S221. 3 Supply Management

9/14/2022
Supply Management
Chapter 3
Chapter Objectives
Be able to:
 Identify and describe the various steps of the strategic sourcing process.
 Perform and interpret the results of a simple spend analysis.
 Use portfolio analysis to identify the appropriate sourcing strategy for a
particular good or service.
 Describe the rationale for outsourcing and discuss when it is appropriate.
 Perform a simple total cost analysis.
 Show how multicriteria decision models can be used to evaluate suppliers and
interpret the results.
 Understand when negotiations should be used and the purpose of contracts.
 Describe the major steps of the procure-to-pay cycle.
 Discuss some of the longer-term trends in supply management and why they
are important.
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Supply Management
Supply Management
Supply Management – The broad set of

activities carried out by organizations to:
 analyze sourcing opportunities,
 develop sourcing strategies,
 select suppliers, and
 carry out all the activities required to procure
goods and services.
>> referred to as sourcing or purchasing

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Why is
Supply Management critical?
Several factors:
 increased levels of global sourcing,
 the financial impact of sourcing, and
 the impact sourced goods and services have
on other performance metrics, including
quality and delivery performance.
Why is
 Global Sourcing
 Competition against global competitors and their
supply chains.
 Advances in information systems have helped.
 Build relationships with world-class suppliers,
regardless of their location
>>Source globally
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Why is
 Global
Sourcing:
For example:
Top 10 First-Tier
Suppliers in
Global
Automotive
Industry
Why is
 Financial Impact
For the average manufacturer, just over 59% of the

value of shipments comes from materials
>> Supply management represents a major opportunity
to increase profitability through what is known as the
profit leverage effect 8
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Why is
 Cost of goods sold – The purchased cost of goods from outside
suppliers.
 Merchandise inventory – A balance sheet item that shows the
amount a company paid for the inventory it has on hand at a
particular point in time.
 Profit margin – The ratio of earnings to sales for a given time
period.
 Return on assets (ROA) – A measure of financial performance

defined as Earnings/Total Assets
Profit Leverage
For example: Profit Leverage at Target Corporation
Selected
Financial Data
for Target
Corporation
(all figures
in $ millions)
Profit Margin = 100% X ($4,629 / $65,786) = 7%

Return on Assets = 100% X (4,629 / $17,213) = 26.9%
What can this company do to improve these figures?

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Profit Leverage – Example
1. Every dollar saved in purchasing lowers COGS
by $1 and increases pretax profit by $1.
• Profit leverage effect – A term used to describe
the effect of $1 in cost savings increasing pretax
profits by $1 and a $1 increase in sales
increasing pretax profits only by $1 multiplied
by the pretax profit margin.
Question: to have the same impact on pretax profit, COGS
not change, how much would Target have to generate in
new sales? 11

2. Every dollar saved in purchasing also lowers the
merchandise inventory figure—and as a result, total
assets—by $1. The result is a higher ROA for the
same level of sales.
3% purchasing reduction in COGS
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2. Every dollar saved in purchasing also lowers the
merchandise inventory figure—and as a result, total
assets—by $1.
13

Earnings and Expenses Current Reflecting Savings Pretax earnings
increase by $1372
Sales $65,786 $65,786 (30%)
COGS $45,725 $44,353
Pretax earnings $4,629 $6,001
ROA increases
Selected Balance Sheet Items from 26.9% to
Merchandise inventory $7,596 $7,368 35.3%
Total assets $17,213 $16,985
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Why is
Performance Impact
 Purchased goods and services can have a major
effect on other dimensions such as quality and
delivery performance.
Example: Purchasing Valves at Springfield Hospital
- normally replaced every two weeks when the machines
are idle
- uses about 50 valves per year.
- two alternative sources for the valves.
The purchase price and quality for these two suppliers are as
follows: 15
Performance Impact – Example

Sourcing dialysis machine valves
Effect of defective dialysis machine

 Interruption in patient treatment
 Rescheduling difficulties
 Reduction in the effective capacity for dialysis
 Possible medical emergencies
Estimated cost of a failed valve = $1,000 16
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Performance Impact – Example

Sourcing 50 dialysis machine valves
(Total Costs)
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The Strategic Sourcing Process
Strategic sourcing is concerned with identifying ways to

improve long-term business performance by better:
 understanding sourcing needs,
 developing long-term sourcing strategies,
 selecting suppliers, and
 managing the supply base
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The Strategic Sourcing Process
The six steps of the strategic sourcing process:
 How much effort a company spends on each step will differ

greatly from one situation to the next.
 Gain a competitive advantage by performing these steps
better than their competitors do. 20
Step 1. Assess Opportunities

 The strategic sourcing process is conducted to improve
the performance of a firm’s existing sourcing activities
>>assess sourcing performance
 Spend Analysis – The application of quantitative
techniques to purchasing data in an effort to better
understand spending patterns and identify opportunities
for improvement.
 What categories of products or services make up the bulk of
company spending?
 How much are we spending with various suppliers?
 What are our spending patterns like across different locations?
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Assess Opportunities – Example

El-Way Consultants, a consulting firm with offices located in
six major cities.
 how money is spent on office supplies
 opportunity to save the company some money
Examine the trends and impact of spending.
Useful insights:
• Total office supply expenditures for last year were approximately $10 million
• London, New York, and Paris—account for 84% of all office supply expenditures.
22
Step 2. Profile Internally and Externally
 Develop a more detailed picture, or profile, of the

internal needs of the organization, as well as the
characteristics of the external supply base
 Two approaches to creating profiles:
 Category profile – An approach to understand all aspects of
a particular sourcing category that could ultimately have an
impact on the sourcing strategy.
 Industry Analysis – An approach to provide a more detailed
understanding of the characteristics of the external supply
base.
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Profile Internally and Externally
Category profile – An approach to understand all

aspects of a particular sourcing category that could
ultimately have an impact on the sourcing strategy.
 a breakdown of the total category spend by
subcategories, suppliers, and locations.
 understanding how the purchased components or
services are used and
 how demand levels in the organization will change
over time.
24
Industry Analysis – An approach to provide a more

detailed understanding of the characteristics of the
external supply base.
 profiles the major forces and trends that are
impacting an industry, including pricing, competition,
regulatory forces, substitution, technology changes,
and supply/demand trends.
 require highly specialized knowledge
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Example
Internal Profiling at El-Way Consultants:
 Perform a more detailed category profile for office
supplies
26

Example
Note:
Top two subcategories—paper
and pads and basic office
supplies—together make up
63% of total office supply
expenditures
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Example
Which suppliers the various locations are spending their office
supply dollars with!
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Example
Which suppliers the various locations are spending their office
supply dollars with!
Note:
 62% of El-Way’s
expenditures are
concentrated in
three suppliers
>>seeking
favorable price
discounts and
delivery terms.
 27% of El-Way’s office supply expenditures are spread over the bottom
143 suppliers 29
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Step 3. Develop the Sourcing Strategy
Three parts:
(1) the make-or-buy decision,
(2) total cost analysis, and
(3) portfolio analysis.
30
Develop the Sourcing Strategy
 The Make-or-Buy Decision

 A high-level, often strategic, decision regarding
which products or services will be provided
internally and which will be provided by external
supply chain partners.
• Insourcing – The use of resources within the
firm to provide products or services.
• Outsourcing – The use of supply chain partners
to provide products or services.
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 The Make-or-Buy Decision
• Outsourcing – The use of supply chain partners
to provide products or services. The decision to
outsource goods or services raises a host of
strategic questions:
– What are the pros and cons of outsourcing?
– Are there suppliers capable of meeting our needs?
Which supplier is the “best”?
– How many suppliers should be used to ensure supply
continuity, maintain competition, yet achieve the
benefits of a solid supply relationship?
32

Advantages and Disadvantages of
Insourcing and Outsourcing
Companies should try to insource processes that are core competencies—

organizational strengths or abilities, developed over a long period, that customers
find valuable and competitors find difficult or even impossible to copy. Products or
processes that could evolve into core competencies are prime candidates for
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insourcing.
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Factors that affect the decision
to Insource or Outsource.
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Total cost analysis

A process by which a firm seeks to identify and
quantify all of the major costs associated with
various sourcing options.
 Direct costs – Costs tied directly to the level of
operations or supply chain activities such as the
production of a good or service, or transportation
 Indirect costs – Costs that are not tied directly to
the level of operations or supply chain activity.
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Insourcing and Outsourcing Costs
36

Total cost analysis – Example
The VinC considers:
Insourcing option Outsourcing option
Company would need to invest in another The supplier has bid $0.10 per part,
machine that would cost $10,000, depreciated given a forecasted demand of 200,000
over the life of the product. parts in year 1, 300,000 in year 2, and
Direct materials can be purchased for $0.05 500,000 in year 3.
per unit. Direct labor is estimated at $0.03 per Shipping and handling of parts from
unit plus a 50% surcharge for benefits; the supplier’s facility is estimated at
indirect labor is estimated at $0.011 per unit $0.01 per unit.
plus 50% for benefits. Additional inventory handling charges
Up-front engineering and design costs will should amount to $0.005 per unit.
amount to $30,000. Finally, administrative costs are
Finally, VinC management has insisted that estimated at $20 per month.
overhead (an indirect cost) be allocated to
theparts at a rate of 100% of direct labor cost.
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Total cost
analysis –
Example
The VinC
considers:
Total Cost
Analysis for
the Sourcing
Decision
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Portfolio analysis –
A structured approach used by decision makers to
develop a sourcing strategy for a product or service,
based on the value potential and the relative
complexity or risk represented by a sourcing
opportunity.
The products or services to be sourced are assigned
to one of four strategic quadrants, based on their
relative complexity and/or risk impact to the firm
and their value potential
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Portfolio Analysis
High
Bottleneck Critical
Complexity
or Risk
Impact
Routine Leverage
Low
Low High
Value Potential
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 Portfolio Analysis
 The Routine Quadrant – Readily available products or services (small %
of total).
• Electronic Data Interchange: An information technology that allows
supply chain partners to transfer data electronically between their
information systems.
 The Leverage Quadrant – Standardized and readily available products or
services (large % of total).
• Preferred suppliers: a supplier that has demonstrated its
performance capabilities through previous purchase contracts and
therefore receives preference during the supplier selection process
 The Bottleneck Quadrant – Unique or complex products or services
supplied by few suppliers.
 The Critical Quadrant - Unique or complex products or services supplied
by few suppliers, representing large % of total.
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Sourcing
Portfolio
Analysis
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How many suppliers to use

when sourcing a good or service!
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Single and Multiple Sourcing, Cross Sourcing, and Dual Sourcing
 Single sourcing – The buying firm depends on a single
company for all or nearly all of an item or service.
 Multiple sourcing – The buying firm shares its business
across multiple suppliers.
44
Advantages and
Disadvantages of
Multiple/ Single Sourcing
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Single and Multiple Sourcing, Cross Sourcing, and Dual Sourcing
 Single sourcing – The buying firm depends on a single
company for all or nearly all of an item or service.
 Multiple sourcing – The buying firm shares its business
across multiple suppliers.
 Cross sourcing – A sourcing strategy in which a company
uses a single supplier for one particular part or service and
another supplier with the same capabilities for a different
part or service
 Dual sourcing – Using two suppliers for the same
purchased product or service.
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Step 4: Screen Suppliers and

Create Selection Criteria
Which is the best supplier

for the new product or service?
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 Criteria to evaluate suppliers
Process and design capabilities
Management capability
Financial condition and cost structure
Longer-term relationship potential
48

 different manufacturing and service processes
>> inherent strengths and weaknesses
 assess the supplier’s design capability
>>perform component design and production
 qualified suppliers >>reduce the time required
to develop new products
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 management’s commitment to continuous
process and quality improvement,
 overall professional ability and experience,
 ability to maintain positive relationships with
the workforce,
 and willingness to develop a closer working
relationship with the buyer.
50

Financial condition and cost structure >>reduce
risks
 disrupt the flow of goods or services
 suppliers may not have the resources to invest in
required personnel, equipment, or improvement
efforts
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Financial condition and cost structure
Longer-term relationship potential

>> looking to develop a long-term relationship with a
potential supplier
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 Process and design capabilities
 Management capability
 Financial condition and cost structure
 Longer-term relationship potential
Gather data about potential suppliers >>request for

information (RFI)
 provide useful quantitative and qualitative information
about a supplier
 serves as a signal that a supplier might be interested in
entering into a business relationship with the buying firm
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Step 5: Conduct Supplier Selection
 Identify a short list of suppliers with whom the

buying firm will engage in competitive bidding
or negotiations.
 Multicriteria decision models allow decision
makers to evaluate various alternatives across
multiple decision criteria.
 a mix of quantitative and qualitative decision
criteria
 Consider numerous decision alternatives
 no clear “best” choice 54
 Weighted-point evaluation system – An

evaluation system to evaluate potential
suppliers, track supplier’s performance over
time, and rank current suppliers.
 Method
 Assign weights to performance dimensions.
 Rate the performance of each supplier with regard
to each dimension.
 Calculate the total score.
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 Weighted-point evaluation system –

Calculate the total score.
56
Supplier Selection – Example
Using the Weighted Point Evaluation System to

Support Supplier Evaluation at Electra Company
Summary Data for Three Possible Suppliers
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n
Score X   Performanc e XY  WY
Y 1
Assign the weight for each of the criteria

Criteria Weights Scoring Scheme
WPrice = 0.3 5 = excellent

4 = good
WQuality = 0.4 3 = average
2 = fair
WDelivery = 0.3 1 = poor 58
Assigned performance scores for each criterion

Performance Values for Alternative Suppliers
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Calculate Total Scores for Alternative Suppliers
Score Aardvark = (4 x 0.3) + (3 x 0.4) + (4 x 0.3) = 3.6
Score Beverly = (3 x 0.3) + (5 x 0.4) + (2 x 0.3) = 3.5
Score Conan = (5 x 0.3) + (1 x 0.4) + (1 x 0.3) = 2.2
 Aardvark should improve their quality.

 Beverly Hills should improve their delivery and price.
 Conan is out of the running as a potential supplier.
60
AIC – 10 minutes to complete

Excercise
Industrial Engineering (IE) firm produces customized instrumentation for the aerospace
industry. IE is thinking about outsourcing the production of a particular component to a Fort
Worth manufacturer. The Fort Worth manufacturer has offered to make the components for
a price of $25 each, based on an annual volume of 32,000. However, there are additional
costs associated with maintaining this supplier relationship. IE management has developed
the following cost figures:
1. Total cost: x = 32.000
PA1: 800.000 + 8.5x + 5x =
1.232.000
PA2: 25x + 50.000 + 65.000
+ 1.5x = 963000
In addition to cost, IE management has identified two other dimensions to consider:
quality (specifically, the percentage of defect-free items) and on-time delivery. IE
management has established importance weights of 0.2, 0.5, and 0.3 for cost, quality, and
on-time delivery, respectively. Finally, purchasing managers at IE have rated the
performance of the current assembly operation and the Fort Worth manufacturer with regard
to these three dimensions. Their ratings (1 5 “poor” to 5 5 “excellent”) are as follows:
1. Calculate the total cost of

each option,
2. Calculate the overall
preference score 61
4 3.9
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Step 6: Negotiate and Implement

Agreements
 Reach a formal agreement with one or more
suppliers regarding terms and conditions
 the price to be paid,
 volume levels,
 quality levels, and
 delivery performance.
 Two methods commonly used to select a
supplier:
 competitive bidding and
 negotiation
64

Agreements
 Competitive bidding – A request for bids from
suppliers with whom a buyer is willing to do
business.
 Request for quotation (RFQ) – A formal request
for the suppliers to prepare bids, based on the
terms and conditions set by the buyer.
• Description by market grade/industry standard
• Description by brand
• Description by specification
• Description by performance characteristics65
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Agreements
 Request for quotation (RFQ) – A formal request for
the suppliers to prepare bids, based on the terms
and conditions set by the buyer.
• Description by market grade/industry standard:
A description method that is used when the
requirements are well understood and there is
common agreement between supply chain partners
about what certain terms mean
66

Agreements
 Request for quotation (RFQ) – A formal request
for the suppliers to prepare bids, based on the
terms and conditions set by the buyer.
• Description by brand:
A description method that is used when a
product or service is proprietary or when there is
a perceived advantage to using a particular
supplier’s products or services.
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Agreements
• Description by specification:
A description method that is used when an
organization needs to provide very detailed
descriptions of the characteristics of an item or a
service.
68

Agreements
• Description by specification
• Description by performance characteristics
A description method that focuses attention on the
outcomes the customer wants rather than on the
precise configuration of the product or service.
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Agreements
When is competitive bidding method used?
The buying firm can provide qualified suppliers
with clear descriptions of the items or services to
be purchased.
Volume is high enough to justify the cost and
effort.
The buying firm does not have a preferred
supplier.
70
Negotiate and Implement

Agreements
 Negotiating – A more costly, interactive
approach to final supplier selection.
 Negotiation is used best when:
 The item is a new or technically complex item with only
vague specifications.
 The purchase requires agreement about a wide range of
performance factors.
 The buyer requires the supplier to participate in the
development efforts.
 The supplier cannot determine risks and costs without
additional input from the buyer.
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Agreements
 Contracting – The process of creating a
detailed purchasing contract to formalize the
buyer-supplier relationship.
 if the size of the purchase exceeds a
predetermined monetary value
 if there are specific business requirements that
need to be put in writing
 two basic types: fixed-price and cost-based
contracts.
72

Agreements
 Contracting –
 Fixed-price contract – A type of purchasing contract in which
the stated price does not change, regardless of fluctuations
in general overall economic conditions, industry competition,
levels of supply, market prices, or other environmental
changes.
 Cost-based contract – ties the price of a good or service to
the cost of some key input(s) or other economic factor(s),
such as interest rates.
>>the purchasing manager’s responsibility to ensure that all of
the terms and conditions of the agreement are fulfilled.
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The Procure-to-Pay Cycle

 Signal to the supplier that delivery of the product or
service is required >>Procure-to-pay cycle.
the set of activities required to first identify a need, assign a
supplier to meet that need, approve the specification or
scope, acknowledge receipt, and submit payment to the
supplier.
 involves day-to-day communications and transactions
between the buyer and supplier
 completed once the goods or services have been received,
the supplier has been paid, and the information has been
recorded into the database.
74
The five main steps of the procure-to-pay cycle:

1. Ordering
2. Follow-up and expediting
3. Receipt and inspection
4. Settlement and payment
5. Records maintenance
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1. Ordering - Purchase order PO:
A document that authorizes a supplier to deliver a
product or service and often includes terms and
conditions, such as price, delivery, and quality
requirements
 monitor the status of open purchase orders
 expedite an order or work with a supplier to
avoid shipment delays
76

1.Ordering
2.Follow-up and expediting
3.Receipt and inspection
 received and inspected to ensure that the right quantity
was shipped and that it was not damaged in transit.
 ensure that the service is being performed according to
the terms and conditions stated in the purchase order
>>statement of work, or scope of work (SOW)
Terms and conditions for a purchased service that indicate, among
other things, what services will be performed and how the service
provider will be evaluated.
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1. Ordering
 authorization for payment to the supplier.
 May be paid through Electric Funds Transfer (EFT) -
automatic transfer of payment from the buyer’s bank
account to the supplier’s bank account
78

1. Ordering
5. Records maintenance
 a record of critical events associated with the purchase is
entered into a supplier performance database
 used in future negotiations and dealings with the supplier
in question
 support spend analysis efforts
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Trends in Supply Management

Two key trends affecting supply management:
environmental sustainability and planning for
supply chain disruptions
 Sustainable Supply
 Becoming more conscious of the importance of
being environmentally friendly and using
environmental performance in selecting suppliers.
 Ensuring compliance with regulations.
 Reducing packaging, promoting recycling,
reducing costs.
80
Trends in Supply Management

 Supply Chain Disruptions
 Caused by natural disasters, economic/political
events.
 Cause a big threat to revenue streams.
 Increased risk due to outsourcing to global
suppliers.
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Chapter Objectives
Be able to:
 Identify and describe the various steps of the strategic sourcing process.
 Perform and interpret the results of a simple spend analysis.
 Use portfolio analysis to identify the appropriate sourcing strategy for a
particular good or service.
 Describe the rationale for outsourcing and discuss when it is appropriate.
 Perform a simple total cost analysis.
 Show how multicriteria decision models can be used to evaluate suppliers and
interpret the results.
 Understand when negotiations should be used and the purpose of contracts.
 Describe the major steps of the procure-to-pay cycle.
 Discuss some of the longer-term trends in supply management and why they
are important.
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40

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9/14/2022

Supply Management – The broad set of

>> referred to as sourcing or purchasing

For the average manufacturer, just over 59% of the

 Return on assets (ROA) – A measure of financial performance

Profit Margin = 100% X ($4,629 / $65,786) = 7%

What can this company do to improve these figures?

Profit Leverage – Example

Profit Leverage – Example

Profit Leverage – Example

Profit Leverage – Example

3% purchasing reduction in COGS

Performance Impact – Example

Effect of defective dialysis machine

Estimated cost of a failed valve = $1,000 16

Performance Impact – Example

The Strategic Sourcing Process

Strategic sourcing is concerned with identifying ways to

The Strategic Sourcing Process

The six steps of the strategic sourcing process:

 How much effort a company spends on each step will differ

Step 1. Assess Opportunities

Assess Opportunities – Example

Step 2. Profile Internally and Externally

 Develop a more detailed picture, or profile, of the

Profile Internally and Externally

Category profile – An approach to understand all

Profile Internally and Externally

Industry Analysis – An approach to provide a more

Profile Internally and Externally

Profile Internally and Externally

Profile Internally and Externally

Profile Internally and Externally

Step 3. Develop the Sourcing Strategy

Develop the Sourcing Strategy

 The Make-or-Buy Decision

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Companies should try to insource processes that are core competencies—

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Total cost analysis

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Develop the Sourcing Strategy

How many suppliers to use

Develop the Sourcing Strategy

Develop the Sourcing Strategy

Step 4: Screen Suppliers and

Which is the best supplier

Step 4: Screen Suppliers and

Process and design capabilities

Financial condition and cost structure

Longer-term relationship potential

Step 4: Screen Suppliers and

Step 4: Screen Suppliers and

Step 4: Screen Suppliers and

Step 4: Screen Suppliers and

Longer-term relationship potential

Step 4: Screen Suppliers and