Lecture 15

Purchasing and Supply Chain

Books• Introduction to Materials Management, Sixth Edition, J. R. Tony Arnold, P.E., CFPIM, CIRM, Fleming

College, Emeritus, Stephen N. Chapman, Ph.D., CFPIM, North Carolina State University, Lloyd M. Clive, P.E., CFPIM, Fleming College

• Operations Management for Competitive Advantage, 11th Edition, by Chase, Jacobs, and Aquilano, 2005, N.Y.: McGraw-Hill/Irwin.

• Operations Management, 11/E, Jay Heizer, Texas Lutheran University, Barry Render, Graduate School of Business, Rollins College, Prentice Hall

Objectives

• Purchasing overview• Purchasing cycle• Purchasing function• Make or buy decision• Purchasing techniques• JIT purchasing• Supply chain management• Outsourcing• Ethics in Supply chain

Purchasing Overview

• Purchasing– The acquisition of goods and services.

• Purchasing Activity– Helps identify the products and services that can be

best obtained externally; and– Develops, evaluates, and determines the best

supplier, price, and delivery for those products and services.

Purchasing Objectives

• Obtaining goods and services of the required quality and quantity.

• Obtaining goods and services at the lowest cost.• Ensuring the best possible service and prompt delivery

by the supplier.• Developing and maintaining good supplier relations

and developing potential suppliers.

Purchasing Functions

• Determining purchasing specifications: quality, quantity, delivery

• Selecting suppliers• Negotiating terms and conditions of purchase• Issuing and administering purchase orders

Purchasing Cycle

• Receiving and analyzing purchase req’s.• Selecting suppliers• Determining the right price• Issuing purchase orders• Following up to assure delivery dates are met• Receiving and accepting goods• Approving supplier’s invoice for payment

Order Cycle(one to three

weeks)Order RequestVerification by inventory controlPurchasing researches suppliers, obtains quotes, etc.Signatures obtainedOrder mailed

Order Cycle(one to three

weeks)Order RequestVerification by inventory controlPurchasing researches suppliers, obtains quotes, etc.Signatures obtainedOrder mailed

Supplier Cycle(one to many weeks)

Supplier receives and enters orderSupplier manufactures or “picks” orderSupplier ships order

Supplier Cycle(one to many weeks)

Supplier receives and enters orderSupplier manufactures or “picks” orderSupplier ships order

Receiving Cycle(one week)

ReceivingIncoming inspectionInventory control receives order, updates records, and notifies department

Receiving Cycle(one week)

ReceivingIncoming inspectionInventory control receives order, updates records, and notifies department

The Typical Procurement Cycle

Purchasing Terminology

• Purchasing Agent– Has legal authority to execute contracts on behalf of the

firm.• Make or Buy Decision

– Choosing products and services that can be advantageously obtained externally or produced internally depending on which is best for the company.

– Vertical Integration– Developing the ability to produce goods or services

previously purchased, or actually buying a supplier or a distributor.

Make-or-Buy Decisions

1. Maintain core competence2. Lower production cost3. Unsuitable suppliers4. Assure adequate supply (quantity or delivery)5. Utilize surplus labor or facilities6. Obtain desired quality7. Remove supplier collusion8. Obtain unique item that would entail a prohibitive

commitment for a supplier9. Protect personnel from a layoff10. Protect proprietary design or quality11. Increase or maintain size of company

Reasons for Making

Make-or-Buy Decisions

1. Frees management to deal with its core competence2. Lower acquisition cost3. Preserve supplier commitment4. Obtain technical or management ability5. Inadequate capacity6. Reduce inventory costs7. Ensure alternative sources8. Inadequate managerial or technical resources9. Reciprocity10. Item is protected by a patent or trade secret

Reasons for Buying

Make/Buy Considerations

• Lower production cost• Unsuitable suppliers• Assure adequate supply• Utilize surplus labor and make

a marginal contribution• Obtain desired quantity• Remove supplier collusion• Obtain a unique item that

would entail a prohibitive commitment from the supplier

• Lower acquisition cost• Preserve supplier commitment• Inadequate capacity• Reduce inventory costs• Ensure flexibility and alternate

source of supply• Product improvements may be

difficulty because it is a sideline

Reasons for Making Reasons for Buying

Purchasing Terminology

• Keiretsu– The Japanese word to describe a company coalition

with long-term contracts with the firm; members of the Keiretsu function much like partners would.

Supplier Relations

• Three aspects of supplier relations– Supplier Evaluation - Involves finding potential

suppliers and determining the likelihood of their becoming good partners.

– Supplier Development - May include everything from training, to engineering and production help, to formats for electronic transfer.

– Negotiations - Are of three classic types: cost-based model, market-based price model, and competitive bidding.

Sourcing

• Sole sourcing implies that only one supplier is available.

• Multiple sourcing is the use of more than one supplier for an item.

• Single sourcing is the selection of one item for an item when several sources are available.

Factors in Selecting Suppliers

• Technical ability• Manufacturing capability• Reliability• After-sales service• Supplier location• Price • Other considerations

Supplier Relations

• The supplier should be treated as an extension of the company.

• Long-term, close relationships with a few suppliers is best for many critical products.

• The supplier should be committed to helping the purchaser improve its product and win orders.

• Suppliers can also be a source of ideas about new technology, materials, and processes.

• A good supplier relationship is like a marriage.

Supplier Relations

The following characteristics have been proven to be present in good relationships.

• Commitment• Communication• Working through change / improvement• Principles centered relationship• Spending time together• Appreciation / recognition / feedback

Supplier Relations

• Negotiation Strategies– Cost-Based Model - Requires the supplier to open

its books so that the purchaser can determine actual costs.

– Market-Based Price Model - Based on a published price or index such as exists for many metal and paper suppliers.

– Competitive Bidding - Appropriate where suppliers are not willing to discuss cost or where near perfect markets do not exist.

Negotiations and Product Type

• Commodities: Contracts for future prices.• Standard Products: May negotiate large

purchases.• Items of Small Value: Minimize cost of

ordering. Negotiate ordering system.• Made-to-order items: Can be negotiated.

Purchasing Techniques

• Blanket orders

• Invoiceless purchasing

• Electronic ordering and funds transfer

• Electronic data interchange (EDI)

• Stockless purchasing

• Standardization

Purchasing Techniques

• Blanket Orders– A contract to purchase certain items from a vendor,

although they all may not be delivered until requested by the purchaser.

• Invoice-less Purchasing– Appropriate where substantial trust exists between

the purchaser and supplier and deliveries are made on a regular basis and are easily verifiable.

Purchasing Techniques

• Electronic Ordering and Fund Transfer– Reduces cost by reducing paperwork; also increases the

speed of ordering.• Stockless Purchasing

– Developing with the supplier, a means of reducing inventory costs by the supplier holding inventory.

• Standardization– A technique for reducing purchases for specialized

items when in fact a very similar standard product is commercially available.

Supplier Concerns in Just-in-Time Purchasing

• Desire for Diversification. – Supplier is concerned about all business stemming from

single customer.• Poor Customer Scheduling.

– Supplier is concerned that customer will not be able to develop smooth, consistent schedule.

• Engineering Changes. – Supplier is concerned that customer will promulgate

frequent engineering changes with inadequate lead time.

Supplier Concerns in Just-in-Time Purchasing

• Quality Assurance. – Supplier may consider production with zero defects

unrealistic.• Small Lot Sizes.

– Many suppliers are unaccustomed to working with small lot sizes.

• Proximity. – Delivery of small lot sizes over long distances may not

be economical.

The Supply Chain’s Strategic Importance

Supply chain management is the integration of the activities that procure materials and services, transform them

into intermediate goods and the final product, and deliver them to customers

Competition is no longer between companies; it is between supply chains

Supply Chain Management

1. Transportation vendors

2. Credit and cash transfers

3. Suppliers

4. Distributors

5. Accounts payable and receivable

6. Warehousing and inventory

7. Order fulfillment

8. Sharing customer, forecasting, and production information

Important activities include determining

A Supply Chain for Beer

Global Supply Chain Issues

React to sudden changes in parts availability, distribution, or shipping channels, import duties, and currency rates

Use the latest computer and transmission technologies to schedule and manage the shipment of parts in and finished products out

Staff with local specialists who handle duties, freight, customs and political issues

Supply chains in a global environment must be able to

How Supply Chain Decisions Impact Strategy

Low-Cost Strategy

Response Strategy

Differentiation Strategy

Supplier’s goal

Supply demand at lowest possible cost (e.g., Emerson Electric, Taco Bell)

Respond quickly to changing requirements and demand to minimize stockouts (e.g., Dell Computers)

Share market research; jointly develop products and options (e.g., Benetton)

Primary selection criteria

Select primarily for cost

Select primarily for capacity, speed, and flexibility

Select primarily for product development skills

How Supply Chain Decisions Impact Strategy

Low-Cost Strategy

Response Strategy

Differentiation Strategy

Process charact-eristics

Maintain high average utilization

Invest in excess capacity and flexible processes

Modular processes that lend themselves to mass customization

Inventory charact-eristics

Minimize inventory throughout the chain to hold down cost

Develop responsive system with buffer stocks positioned to ensure supply

Minimize inventory in the chain to avoid obsolescence

How Supply Chain Decisions Impact Strategy

Low-Cost Strategy

Response Strategy

Differentiation Strategy

Lead-time charact-eristics

Shorten lead time as long as it does not increase costs

Invest aggressively to reduce production lead time

Invest aggressively to reduce development lead time

Product-design charact-eristics

Maximize performance and minimize costs

Use product designs that lead to low setup time and rapid production ramp-up

Use modular design to postpone product differentiation as long as possible

Supply Chain Economics

Supply Chain Costs as a Percent of Sales

Industry % Purchased

All industry 52

Automobile 67

Food 60

Lumber 61

Paper 55

Petroleum 79

Transportation 62

Supply Chain Economics

Dollars of additional sales needed to equal $1 saved through the supply chain

Percent of Sales Spent in the Supply Chain

Percent Net Profitof Firm 30% 40% 50% 60% 70% 80% 90%

2 $2.78 $3.23 $3.85 $4.76 $6.25 $9.09 $16.674 $2.70 $3.13 $3.70 $4.55 $5.88 $8.33 $14.296 $2.63 $3.03 $3.57 $4.35 $5.56 $7.69 $12.508 $2.56 $2.94 $3.45 $4.17 $5.26 $7.14 $11.11

10 $2.50 $2.86 $3.33 $4.00 $5.00 $6.67 $10.00

Outsourcing

Transfers traditional internal activities and resources of a firm to outside vendors

Utilizes the efficiency that comes with specialization

Firms outsource information technology, accounting, legal, logistics, and production

Ethics in the Supply Chain

Opportunities for unethical behavior are enormous and temptations are high

Many companies have strict rules and codes of conduct that define acceptable behavior

Institute for Supply Management has developed a detailed set of principles and standards for ethical behavior

Principles and Standards for Ethical Supply Management Conduct

LOYALTY TO YOUR ORGANIZATION

JUSTICE TO THOSE WITH WHOM YOU DEAL

FAITH IN YOUR PROFESSION

Principles and Standards for Ethical Supply Management Conduct

1. Avoid the intent and appearance of unethical or compromising practice in relationships, actions, and communications

2. Demonstrate loyalty to the employer by diligently following the lawful instructions of the employer, using reasonable care and granted authority

3. Avoid any personal business or professional activity that would create a conflict between personal interests and the interests of the employer

Principles and Standards for Ethical Supply Management Conduct

4. Avoid soliciting or accepting money, loans, credits, or preferential discounts, and the acceptance of gifts, entertainment, favors, or services from present or potential suppliers that might influence, or appear to influence, supply management decisions

5. Handle confidential or proprietary information with due care and proper consideration of ethical and legal ramifications and government regulations

6. Promote positive supplier relationships through courtesy and impartiality

7. Avoid improper reciprocal agreements

Principles and Standards for Ethical Supply Management Conduct

8. Know and obey the letter and spirit of laws applicable to supply management

9. Encourage support for small, disadvantaged, and minority-owned businesses

10. Acquire and maintain professional competence

11. Conduct supply management activities in accordance with national and international laws, customs, and practices, your organization’s policies, and these ethical principles and standards of conduct

12. Enhance the stature of the supply management profession

End of Lecture 15