. Electronic catalogs allow buyers to
quickly identify product and place orders. Many companies have developed their own online
electronic catalogs and efforts have also been devoted to developing catalogs containing products
from multiple suppliers, which permits buyers to rapidly compare features, specifications, and
prices.
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Buying exchanges are another technology-based purchasing development. Typically,

buying exchanges allow users to look for sellers or buyers of specific goods or services. Depending
on the approach, a buyer may post a request for proposal, post a request for quotation, or invite
bids for specified products and services. Transaction can be initiated and completed electronically.

The potential volume of procurement activity through buying exchanges is enormous.

Exchanges have been developed in the aircraft parts industry, chemicals, steel building products,
food distribution, and even retailing. However, there is a potential downside. Many suppliers fear
that the exchanges will become a mechanism that ultimately will reinforce past practice of buyers
to focus strictly on purchase price. If buyers post their requirements and needs on the Internet
primarily for the purpose of soliciting bids from alternative suppliers, or use the technology to
have suppliers enter into an auctioning process, some fear many of the advances in supplier
integration and value management will suffer.

In a supply management context, the link between a company and its external suppliers is
critical. It provides for the integration of materials and resources from outside the organization into
internal operations. Procurement is charged with the responsibility of ensuring that this transition
is accomplished as efficiently and effectively as possible. Much of the concern in procurement is
focused on the logistical interface between the organization and its supply base. ultimately, the
purpose of procurement is to integrate material flow in accordance with requirements. It’s the job
of logistics to efficiently move purchases to the desired location. In the next section, alternative
manufacturing strategies are discussed with a focus on identifying their logistical requirements.

LOGISTICAL INTERFACES WITH PROCUREMENT

Effective execution of procurement strategy ultimately depends on logistics. The interface

between logistics and procurement links an organization with its suppliers and therefore has
significant implications for achieving procurement objectives. Procurement may also provide an
organization’s logistical linkage with customers as many organizations have turned to outsourcing
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of logical represent three critical aspects of the interface between logistics and procurement within
an organization.

Just-in-Time

Just-In-Time (JIT) techniques have received considerable attention and discussion in

recent years in all areas related to supply chain management. Sometimes referred as just-in-time
purchasing and frequently referred to as just-in-time delivery, the goal of JIT is to time-phase
activities so that purchased materials and products arrive just at the time they are required for the
transformation process. Ideally, raw materials and work-in-process inventories are minimized as a
result of reducing or eliminating reserve stocks.

The implications of JIT are numerous. Obviously, it is necessary to deal with suppliers who
have high and consistent levels of product quality. Absolutely reliable logistical performance is
required and eliminates, or at least reduces, the need for buffer sticks of materials. JIT generally
requires more frequent deliveries of smaller quantities of purchased inputs, which may require
modification of inbound transportation. Clearly, to make JIT work, there must be very close
operation and communication between the procurement organizations and suppliers. In JIT
operations, companies attempt to gain the benefits of backward vertical integration but avoid the
formal tie of ownership. They achieve many of the same ends through coordination and process
integration with suppliers.

Originally, JIT was applied to manufacturing processes characterized as make-to-plan,

since the effective functioning of the system is dependent upon a finalized production schedule.
However, as manufacturing strategies have evolved with more emphasis on flexibility, reduced
lot-sized production quantities, and quick changeovers, JIT concepts have evolved to
accommodate assemble-to-order and make-to-order manufacturing as well and is now referred to
as lean, as discussed in the next chapter. In many situations, lead suppliers are used by
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manufactures to sort, segregate, and sequence materials as they flow into assembly operations. The
goal is to reduce handling and facilitate continuous JIT.

Some organizations, seeing the benefits of JIT systems and recognizing the benefits of
supplier integration, have gone so far as to bring their suppliers’ personnel into their own
organization. The supplier personnel are empowered to use the customers purchase orders, have
full access to all information, and have responsibility for scheduling arrival of materials. Originally
introduced by the Bose Corporation, the term JIT II has been applied to these efforts to reduce
leadtimes and cost.

Procurement of Logistics Services

Historically, procurement departments in the most organizations have been primarily

concerned with “direct spend”, the strategies and relationships with suppliers of materials,
components, and other physical products inputs required by the firm. The procurement of logistics
services was considered an “indirect spend” and has not typically received the same strategic
emphasis. User-buy approaches were the norm in many companies. That situation is rapidly
changing. With continued growth in the outsourcing of on-core capabilities, procurement of
logistics services is receiving increased attention. Chapter 1 mentioned that the third-party logistics
market in 2010 was approximately $160 billion. A recent study of major manufacturing firms
noted that on the average the companies spent 11 percent of sales revenue on logistics and the 42
percent of that expenditure is directed to outsourcing of logistics services.

Managing the procurement of logistics services should be given the same strategic
considerations any other category of products or services. In fact, while performance of logistics
activities may not be a core capability of many shippers, the importance of logistics service to
customers results in this category of spend being classified as a leverage and or critical purchase
in many firms.

Tyco International is one firm that has taken a close look at its strategy for procurement of
logistics services. The company, a diversified manufacturer composed of several separate business
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units, found that its total dollar expenditure on transportation services alone was $390 million. As
a result, a centralized group was established to focus on strategy for logistics services and
contracting issues with service providers. This centralized organization focused on aggregating the
total expenditures across the business units and establishing relationship with a small core groups
of carriers. This allows logistics managers within each business unit to focus on the operational
issues.

The Tyco strategy is complicated by the vast geographical reach of the company. It uses
regional councils consisting of personnel from the business units as well as the centralized
procurement group to establish a list of transportation providers for each mode and geographic
region. the centralized organized then negotiates contracts with the selected carriers. With these
contracts in place, the operations logistics managers in the business units then have the flexibility
to deal with specific carriers on a day-to-day basis.

Performance-Based Logistics

Initiated by the U.S Department of Defense (DoD), a new approach to dealing with
suppliers called performance-based logistics has recently emerged. PBL is used to buy what the
military has traditionally referred to as logistics support. The most interesting aspect of the PBL is
that the military buys performance outcomes instead of what has historically been individual
transactions defined by product specifications. As outsourcing of logistics services increases, the
concept of performance-based logistics is likely to increase.

Historically, the DoD told contractors what products to produce, when to produce them,
and what activities to perform, and then paid them upon completion. In this traditional
arrangement, the more the contractor produced, the more money it made. With PBL, the
government simply tells the contractor what the desired outcomes are and lets the supplier
determine the best wat to meet those requirements. The government has found PBL to be an
effective means for obtaining higher quality while simultaneously achieving lower cost. While
 Republic of the Philippines
POLYTECHNIC UNIVERSITY OF THE PHILIPPINES
QUEZON CITY BRANCH

PBL has been limited thus far to government purchasing, it is expected that business organizations
may begin to adopt the practice in the future.