procurement chain management2

7/28/2019 Procurement Chain Management2

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The Landscape changed

In 2001, Nike reported a profit shortfall due to

inventory buildup, shortage for others, and late

deliveries.

In 2000, CISCO was forced to announce 2.25 Bwrite-down for obsolete inventory.

In 1999, Apple had huge customer dissatisfaction

because of shortage of G4 chip supplied by

Motorola.


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What went wrong?

In the examples, the difficulties reflect problems withprocurement chain strategies.

Nike, CISCO, Apple have short product life cycles.

When technologies changed, uncertainties related to

customer demand increased. Procurement landscape changed significantly with the

introduction of independent, private, and consortium-basede-market places.

With changes in procurement landscape, both problems

and opportunities also changed.

But, Nike, CISCO, and Apple were not able to react tothese changes and formulate a new corporate andprocurement strategy.


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The need for a good strategy

The most important requirement for sustainability

is a well-formulated corporate strategy;

A corporate strategy, in turn, requires forming sub

strategies such as product strategy, procurement

strategy, marketing strategy, and so on. And,

A firm should continually evaluate its corporate

strategy and its sub strategies and ensure that theyare appropriate for a changing environment.

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Competitive Strategy let managers answer

questions such as

Relative to competitors, how should my firm

satisfy customers?

What products and services should we offer?

Should we focus on cost or should we focus more

on service and quick response?

How much customization should we allow on our

products? Compare the competitive strategies of: Lands End

and a local retailer.


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Competitive Strategy and procurement Strategy

The relationship

Competitive strategy

New Product

Development

Marketing &

SalesOperations Distribution Service

procurement Strategy

Supplier

Strategy

Operations

Strategy

Logistics

Strategy


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See the Dell example Matching competitive and

procurement strategies

Suppose Dells competitive strategy is to deliver a product

within 72 hours of receiving an order but is product

suppliers, on average take 7 days to resupply inventory,

then, Dell is not going to be able to accomplish its

competitive strategy.

There is a lack of strategic fit.

Also, look at Dells competitive strategy.

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The Dells competitive and procurement

strategies

Competitive strategy: provide a large variety ofcustomizable computer-related products at a reasonableprice and to let customers select from thousands ofconfigurations.

procurement strategy: Two possible options: 1. Efficientprocurement limiting variety and exploiting economies ofscale or 2. High flexibility and responsiveness producing alarge variety of products.

Dells procurement Strategy is No. 2 Consequently, Dell focuses on designing easily

customizable products, common platforms andcomponents that can be assembled quickly.


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Achieving Strategic Fit Achieved

The steps involved

Step 1: Understanding the customer and

procurement uncertainty

Step 2: Understanding the procurementcapabilities

Step 3: Achieve strategic fit


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First, take a look at two types of uncertainties Demand

Uncertainty and procurement chain uncertainty

Demand uncertainty: arises because of changingcustomer needspredicting demand for a product orservice absolutely is impossible. This is an externalfactor controlled by the customer.

Procurement chain uncertainty, in contrast, arisesbecause of uncertainties within a procurementprocess.

While a firm would like to meet 100% of customer

demand, it may not be able to do so because itsprocurement is unable to because of multiple reasonsthat were listed under procurement uncertainty.

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Demand uncertainty

(customer-induced)

Usually products that are less mature (electronics,computers) have greater demand uncertainty (unlikeSalt or milk).

Forecasting demand for such products is very difficult

and usually not very accurate.

With forecasting difficulties, matching demandagainst product and services supply is difficult.

For uncertain demand products, prices are not steady

and varies depending on demand levels.

At the same time, a firm could earn greater marginfrom uncertain demand products.

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Procurement chain uncertainty, on the contrary, arises

due to constraints within a procurement

procurement uncertainty: The portion ofuncertainty introduced by procurement attributessuch as: production breakdowns, low productyields, poor quality and rework, procurementcapacity is limited (because of limited productionfacilities, availability of raw materials, labor, andnumerous other factors);

Supply capability is inflexible and cannot increasewith increased product demand;

Also, changes in production process could lead tobottlenecks.

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Step 1: Therefore, understand both demand and procurement

chain uncertainties

Identify the needs of the customer segment beingserved (retail, wholesale, discount, high-endcustomers)

Quantity of product needed in each lot (large,small)

Response time customers will tolerate

Variety of products needed

Service level required Price of the product

Desired rate of innovation in the product


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Step 2: Evaluate procurement capabilities

A procurement can rarely meet all demands of allof its customers. Why?

How many of the following demands of customerscan we meet?

Responding to wide range of product demands

Meeting short lead times

Handling a large variety of products

Meeting high service level possible

Where do we compromise?


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Given procurement limitations, responding to

customer demand would require a compromise

How responsive should a procurement be?

Quicker response implies increased costs

(responsiveness).

Delayed response implies lower costs (efficient).

Therefore, a firm must compromise between

quicker response and lower costs and strike a

balance that suits its objectives. See the graph.


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A comparison of cost and responsiveness

High Low

Low

High

Responsiveness

Cost


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Efficient and Responsive procurement chains A Comparison

Efficient Responsive

Primary goal Supply demand at the lowest

cost

Respond quickly to demand

Product design strategy Min. product cost Modularity to allow

postponement

Pricing strategy Lower margins Higher margins

Mfg strategy High utilization Capacity flexibility

Inventory strategy Minimize inventory Buffer inventory

Lead time strategy Reduce but not at expense of

greater cost

Aggressively reduce even if

costs are significant

Supplier selection strategy Cost and low quality Speed, flexibility, quality

Transportation strategy Greater reliance on low cost

modes

Greater reliance on responsive

(fast) modes


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3. Achieving Strategic Fit

Now that a firm has assessed customer needs, demand

uncertainties, and procurement chain constraints and

uncertainties, it is time to make the two fit with each

other.

How?

In most cases, by offering high responsiveness to

products with high demand uncertainties and

Striving towards more cost efficiencies for productswith low demand uncertainties.

Compare these two products: computers and cheese.

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Let us revisit Dells strategy

Dell proposed a competitive strategy that it will

ship ordered consumer products within 72 hours;

a relatively high response rate.

What are the factors that Dell must consider?

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Dell Achieving Strategic Fit

First, Dell should be able to forecast customer

demand with some degree of accuracy (demand

uncertainty).

Decide how much of this demand uncertainty itcan meete.g. we can offer 72 hours shipment in

the case of jackets and overcoats but not for school

bags (implied demand uncertainty).

Also, note other items that Dell must consider:

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Dell Achieving Strategic Fit

Decide whether its procurement chainfrom manufacturers totrucking companies to warehouses would be able to meet its goal of72 hours shipment.

Decide how much inventory Dell should carry and how muchshould its procurement chain partners carry.

How soon can Dell inform manufacturers of changing fashions anddemands?

Ascertain the flexibility (in procurement of raw materials, mfg.capacity, labor, etc.) that its procurement chain partners have (ordo not have)?

Consider the cost of all of these factors and decide on the

responsiveness spectrum or the zone of fit. See the next slide.

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Remember the following about Strategic Fit

Two key points

there is noright procurement chain strategy

independent of competitive strategy

there isonly a right procurement chain strategyfor a given competitive strategy


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What did we learn

Formulating corporate strategy is easier thanimplementing strategy.

Strategy implementation requires the cooperation ofboth internal and external parties and

In turn, that requires common objectives and commonbenefits.

Strategy is not an one time implementation butsomething that requires constant redesign.

Procurement or supply management is one of thelargest assets in an organization and

The implication of managing it well has significantconsequences to an organization.


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Procurement Chain Management

A Strategic Implementation Process


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Product supply management is nothing but ProcurementStrategy, which is integral to corporate strategy.

A corporations corporate strategy and procurement

strategy must fit with each other or otherwise, both will

fail.

We will discuss the strategic decision making issues of

procurement and also how managers make decisions

related to both corporate and procurement strategy.

The discussions should facilitate understanding of the

issues of strategic implementation.


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The new global business environment

Fierce competition

Introduction of products with shorter and shorter

life cycles

Heightened expectations of customer

Continuing advances in communications and

transportation technologies (e.g. mobile

communication, Internet, overnight delivery)


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Cost impact of managing inventory

It is estimated that the grocery industry could save

$30 billion (10% of its operating cost) by using

effective logistics strategies.

Compaq computer estimates it lost $500 million to$1 billion in sales because its laptops and desktops

were not available when and where customers

were ready to buy them (Compaq does not exist

anymore).


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Managing costs in the supply arena

JIT, TQM, lean mfg. techniques have reduced

manufacturing costs as much as they could.

One area that yet requires improvement:

Inventory Procurement. See the followingexamples:

It takes a typical box of cereals more than 3

months to get from factory to supermarket.

It takes a new car, on average, 15 days to travel

from factory to dealership.


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The Success Stories

In 10 years, Wal-Mart transformed itself bychanging its logistics system. It has the highestsales per square foot, inventory turnover andoperating profit of any discount retailer.

Dell Computer has outperformed the competitionin terms of shareholder value growth over theeight years period, 1988-1996, by over 3,000%


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What exactly is procurement?

All stages and parties involved, directly orindirectly, in fulfilling a customer request

Internally, the procurement process includes allfunctions involved in fulfilling a customer request(product development, marketing, operations,distribution, finance, customer service).

Externally, it includes the suppliers, vendors,

manufacturers, transportation, and distributors,that exist to transform raw materials to finalproducts and supply those products to customers.


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Let us briefly go over how selling a simple box of

detergent through a retail store involves so manyparties and contractual arrangements and why each one

must function effectively to make the process efficient.

A procurement or a supply example


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Buying Cereals from Wal-MartTenneco

Packaging

Paper

Manufacturer

Timber

Company

P&G or other

Manufacturer

Corn

manufacturer

Wal- Mart

Plastic

Producer

Customer


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The Objectives of a Procurement Chain

Primary purpose is satisfying customer needs.

Maximizing the overall value created

Value, measured monetarily, refers to: the difference

between what the final product is worth to the customer

(price the customer is willing to pay) and the effort,

collectively, the procurement chain expends in filling the

customers request (the collective costs)

Therefore, procurement profitability would be: the

difference between revenue generated from the customer

and the overall cost across the entire Procurement chain.


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While managing procurement process is important for

managing costs and profits and delivering value to the

customer, it is not easy to do.

It requires understanding, cooperation, coordination, and

information sharing among several trading partners both

internal and internal.

And, given that there are so many parties, it is indeed a

formidable task to make all of them work towards a common

objective.


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Why should procurement be a challenging

problem?

Procurement chain network is often very

complex

Procurement chain partners have conflicting

objectives. Consequently, making everyone to agree is

not an easy task.


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Conflicting Objectives

in the Procurement Chain

1. Purchasing wants

Stable volume requirements

Flexible delivery time

Little variation in mix

Large quantities2. Manufacturing wants

Long run production

High quality

High productivity

Low production cost

Tell me why some of these objectives are conflicting.


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Conflicting Objectives

in the Procurement Chain

3. Warehousing wants

Low inventory

Reduced transportation costs

Quick replenishment capability4. Customers want

Short order lead time

High in stock

Enormous variety of products

Low prices

Tell me why some of these objectives are conflicting.


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While we agree on the importance of

procurement, how does it translateinto a corporate strategy?


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Achieving strategic Fit

Matching multiple strategies

procurement chain management2

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