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Purchasing
and Supply
Management
The McGraw-Hill Series in Operations and Decision Sciences

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Purchasing and
Supply Management
Sixteenth Edition
P. Fraser Johnson, PhD
Leenders Supply Chain Management
Association Chair
Director, Ivey Purchasing Managers Index
Professor, Operations Management
Ivey Business School
Western University
PURCHASING AND SUPPLY MANAGEMENT, SIXTEENTH EDITION
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Names: Johnson, P. Fraser, author.
Title: Purchasing and supply management / P. Fraser Johnson, PhD.
Description: Sixteenth edition. | New York, NY: McGraw-Hill Education, [2019]
Identifiers: LCCN 2018021493 | ISBN 9781259957604 (alk. paper)
Subjects: LCSH: Industrial procurement. | Materials management.
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Purchasing and Supply

Management
 About the Authors
P. Fraser Johnson is the Leenders Supply Chain Management Association Chair at
the Ivey Business School, Western University. Professor Johnson is director of the Ivey
Purchasing Managers Index, the most widely watched and utilized indicator of future eco-
nomic activity in Canada. He was faculty director of the Ivey MBA program from 2009
to 2014. Dr. Johnson received his PhD in Operations Management from Ivey in 1995, and
following graduation, joined the Faculty of Commerce & Business Administration at the
University of British Columbia. He returned to Ivey as a faculty member in 1998, where
he currently teaches courses in supply chain management and operations. Prior to joining
Ivey, Professor Johnson worked in the automotive parts industry where he held a number
of senior management positions in finance and operations. His experience includes man-
aging automotive parts facilities in both Canada and the United States, and overseeing a
joint venture partnership in Mexico. Professor Johnson is an active researcher in the area of
supply chain management and he has authored articles that have been published in a wide
variety of journals and magazines. Fraser has also authored a number of teaching cases. He
is an associate editor for The Journal of Supply Chain Management and sits on the editorial
review board for the Journal of Purchasing and Supply Management. Professor Johnson
has worked with a number of private- and public-sector organizations in both consulting
and corporate education assignments in the United States, Canada, and Europe.

Purchasing and Supply

Management
Preface
Purchasing and supply management has become increasingly visible in a world where sup-
ply is a major determinant of corporate survival and success. Supply chain performance
influences not only operational and financial risks but also reputational risk. Extending the
supply chain globally into emerging regions places new responsibilities on the supplier and
supply, not only to monitor environmental, social, political, and security concerns, but also
to influence them. Thus, the job of the supply manager of today goes beyond the scope of
supply chain efficiency and value for money spent to search for competitive advantage in
the supply chain. Cost containment and improvement represent one challenge; the other
is revenue enhancement. Not only must the supply group contribute directly to both the
balance sheet and the income statement; it must also enhance the performance of other
members of the corporate team. Superior internal relationship and knowledge manage-
ment need to be matched on the exterior in the supply network to assure that the future
operational and strategic needs of the organization will be met by future markets. The joy
of purchasing and supply management lives in the magnitude of its challenges and the
opportunities to achieve magnificent contributions.
For more than 85 years, this text and its predecessors have championed the purchasing
and supply management cause. Based on the conviction that supply and suppliers have to
contribute effectively to organizational goals and strategies, this and previous editions have
focused on how to make that mission a reality.
A great deal has happened in the supply field since the fifteenth edition was pub-
lished. Continuing advances in information technology provide new ways to improve sup-
ply efficiency and effectiveness. New risk management, sustainability, and transparency
requirements, and the search for meaningful supply metrics, have further complicated the
challenges faced by supply managers all over the world. As a consequence, several changes
and updates have been made to the sixteenth edition. First, the new edition provides an
opportunity to incorporate the latest theory and best practice in supply chain management
into the text. Wherever appropriate, real-world examples and current research are used to
illustrate key points. Second, the application of information technology to supply chain
processes continues to change rapidly, including the evolution of cloud-based computing,
digitization, and blockchain. The text has been updated accordingly. Third, there are also
several important emerging issues—including sustainability, challenges of managing risk
in a global supply chain, and collaboration—that are addressed in this text. Meanwhile,
other supply management issues, such as global sourcing and supply chain collaboration,
continue to remain at the forefront. As the world’s technological and political environ-
ments continue to change and evolve, supply managers are faced with new challenges and
risks managing their global supply chains. Lastly, nearly one-third of the cases have been
replaced with new cases that cover topics such as risk management, cost analysis, metrics,
purchasing consortiums, and acquisition of capital equipment. Thus, the examples in the
text and 49 real-life supply chain cases afford the chance to apply the latest research and
theoretical developments in the field to real-life issues, opportunities, decisions, and prob-
lems faced by practitioners.

vi

Purchasing and Supply

Management
 Preface vii

In this edition, the focus on decision making in the supply chain has also been strength-
ened considerably. The chapter sequence reflects the chronological order of the acquisition
process. Criteria for supply decisions have been identified in three categories: (1) strate-
gic, (2) operational, and (3) additional. Criteria in the third category, including balance
sheet and income statement considerations, all dimensions of risk, sustainability consider-
ations, are growing in relevance and making sound supply decisions an even more complex
challenge.
Anna E. Flynn has been a coauthor of this text since the twelfth edition of this text
in 2002, after previously assisting with tenth and eleventh editions. Anna has been a
committed educator in the supply management field. She is a former faculty member at
Thunderbird School of Global Management and Arizona State University, where she was
also director of the undergraduate program in supply chain management. Anna also served
as vice president and associate professor at the Institute for Supply Management (ISM). As
a research associate for CAPS Research, she was able to explore important topics relevant
for supply management professionals. Her accomplishments include authorship of several
books. Although Anna did not participate in this edition, her past contributions are still
evident throughout this text.
A book with text and cases depends on many to contribute through their research and
writing to expand the body of knowledge of the field. Thus, to my academic colleagues,
I extend my thanks for pushing out the theoretical boundaries of supply management. To
many practitioners, I wish to extend my gratitude for proving what works and what does
not and providing their stories in the cases in this text. Also, many case writers contrib-
uted their efforts so that approximately one-third of all the cases in this edition are new.
Case contributors in alphabetical order included: Carolynn Cameron, Garland Chow, Jenni
Denniston, Dominque Fortier, Manish Kumar, Glen Luinenberg, Eric Silverberg, Dave
Vannette, and Marsha Watson.
The production side of any text is more complicated than most authors care to admit.
At McGraw-Hill Education Noelle Bathurst, Harper Christopher, Michele Janicek, Erika
Jordan, Elizabeth Kelly, Tobi Philips, Charles (Chuck) Synovec, Erin Tilley, and many
others contributed to turn our efforts into a presentable text.
The support of Acting Dean Mark Vandenbosch and my colleagues at the Ivey Business
School has been most welcome. Professors Larry Menor and Robert Klassen have pro-
vided invaluable feedback and assistance.
The assistance of the Institute for Supply Management (ISM) and the Supply Chain
Management Association in supporting the continuous improvement of supply education
is also very much appreciated.
P. Fraser Johnson

Purchasing and Supply

Management
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viii

Purchasing and Supply

Management
 Brief Contents
About the Authors v 10 Price 265
Preface vi 11 Cost Management 302
1 Purchasing and Supply 12 Supplier Selection 330
Management 1 13 Supplier Evaluation and Supplier
2 Supply Strategy 28 Relationships 371
3 Supply Organization 47 14 Global Supply Management 401
4 Supply Processes and Technology 79 15 Legal and Ethics 437
5 Make or Buy, Insourcing, and 16 Other Supply Responsibilities 488
Outsourcing 120 17 Supply Function Evaluation and
6 Need Identification and Trends 507
Specification 137
7 Quality 164 INDEXES
8 Quantity and Inventory 202 Case Index 542
9 Delivery 241 Subject Index 543

ix

Purchasing and Supply

Management
Table of Contents

About the Authors v Strategic Planning in Supply Management 31

Risk Management 32
Preface vi Operational Risk 32
Financial Risk 33
Chapter 1 Reputational Risk 33
Purchasing and Supply Management 1 Managing Supply Risk 34
The Corporate Context 34
Purchasing and Supply Management 3 Strategic Components 35
Supply Management Terminology 4 What? 35
Supply and Logistics 5 Quality? 36
The Size of the Organization’s Spend How Much? 37
and Financial Significance 6 Who? 38
Supply Contribution 8 When? 38
The Operational versus Strategic Contribution of What Price? 38
Supply 8 Where? 38
The Direct and Indirect Contribution of Supply 9 How? 38
The Nature of the Organization 13 Why? 38
Supply Qualifications and Associations 17 Conclusion 39
Challenges Ahead 19 Questions for Review and Discussion 39
Supply Chain Management 19 References 40
Measurement 19 Cases 40
Risk Management 19 2–1 Spartan Heat Exchangers Inc. 40
Sustainability 19 2–2 Suman Corporation 42
Growth and Influence 20 2–3 Stedmann Technologies 44
Technology 20
Effective Contribution to Organizational Success 21 Chapter 3
The Organization of this Text 21
Supply Organization 47
Conclusion 21
Questions for Review and Discussion 22 Objectives of Supply Management 49
References 22 Organizational Structures for Supply
Cases 23 Management 52
1–1 Denniston Spices 23 Small and Medium-Sized Organizations 52
1–2 Brennan Bank 24 Large Organizations 53
1–3 Hansen Equipment 25 Centralized and Decentralized Supply Structures 53
Hybrid Supply Structure 54
Chapter 2 Specialization within the Supply Function 55
Structure for Direct and Indirect Spend 58
Supply Strategy 28
Managing Organizational Change in Supply 58
Levels of Strategic Planning 29 Organizing the Supply Group 60
Major Challenges in Setting Supply Objectives The Chief Purchasing Officer (CPO) 60
and Strategies 31 Reporting Relationship 61
x

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Management
 Table of Contents xi

Supply Activities and Responsibilities 62 9. Maintenance of Records and Relationships 93

What Is Acquired 62 Linking Data to Decisions 94
Supply Chain Activities 63 Manage Supplier Relationships 94
Type of Involvement 63 Improving Process Efficiency
Involvement in Corporate Activities 64 and Effectiveness 94
Influence of the Industry Sector on Supply A Supply Process Flowchart 94
Activities 65 Strategic Spend 95
Supply Teams 66 Nonstrategic Spend 96
Leading and Managing Teams 66 Information Systems and the Supply
Cross-Functional Supply Teams 67 Process 100
Other Types of Supply Teams 68 Benefits of Information Systems Technology 100
Consortia 70 ERP Systems 101
Conclusion 71 Cloud Computing and the Supply Chain 102
Questions for Review and Discussion 71 Electronic Procurement Systems 103
References 72 Electronic or Online Catalogs 105
Cases 73 EDI 106
3–1 Donovan Valley Purchasing Consortium 73 Marketplaces 106
3–2 Kokko Foods 76 Online Auctions 107
3–3 Lambert-Martin Automotive Systems Inc. 77 Radio Frequency Identification (RFID) 109
Implications for Supply 110
Chapter 4 Policy and Procedure Manual 111
Supply Processes and Conclusion 112
Questions for Review and Discussion 112
Technology 79
References 113
The Supply Management Process 81 Cases 114
Strategy and Goal Alignment 81 4–1 Qmont Mining 114
Ensuring Process Compliance 82 4–2 Eastern Pharmaceuticals Ltd. 115
Information Flows 83 4–3 Portland Bus Company 117
Steps in the Supply Process 83
1. Recognition of Need 83 Chapter 5
2. Description of Need 84
Make or Buy, Insourcing,
Purposes and Flow of a Requisition 84
and Outsourcing 120
Types of Requisitions 85
3. Identification of Potential Sources 86 Make or Buy 121
Issue an RFx 86 Reasons for Making 123
4. Supplier Selection and Determination Reasons for Buying 123
of Terms 87 The Gray Zone in Make or Buy 124
5. Preparation and Placement Subcontracting 125
of the Purchase Order 88 Insourcing and Outsourcing 126
6. Follow-Up and Expediting 89 Insourcing 126
Assess Costs and Benefits 90 Outsourcing 127
7. Receipt and Inspection 90 Implications For Supply 129
Eliminate or Reduce Inspection 91 Outsourcing Supply and Logistics 129
8. Invoice Clearing and Payment 91 Supply’s Role in Insourcing and Outsourcing 130
Improving the Procure-to-Pay Process 92 Conclusion 131
Cash Discounts and Late Invoices 93 Questions for Review and Discussion 131

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xii Table of Contents

References 131 Function 167

Cases 132 Suitability 167
5–1 Garland Chocolates 132 Reliability 167
5–2 Marshall Insurance Company 134 Quality Dimensions 168
5–3 Alicia Wong 135 “Best Buy” 168
Determining the “Best Buy” 169
Chapter 6 The Cost of Quality 169
Prevention Costs 171
Need Identification and Specification 137
Appraisal Costs 171
Need Criteria In The Value Proposition 138 Internal Failure Costs 171
1. Strategic Criteria 138 External Failure Costs 171
2. Traditional Criteria 139 Morale Costs 172
3. Additional Current Criteria 140 An Overall Quality–Cost Perspective 172
Categories of Needs 142 Quality Management Tools and Techniques 172
1. Resale 142 Lean Enterprise 172
2. Raw and Semiprocessed Materials 143 Total Quality Management (TQM) 173
3. Parts, Components, and Packaging 144 Continuous Improvement 174
4. Maintenance, Repair, and Operating Six Sigma 175
Supplies 145 Quality Function Deployment (QFD) 176
5. Capital Assets 145 Statistical Process Control (SPC) 176
6. Services 147 Sampling, Inspection, and Testing 180
7. Other 149 The Quality Assurance and Quality Control
Repetitive or Nonrepetitive Requirements? 149 Group 184
Commercial Equivalents 150 Assuring the Quality of Purchased Services 184
Early Supply and Supplier Involvement 151 Supplier Certification 189
Methods of Description 151 Quality Standards and Awards Programs 190
Brand 152 ISO Quality Standards 190
“Or Equal” 153 The Malcolm Baldrige National Quality Award 192
Specification 153 The Deming Prize 192
Miscellaneous Methods of Description 154 Conclusion 192
Combination of Descriptive Methods 155 Questions for Review and Discussion 193
Sources of Specification Data 155 References 193
Standardization and Simplification 156 Cases 194
Conclusion 157 7–1 The Power Line Poles 194
Questions for Review and Discussion 158 7–2 Caledon Concrete Mixers 196
References 158 7–3 Wentworth Hospital 198
Cases 159
6–1 Moren Corporation (A) 159 Chapter 8
6–2 Moren Corporation (B) 161 Quantity and Inventory 202
6–3 Haniff Machining 162
Quantity and Timing Issues 203
Chapter 7 Quantity and Delivery 204
Time-Based Strategies 204
Quality 164
Forecasting 205
Role of Quality in Supply Management 165 Forecasting Techniques 206
Defining Quality 167 Collaborative Planning, Forecasting, and
Quality 167 Replenishment (CPFR) 207

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 Table of Contents xiii

Determining Order Quantities Transportation Regulation and

and Inventory Levels 207 Deregulation 245
Fixed-Quantity Models 208 Supply’s Involvement in Transportation 245
Fixed-Period Models 209 Transportation Modes and Carriers 246
Probabilistic Models and Service Coverage 210 Truck 246
Buffer or Safety Stocks and Service Levels 210 Rail and Intermodal 246
Planning Requirements and Resources 212 Pipelines 247
Material Requirements Planning (MRP) 212 Air 247
Capacity Requirements Planning (CRP) 214 Marine 247
Manufacturing Resource Planning (MRP II) 214 Types of Carriers, Providers, and Service
Demand Driven MRP 214 Options 247
Enterprise Resource Planning (ERP) Systems 214 Types of Carriers 248
Supply Implications of MRP 215 Transportation Service Providers 248
Functions and Forms of Inventories 216 Specialized Service Options 248
The Functions of Inventory 216 Selection of Mode and Supplier 249
The Forms of Inventory 218 “Best Value” Delivery Decisions 249
Inventory Function and Form Framework 218 Key Selection Criteria 249
Inventory Management 220 FOB Terms and Incoterms 251
Costs of Inventories 220 Rates and Pricing 252
ABC Classification 222 Documentation in Freight Shipments 253
Vendor- or Supplier-Managed Inventory Expediting and Tracing Shipments 255
(VMI/SMI) 224 Freight Audits 255
Lean Supply, Just-in-Time (JIT), and Kanban Delivery Options for Services 255
Systems 225 Buyer Location versus Supplier Location 256
Managing Supply Chain Inventories 228 Transportation and Logistics Strategy 256
Determining Quantity of Services 230 Organization for Logistics 258
Aggregating Demand 230 Conclusion 258
Managing Consumption 230 Questions for Review and Discussion 259
Dimensions of Services and Quantity References 259
Decisions 230 Cases 259
Conclusion 232 9–1 Penner Medical Products 259
Questions for Review and Discussion 232 9–2 Russel Wisselink 260
References 233 9–3 Cameron Power Equipment 262
Cases 233
8–1 Lisa Caruso 233 Chapter 10
8–2 Throsel-Teskey Drilling 235 Price 265
8–3 Sondra Fox 237
Relation of Cost to Price 266
Chapter 9 Meaning of Cost 267
How Suppliers Establish Price 269
Delivery 241
The Cost Approach 269
Logistics 242 The Market Approach 269
Role of Logistics in the Economy 243 Government Influence on Pricing 270
Role of Supply in Logistics 243 Legislation Affecting Price Determination 270
Transportation 243 Types of Purchases 272
Outsourcing to Third-Party Logistics (3PLs) Raw and Semiprocessed Materials 273
Service Providers 244 Parts, Components, and Packaging 273

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xiv Table of Contents
Maintenance, Repair, and Operating Supplies (MRO)
and Small-Value Purchases (SVPs) 274
Capital Assets 274
Services 275
Resale 275
Other 275
The Use of Quotations and Competitive
Bidding 275
Steps in the Bidding Process 276
Firm Bidding 277
Determination of Most Advantageous Bid
Collusive Bidding 278
Public-Sector Bidding 279
The Problem of Identical Prices 281
Discounts 282
Cash Discounts 282
Trade Discounts 283
Multiple Discounts 283
Quantity Discounts 283
The Price-Discount Problem 284
Quantity Discounts and Source Selection
Cumulative or Volume Discounts 286
Contract Options for Pricing 286
Firm-Fixed-Price (FFP) Contract 286
Cost-Plus-Fixed-Fee (CPFF) Contract 286
Cost-No-Fee (CNF) Contract 287
Cost-Plus-Incentive-Fee (CPIF) Contract 287
Provision for Price Changes 287
Contract Cancellation 289
Forward Buying and Commodities 289
Managing Risk with Production
and Marketing Contracts 290
Forward Buying versus Speculation 290
Organizing for Forward Buying 291
Control of Forward Buying 291
The Commodity Exchanges 292
Limitations of the Exchanges 293
Hedging 293
Sources of Information Regarding
Price Trends 295
Conclusion 296
Questions for Review and Discussion 297
References 297
Cases 297
10–1 Wedlock Engineered Products 297
10–2 Coral Drugs 299
10–3 Price Forecasting Exercise 301
Purchasing and Supply
Chapter 11
Cost Management 302
Strategic Cost Management 304
Supply Cost-Reduction Programs 304
Supplier Cost Management 305
Frameworks for Cost Management 306
Cost Management Tools and Techniques 308
Total Cost of Ownership 308
Target Costing 314
278 The Learning Curve or Experience Curve 315
Value Engineering and Value Analysis 316
Activity-Based Costing 317
Supply Chain Financing 318
Negotiation 318
Negotiation Strategy and Practice 319
Framework for Planning and Preparing
for Negotiation 320
Conclusion 322
Questions for Review and Discussion 323
285 References 323
Cases 324
11–1 Northwest Gas & Electric Company 324
11–2 McMichael Inc. 326
11–3 Carmichael Corporation 328
Chapter 12
Supplier Selection 330
The Supplier Selection Decision 331
Decision Trees 332
Identifying Potential Sources 333
Information Sources 334
Standard Information Requests 338
Additional Supplier Selection Decisions 339
Single versus Multiple Sourcing 339
Manufacturer versus Distributor 341
Geographical Location of Sources 342
Supplier Size 344
Supplier Development/Reverse Marketing 344
Evaluating Potential Sources 346
Level 1—Strategic 346
Level 2—Traditional 350
Level 3—Current Additional 352
Ranking Potential Suppliers 357
Conclusion 358
Questions for Review and Discussion 358
Management
 Table of Contents xv

References 359 Selecting and Managing Offshore Suppliers 415

Cases 359 Global Sourcing Organizations 415
12–1 Carson Manor 359 Intermediaries 416
12–2 Kettering Industries Inc. 365 Information Sources for Locating and Evaluating
12–3 Bid Assessment 367 Offshore Suppliers 417
Incoterms 418
Chapter 13 Rules for Any Form of Transport 419
Rules for Sea and Inland Waterway Transport
Supplier Evaluation and Supplier
Only 420
Relationships 371 Tools for Global Supply 421
Measuring Supplier Performance 372 Countertrade 421
Key Performance Indicators (KPIs) 372 Foreign Trade Zones 423
Evaluation Methods 373 Bonded Warehouses 425
Informal Evaluation and Rating 373 Temporary Importation Bond (TIB)
Semiformal: Executive Roundtable Discussions 374 and Duty Drawbacks 426
Formal Supplier Evaluation and Rating 374 Regional Trading Agreements 426
Supplier Ranking 377 North American Free Trade Agreement
Unacceptable Suppliers 377 (NAFTA) 426
Acceptable Suppliers 377 The European Union (EU) 427
Preferred Suppliers 377 ASEAN 427
Exceptional Suppliers 377 Mercosur 428
Supplier Relationships 378 Andean Community 428
Supplier Relationship Context 379 China’s Trade Agreements 428
Supplier Goodwill 379 The World Trade Organization (WTO) 428
The Buyer–Supplier Satisfaction Matrix 380 Emerging Markets 428
Supplier Relationship Management 383 Conclusion 430
Partnerships and Alliances 384 Questions for Review and Discussion 430
Early Supplier/Supply Involvement (ESI) 385 References 430
Partner Selection 385 Cases 431
Types of Partnerships and Alliances 386 14–1 Trojan Technologies 431
The Longer-Term Perspective 387 14–2 Marc Biron 433
Concerns about Partnerships and Alliances 388 14–3 Sarin Pharmaceuticals Ltd. 434
Multi-tier Supplier Relationships 389
Conclusion 389 Chapter 15
Questions for Review and Discussion 389
Legal and Ethics 437
References 390
Cases 390 Legal Authority of Buyer and Seller 438
13–1 APC Europe 390 Legal Authority of the Buyer 439
13–2 Stern Aerospace 394 Personal Liability 440
13–3 Northeastern Hospital 397 Authority of Suppliers’ Representatives 441
The Uniform Commercial Code 442
Chapter 14 Purpose of a Uniform Commercial Code 442
The Purchase Order Contract 443
Global Supply Management 401
Acceptance of Offers 444
The Importance of Global Supply 402 Purchases Made Orally—Statute of Frauds 445
Reasons for Global Purchasing 403 Inspection 446
Potential Problem Areas 407 Acceptance and Rejection of Goods 447

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xvi Table of Contents

Warranties 448 Accounts Payable 491

Title to Purchased Goods 449 Investment Recovery 491
Protection against Price Fluctuations 449 Categories of Material for Disposal 493
Cancellation of Orders and Breach of Contract 450 Responsibility for Material Disposal 497
Common Law and the Purchase of Services 451 Keys to Effective Disposal 497
Software Contracts 457 Disposal Channels 498
E-Commerce and the Law 458 Disposal Procedures 500
Electronic Signatures 458 Selection of Disposal Partners 501
U.S. Uniform Electronic Transactions Act 459 Conclusion 502
Intellectual Property Laws 460 Questions for Review and Discussion 502
Copyright Law 460 References 503
Patents 460 Cases 503
Trademarks 462 16–1 Ross Wood 503
Industrial Design 463 16–2 Raleigh Plastics 504
Geographical Indication 463 16–3 Durham Cabinets 506
Product Liability 463
Alternative Dispute Resolution 464 Chapter 17
Commercial Arbitration 465
Supply Function Evaluation and
Mediation 465
Trends 507
Internal Escalation 466
Regulatory Requirements 466 Supply Research 509
The Dodd-Frank Act and Conflict Minerals 466 Full-Time or Part-Time
The Sarbanes-Oxley Act 466 Research Positions 510
Environmental Regulations 467 Cross-Functional Teams 511
Ethics 468 Supply Research Opportunities 511
Conflict of Interest 471 Purchased Materials, Products, or Services 512
Gifts and Gratuities 471 Commodities 515
Promotion of Positive Relationships with Suppliers 515
Suppliers 473 Assessing Research Results 518
Reciprocity 474 Supply Planning Process 519
Sustainability 475 Supply Budgets 519
Conclusion 476 Performance Measurement Systems 520
Questions for Review and Discussion 476 The Value of Supply Metrics 520
References 477 The Challenges 521
Cases 477 Measuring Supplier Performance 522
15–1 Rocky Plains Brewing Ltd. 477 Supply Management Performance Metrics 522
15–2 Sinclair & Winston 479 Developing Metrics 523
15–3 Harwich College 483 Setting Targets 523
Establishing Metrics 524
Chapter 16 Operating Reports 525
Validating Results 526
Other Supply Responsibilities 488
Appraising Team Performance 526
Receiving 489 Supply Performance Benchmarking 527
Logistics and Warehousing 490 Supply Management Trends 528
Inbound and Outbound Transportation 491 Emphasis on Total Quality Management
Production Planning 491 and Customer Satisfaction 528

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 Table of Contents xvii

Sustainability 528 Conclusion 535

Global Sourcing 529 Questions for Review and Discussion 536
Protectionism 531 References 536
Risk Management 531 Cases 537
Safety and Security 532 17–1 Randall Corporation 537
Supply Processes and Technology 532 17–2 Stewart Corporation 538
Blockchain 532 17–3 QBL Products 540
Supply Organizations 533
External and Internal Collaboration 534
Metrics and Performance Measurement 535
Indexes
Innovation 535 Case Index 542
Public Procurement 535 Subject Index 543

Purchasing and Supply

Management
Purchasing and Supply
Management
 Chapter One

Purchasing and
Supply Management
Chapter Outline Measurement
Risk Management
Purchasing and Supply Management
Sustainability
Supply Management Terminology
Growth and Influence
Supply and Logistics
Effective Contribution to Organizational
The Size of the Organization’s Spend Success
and Financial Significance
The Organization of This Text
Supply Contribution
Conclusion
The Operational versus Strategic
Questions for Review and Discussion
Contribution of Supply
The Direct and Indirect Contribution References
of Supply Cases
The Nature of the Organization 1–1 Denniston Spices
1–2 Brennan Bank
Supply Qualifications and Associations
1–3 Hansen Equipment
Challenges Ahead
Supply Chain Management

Purchasing and Supply

Management
2 Purchasing and Supply Management

Key Questions for the Supply Decision Maker

Should we

∙ Rethink how supply can contribute more effectively to organizational goals

and strategies?
∙ Try to find out what the organization’s total spend with suppliers really is?
∙ Identify opportunities for meaningful involvement in major corporate activities?

How can we

∙ Align our supply strategy with the organization’s strategy?

∙ Get others to recognize the profit-leverage effect of purchasing/supply management?
∙ Show top management how supply can affect our firm’s competitive position?

Every organization needs suppliers. No organization can exist without suppliers. Therefore,
the organization’s approach to its suppliers, acquisition processes and policies, and rela-
tionships with suppliers will impact not only the performance of the suppliers, but also the
organization’s own performance. No organization can be successful without the short- and
long-term support of its supplier base, operationally and strategically.
Supply management is focused on the acquisition process recognizing the supply chain
and organizational contexts. Special emphasis is on decision making that aligns the sup-
plier network and the acquisition process with organizational goals and strategies and
ensures short- and long-term value for funds spent.
There is no one best way of organizing the supply function, conducting its activities,
and integrating suppliers effectively. This is both interesting and challenging. It is interest-
ing because the acquisition of organizational requirements covers a very wide and complex
set of approaches with different needs and different suppliers. It is challenging because
of the complexity and because the process is dynamic, not static. Moreover, some of
the brightest minds in this world have been hired as marketing and sales experts to persuade
supply managers to choose their companies as suppliers. It is also challenging because
every supply decision depends on a large variety of factors, the combination of which may
well be unique to a particular organization.
For more than 85 years, this text and its predecessors have presented the supply function
and suppliers as critical to an organization’s success, competitive advantage, and customer
satisfaction. Whereas in the 1930s this was a novel idea, over the past few decades there
has been growing interest at the executive level in the supply chain management and its
impact on strategic goals and objectives.
To increase long-term shareholder value, the company must increase revenue, decrease
costs, or both. Supply’s contribution should not be perceived as only focused on cost.
Supply can and should also be concerned with revenue enhancement. What can supply
and suppliers do to help the organization increase revenues or decrease costs? should be a
standard question for any supply manager.
The supply function continues to evolve as technology and the worldwide competi-
tive environment require innovative approaches. The traditionally held view that multiple

Purchasing and Supply

Management
 Chapter 1 Purchasing and Supply Management 3

sourcing increases supply security has been challenged by a trend toward single sourc-
ing. Results from closer supplier relations and cooperation with suppliers call into
question the wisdom of the traditional arm’s-length dealings between purchaser and sup-
plier. Negotiation as opposed to competitive bidding, is receiving increasing emphasis,
and longer-term contracts are replacing short-term buying techniques. E-commerce tools
permit faster and lower-cost solutions, not only on the transaction side of supply but also
in management decision support. Organizations are continually evaluating the risks and
opportunities of global sourcing. All of these trends are logical outcomes of increased
managerial concern with value and increasing procurement aggressiveness in developing
suppliers to meet specific supply objectives of quality, quantity, delivery, price, service,
flexibility, and continuous improvement.
Effective purchasing and supply management contributes significantly to organizational
success. This text explores the nature of this contribution and the management require-
ments for effective and efficient performance. The acquisition of materials, services, and
equipment—of the right qualities, in the right quantities, at the right prices, at the right
time, and on a continuing basis—long has occupied the attention of managers in both the
public and private sectors.
Today, the emphasis is on the total supply management process in the context of orga-
nizational goals and management of supply chains. The rapidly changing supply scene,
with cycles of abundance and shortages, and varying prices, lead times, and availability,
provides a continuing challenge to those organizations wishing to obtain a maximum con-

驘
tribution from this area. Furthermore, environmental and social sustainability, security,
and financial regulatory requirements have added considerable complexity to the task of
ensuring that supply and suppliers provide competitive advantage.

PURCHASING AND SUPPLY MANAGEMENT

Although some people may view interest in the performance of the supply function as a
recent phenomenon, it was recognized as an independent and important function by many
of the nation’s railroad organizations well before 1900.
Yet, traditionally, most firms regarded the supply function primarily as a clerical activ-
ity. However, during World War I and World War II, the success of a firm was not depen-
dent on what it could sell, since the market was almost unlimited. Instead, the ability to
obtain from suppliers the raw materials, supplies, and services needed to keep the factories
and mines operating was the key determinant of organizational success. Consequently,
attention was given to the organization, policies, and procedures of the supply function,
and it emerged as a recognized managerial activity.
During the 1950s and 1960s, supply management continued to gain stature as the
number of people trained and competent to make sound supply decisions increased. Many
companies elevated the chief purchasing officer to top management status, with titles
such as vice president of purchasing, director of materials, or vice president of purchasing
and supply.
As the decade of the 1970s opened, organizations faced two vexing problems: an inter-
national shortage of almost all the basic raw materials needed to support operations and a
rate of price increase far above the norm since the end of World War II. The Middle East

Purchasing and Supply

Management
4 Purchasing and Supply Management

oil embargo during the summer of 1973 intensified both the shortages and the price esca-
lation. These developments put the spotlight directly on supply, for their performance in
obtaining needed items from suppliers at realistic prices spelled the difference between
success and failure. This emphasized again the crucial role played by supply and suppliers.
As the decade of the 1990s unfolded, it became clear that organizations must have an
efficient and effective supply function if they were to compete successfully in the global
marketplace. The early twenty-first century has brought new challenges in the areas of
sustainability, supply chain security, and risk management.
In large supply organizations, supply professionals often are divided into two
categories: the tacticians who handle day-to-day requirements and the strategic thinkers
who possess strong analytical and planning skills and are involved in activities such as
strategic sourcing. The extent to which the structure, processes, and people in a specific
organization will match these trends varies from organization to organization, and from
industry to industry.
The future will see a gradual shift from predominantly defensive strategies, resulting
from the need to change in order to remain competitive, to aggressive strategies, in which
firms take an imaginative approach to achieving supply objectives to satisfy short-term
and long-term organizational goals. The focus on strategy now includes an emphasis on
process and knowledge management. This text discusses what organizations should do
today to remain competitive as well as what strategic purchasing and supply management
will focus on tomorrow.
Growing management interest through necessity and improved insight into the oppor-
tunities in the supply area have resulted in a variety of organizational concepts. Terms
such as purchasing, procurement, materiel, materials management, logistics, sourcing,
supply management, and supply chain management are used almost interchangeably. No
agreement exists on the definition of each of these terms, and managers in public and
private institutions may have identical responsibilities but substantially different titles. The
following definitions may be helpful in sorting out the more common understanding of the
various terms.

Supply Management Terminology

Some academics and practitioners limit the term purchasing to the process of buying:
learning of the need, locating and selecting a supplier, negotiating price and other pertinent
terms, and following up to ensure delivery and payment. This is not the perspective taken
in this text. Purchasing, supply management, and procurement are used interchangeably
to refer to the integration of related functions to provide effective and efficient materi-
als and services to the organization. Thus, purchasing or supply management is not only
concerned with the standard steps in the procurement process: (1) the recognition of
need, (2) the translation of that need into a commercially equivalent description, (3) the
search for potential suppliers, (4) the selection of a suitable source, (5) the agreement on
order or contract details, (6) the delivery of the products or services, and (7) the payment
of suppliers.
Further responsibilities of supply may include receiving, inspection, warehousing,
inventory control, materials handling, packaging scheduling, in- and outbound trans-
portation/traffic, and disposal. Supply also may have responsibility for other compo-
nents of the supply chain, such as the organization’s customers and their customers and

Purchasing and Supply

Management
 Chapter 1 Purchasing and Supply Management 5

their suppliers’ suppliers. This extension represents the term supply chain management,
where the focus is on minimizing costs and lead times across tiers in the sup-
ply chain to the benefit of the final customer. The idea that competition may change
from the firm level to the supply chain level has been advanced as the next stage of
competitive evolution.
In addition to the operational responsibilities that are part of the day-to-day activities of
the supply organization, there are strategic responsibilities. Strategic sourcing focuses on
long-term supplier relationships and commodity plans with the objectives of identifying
opportunities in areas such as cost reductions, new technology advancements, and supply
market trends. The Suman case in Chapter 2 provides an excellent example of the need to
take a strategic perspective when planning long-term supply needs.
Lean purchasing or lean supply management refers primarily to a manufacturing con-
text and the implementation of just-in-time (JIT) tools and techniques to ensure every step
in the supply process adds value, that inventories are kept at a minimum level, and that
distances and delays between process steps are kept as short as possible. Instant communi-
cation of job status is essential and shared.

Supply and Logistics

The large number of physical moves associated with any purchasing or supply chain activ-
ity has focused attention on the role of logistics. According to the Council of Supply Chain
Management Professionals, “Logistics management is that part of supply chain manage-
ment that plans, implements, and controls the efficient, effective forward and reverse flow
and storage of goods, services, and related information between the point of origin and the
point of consumption in order to meet customers’ requirements.”1 This definition includes
inbound, outbound, internal, and external movements. Logistics is not confined to manu-
facturing organizations. It is relevant to service organizations and to both private- and
public-sector firms.
The attraction of the logistics concept is that it looks at the material flow process as a
complete system, from initial need for materials to delivery of finished product or service
to the customer. It attempts to provide the communication, coordination, and control
needed to avoid the potential conflicts between the physical distribution and the materials
management functions.
Supply influences a number of logistics-related activities, such as how much to buy
and inbound transportation. With an increased emphasis on controlling material flow, the
supply function must be concerned with decisions beyond supplier selection and price.
The Qmont Mining case in Chapter 4 illustrates the logistics considerations of supplying
multiple locations.
Organizations are examining business processes and exploring opportunities to inte-
grate boundary-spanning activities in order to reduce costs and improve lead times.
Opportunities include the ability to reduce costs, increase speed to market and improve
quality, achieved through the use of cross-functional teams that integrate purchasing activ-
ities with operations, logistics, and new product development.

1
Council of Supply Chain Management Professionals, “SCM Definitions and Glossary,” http://cscmp
.org/CSCMP/Educate/SCM_Definitions_and_Glossary_of_Terms/CSCMP/Educate/SCM_Definitions_
and_Glossary_of_Terms.aspx?hkey=60879588-f65f-4ab5-8c4b-6878815ef921.

Purchasing and Supply

Management
6 Purchasing and Supply Management

Supply chain management is a systems approach to managing the entire flow of infor-
mation, materials, and services from raw materials suppliers through factories and ware-
houses to the end customer. The Institute for Supply Management (ISM) glossary defines
supply chain management as “the design and management of seamless, value-added
processes across organizational boundaries to meet the real needs of the end customer. The
development and integration of people and technological resources are critical to success-
ful supply chain integration.”2
The term value chain, a term commonly used in the strategy literature, has been used to
trace a product or service through its various moves and transformations, identifying the
costs added at each successive stage. Some academics and practitioners believe the term
chain does not properly convey what really happens in a supply or value chain, and they
prefer to use the term supply network or supply web.
The use of the concepts of purchasing, procurement, supply, and supply chain man-
agement will vary from organization to organization. It will depend on (1) their stage of
development and/or sophistication, (2) the industry in which they operate, and (3) their
competitive position.
The relative importance of the supply area compared to the other prime functions of the
organization will be a major determinant of the management attention it will receive. How
to assess the materials and services needs of a particular organization in context is one of
the purposes of this book. The 49 cases in this book provide insights into a variety of situ-
ations and give practice in resolving managerial problems.

THE SIZE OF THE ORGANIZATION’S SPEND

AND FINANCIAL SIGNIFICANCE
The amount of money organizations spend with suppliers is staggering. Collectively, pri-
vate and public organizations in North America spend about 1.5 times the GDPs of the
United States, Canada, and Mexico combined, totaling at least $33 trillion U.S. dollars
spent with suppliers.
Dollars spent with suppliers as a percentage of total revenues is a good indicator of
supply’s financial impact. Obviously, the percentage of revenue that is paid out to suppli-
ers varies from industry to industry and organization to organization, and increased out-
sourcing over the last two decades has increased the percentage of spend significantly. In
almost all manufacturing organizations, the supply area represents by far the largest single
category of spend, ranging from 50 to 80 percent of revenue. Wages, by comparison, typi-
cally amount to about 10 to 20 percent. In comparison, the total dollars spent on outside
suppliers in service organizations usually ranges from 25 to 35 percent of revenues. The
Lambert-Martin Automotive Systems Inc. case in Chapter 3 is a good illustration of the
significance of spend in a manufacturing organization. Purchases where 50 percent of rev-
enues, which represented 63 percent of total costs.
The financial impact of the corporate spend is often illustrated by the profit-leverage
effect and the return-on-assets effect.

2
Institute for Supply Management, “Glossary of Key Supply Management Terms,” www.instituteforsupply-
management.org.

Purchasing and Supply

Management
 Chapter 1 Purchasing and Supply Management 7

Profit-Leverage Effect
The profit-leverage effect of supply savings is measured by the increase in profit obtained
by a decrease in purchase spend. For example, for an organization with revenue of
$100 million, purchases of $60 million, and profit of $8 million before tax, a 10 percent
reduction in purchase spend would result in an increase in profit of 75 percent. To achieve
a $6 million increase in profit by increasing sales, assuming the same percentage hold,
might well require an increase of $75 million in sales, or 75 percent! Which of these two
options—an increase in sales of 75 percent or a decrease in purchase spend of 10 percent—
is more likely to be achieved?
This is not to suggest that it would be easy to reduce overall purchase costs by 10 percent.
In a firm that has given major attention to the supply function over the years, it would be
difficult, and perhaps impossible, to do. But, in a firm that has neglected supply, it would
be a realistic objective. Because of the profit-leverage effect of supply, large savings are
possible relative to the effort that would be needed to increase sales by the much-larger
percentage necessary to generate the same effect on the profit and loss (P&L) statement.
Since, in many firms, sales already has received much more attention, supply may be the
best untapped “profit producer.”

Return-on-Assets Effect
Financial experts are increasingly interested in return on assets (ROA) as a measure of
corporate performance. Figure 1–1 shows the standard ROA model, using the same ratio
of figures as in the previous example, and assuming that inventory accounts for 30 percent
of total assets. If purchase costs were reduced by 10 percent, that would cause an extra ben-
efit of a 10 percent reduction in the inventory asset base. The numbers in the boxes show
the initial figures used in arriving at the 10 percent ROA performance.

FIGURE 1–1 Sales

Return-on- $1 million
Assets Factors Divided by Investment
turnover 2
* Total
Inventory assets (2.06)
$150,000 $500,000
($135,000) ($485,000)
Multiplied by ROA
10%
Sales
$1 million (20.6%)
Profit
Minus $50,000
† Profit
Total cost ($100,000) Divided by
$950,000 margin
5%
†† ($900,000)
Sales (10%)
$1 million

*Inventory is approximately 30 percent of total assets.

†
Purchases account for half of total sales, or $500,000.
‡
Figures in parentheses assume a 10 percent reduction in purchase costs.

Purchasing and Supply

Management
8 Purchasing and Supply Management

The numbers below each box are the figures resulting from a 10 percent overall
purchase price reduction, and the end product is a new ROA of 20.6 percent or about an
100 percent increase in return on assets.

Reduction in Inventory Investment

Charles Dehelly, senior executive vice president at Thomson Multimedia, headquartered in
Paris, France, said: “It came as quite a surprise to some supply people that I expected them
to worry about the balance sheet by insisting on measuring their return on capital employed
performance.”3 Mr. Dehelly was pushing for reductions in inventory investment, not only by
lowering purchase price, as shown in the example in Figure 1–1, but also by getting suppli-
ers to take over inventory responsibility and ownership, thereby removing asset dollars in
the ROA calculations, but also taking on the risk of obsolescence, inventory carrying, and
disposal costs. Since accountants value inventory items at the purchaser at purchased cost,
including transportation, but inventory at the supplier at manufacturing cost, the same items
stored at the supplier typically have a lower inventory investment and carrying cost.
Thus, it is a prime responsibility of supply to manage the supply process with the lowest
reasonable levels of inventory attainable. Inventory turnover and level are two major
measures of supply chain performance. The QBL Products case in Chapter 17 is an illus-
tration where the company’s board of directors expects improved working capital utiliza-
tion through higher inventory turns.
可达到的
Evidently, the financial impact of supply is on the balance sheet and the income
statement, the two key indicators of corporate financial health used by managers, analysts,
financial institutions, and investors. While the financial impact of the supply spend is obvi-
ously significant, it is by no means the only impact of supply on an organization’s ability
to compete and to be successful.

SUPPLY CONTRIBUTION
Although supply’s financial impact is major, supply contributes to organizational goals
and strategies in a variety of other ways. The three major perspectives on supply are shown
in Figure 1–2:
1. Operational versus strategic.
2. Direct and indirect.
3. Negative, neutral, and positive.

The Operational versus Strategic Contribution of Supply

First, supply can be viewed in two contexts: operational, which is characterized as trouble
avoidance, and strategic, which is characterized as opportunistic.
The operational context is the most familiar. Many people inside the organization are
inconvenienced to varying degrees when supply does not meet minimum expectations.
Improper quality, wrong quantities, and late deliveries may make life miserable for the

3
M. R. Leenders and P. F. Johnson, Major Changes in Supply Chain Responsibilities (Tempe, AZ: CAPS
Research, March 2002), p. 104.

Purchasing and Supply

Management
 Chapter 1 Purchasing and Supply Management 9

FIGURE 1–2 1. Supply contribution

Purchasing’s
Operational
and Strategic Operational Strategic
Contributions4 Trouble prevention Opportunity maximization

2. Supply contribution

Direct Indirect
Bottom-line impact Enhancing performance of others

3. Supply contribution

Negative Neutral Positive

Operationally deficient Operationally acceptable Operationally acceptable
Strategically deficient Strategically deficient Strategically acceptable
Directly deficient Directly acceptable Directly acceptable
Indirectly deficient Indirectly deficient Indirectly acceptable

4Deficient wcetgdfic.int 4 capable

ultimate user of the product or service. This is so basic and apparent that “no complaints”
is assumed to be an indicator of good supply performance. The difficulty is that many
users never expect anything more and hence may not receive anything more.
The operational side of supply concerns itself with the transactional, day-to-day opera-
tions traditionally associated with purchasing. The operational side can be streamlined and
organized in ways designed to routinize and automate many of the transactions, thus free-
ing up time for the supply manager to focus on the strategic contribution.
The strategic side of supply is future oriented and searches for opportunities to provide
competitive advantage. Whereas on the operational side the focus is on executing current
tasks as designed, the strategic side focuses on new and better solutions to organizational
and supply challenges. (Chapter 2 discusses the strategic side in detail.)

The Direct and Indirect Contribution of Supply

The second perspective is that of supply’s potential direct or indirect contribution to orga-
nizational objectives.
Supply savings, the profit-leverage effect, and the return-on-assets effect demonstrate
the direct contribution supply can make to the company’s financial statements. Although
the argument that supply savings flow directly to the bottom line appears self-evident,
experience shows that savings do not always get that far. Budget heads, when presented
with savings, may choose to spend this unexpected windfall on other requirements.

4
Michiel R. Leenders and Anna E. Flynn, Value-Driven Purchasing: Managing the Key Steps in the
Acquisition Process (Burr Ridge, IL: Richard D. Irwin, 1995), p. 7.

Purchasing and Supply

Management
10 Purchasing and Supply Management

To combat this phenomenon, some supply organizations have hired financial control-
lers to assure that supply savings do reach the bottom line. Such was the case at Praxair, a
global supplier of specialty gases and technologies. The chief supply officer and the CFO
agreed that a financial controller position was needed in the supply organization to sup-
port financial analysis and budgeting. Validating cost savings and linking cost savings to
the business unit operating budgets were important parts of this person’s responsibilities.5
The appeal of the direct contribution of supply is that both inventory reduction and
purchasing savings are measurable and tangible evidence of supply contribution, as dem-
onstrated in the QBL Products case in Chapter 17.
The supply function also contributes indirectly by enhancing the performance of other
departments or individuals in the organization. This perspective puts supply on the man-
agement team of the organization. Just as in sports, the team’s objective is to win. Who
scores is less important than the total team’s performance. For example, better quality
may reduce rework, lower warranty costs, increase customer satisfaction, and/or increase
the ability to sell more or at a higher price. Ideas from suppliers may result in improved
design, lower manufacturing costs, and/or a faster idea-to-design-to-product-completion-
to-customer-delivery cycle. Each would improve the organization’s competitiveness.
Indirect contributions come from supply’s role as an information source; its effect on
efficiency, competitive position, risk, and company image; the management training pro-
vided by assignments in the supply area; and its role in developing management strategy
and social policy. The benefits of the indirect contribution may outweigh the benefits of
direct contribution, but measuring the indirect benefits is difficult since it involves many
“soft” or intangible contributions that are difficult to quantify.

Information Source
The contacts of the supply function in the marketplace provide a useful source of information
for various functions within the organization. Primary examples include information about
prices, availability of goods, new sources of supply, new products, and new technology, all
of interest to many other parts of the organization. New marketing techniques and distribu-
tion systems used by suppliers may be of interest to the marketing group. News about major
investments, mergers, acquisition candidates, international political and economic develop-
ments, pending bankruptcies, major promotions and appointments, and current and potential
customers may be relevant to marketing, finance, research, and top management. Supply’s
unique position vis-à-vis the marketplace should provide a comprehensive listening post.

Effect on Efficiency
The efficiency with which supply processes are performed will show up in other operating
results. While the firm’s accounting system may not be sophisticated enough to identify
poor efficiency as having been caused by poor purchase decisions, that could be the case.
If supply selects a supplier who fails to deliver raw materials or parts that measure up to
the agreed-on quality standards, this may result in a higher scrap rate or costly rework,
requiring excessive direct labor expenditures. If the supplier does not meet the agreed-on
delivery schedule, this may require a costly rescheduling of production, decreasing overall
production efficiency, or, in the worst case, a shutdown of the production line—and fixed

5
Leenders and Johnson, Major Changes in Supply Chain Responsibilities, p. 89.

Purchasing and Supply

Management
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