Purchasing and Supply Chain Managementby W.C. Benton

Chapter EightSupplier Selection and

Evaluation

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Learning Objectives1. To identify the qualifications a good supplier.2. To learn about the key elements of the make-versus-buy

decision.3. To identify appropriate supplier selection techniques.4. To learn about supplier relationship management.5. To identify potential disadvantages of single sourcing.6. To analyze how to reduce the number of suppliers.7. To learn about strategic supplier relationship management.8. To understand how supplier evaluation is accomplished in a

variety of industrial environments.

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Suppliers Must be Carefully Evaluated

• In today’s competitive environment, progressive firms must be able to produce quality products at reasonable prices. Product quality is a direct result of the production workforce and the suppliers.

• Buying firms select suppliers based on their capabilities, and not purely on the competitive process. The current trend in sourcing is to reduce the supplier base.

• In order to select suppliers who continually outperform the competition, suppliers must be carefully analyzed and evaluated.

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A New Role for Purchasing• Traditional purchasing professionals who act as little

more than order placers are giving way to strategically involved analytical managers who control vital inputs to the production process.

• More and more power is being placed in the hands of professional purchasing managers because industry is beginning to realize the importance of defect-free parts and the value-added capabilities of suppliers.

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Make Versus Buy• The use of outsourcing has quickly become a competitive

weapon for an increasing number of businesses. • It is no easy task for management to decide to make lease or buy

component parts and services. • The decision to outsource has led to a need for strategic

partnerships.

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Key Make-or-buy Mistakes• In most cases, businesses are not proficient at identifying their

core capabilities . Buyers usually rationalize in-house decisions based on capacity capabilities.

• Buying organizations wait too late to assess the value of consultants or strategic partners.

• Buyers do not recognize that the product or service is approaching maturity.

• There are always new competitors with new technology attacking the market.

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Key Make-or-Buy Success Factors• Perform a realistic assessment of the capabilities and

expertise of each member of the in-house team. If the core competencies exist, what happens if a key member leaves the team. Can the member be easily replaced?

• Evaluate alternative strategic partnership arrangements and select the appropriate partner.

• Share information with all functional areas and request their input.

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The Make or Buy Decision• When a firm has answered the make-or-buy question

with a decision to buy , the question then becomes to whom to “delegate” this responsibility.

• Thus, the firm must select a supplier or suppliers for the part (s) in question.

• The buying firm must be highly skilled at (1) specifying product attributes, (2) forecasting expected requirements, (3) ensuring the right quality at a reasonable price.

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Strategic Selection• Each business unit and department should have a

clear understanding of the strategy of the whole firm and have a departmental strategy that complements and aids the overall strategy execution of the firm.

• Purchasing, logistics, inventory management, and production control are all linked tightly together under the materials management umbrella.

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Strategy and Outsourcing

• Since outsourcing is a delegation of responsibilities, it should be viewed as an extension of the OEM’s strategy.

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Supplier Relationship Management (SRM)

• The supply chain management process is based on the idea of efficient resource coordination and teamwork.

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Supplier Relationship Management (SRM)

Buyer and supplier relationships have become increasingly important for a number of reasons.

1. There is a trend toward specialization away from manufacturing an entire product and to more contract manufacturing and purchasing.

2. In some market segments, it is estimated that 80 percent or more of total product revenue often passes directly to suppliers as payment for labor, materials, and equipment.

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Supplier Relationship Management (SRM)

3. This significant transfer of value downstream emphasizes the importance and significance of supply chain relationship management.

4. For any buying organization to stay competitive in today’s aggressive market sectors, it is essential that they maintain strong relationships with their best contract manufacturers and suppliers.

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5. Buying firms experience a great deal of pressure from customers and competitors to keep their edge and stay in business by reducing costs, improving product, improving service quality and enacting continuous improvement.

6. With the decreasing number of suppliers used by buying firms, it is more important than ever to maintain strong buyer-supplier relationships.

Supplier Relationship Management (SRM)

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Four Pure Supply Management Relationships

• One model that explains supply chain relationship management includes four behavioral dimensions—the four Cs:

1. counterproductive (lose-lose)

2. competitive (win-lose),

3. cooperative (win-win),

4. collaborative (win-win) relationships.

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Counterproductive Relationships

• Counterproductive relationships are those in which each organization (buying and supplying) is so focused on getting what is best for it that each puts the other at a disadvantage.

• This type of relationship is undesirable because:– it does not promote a positive rapport between buying and

supplying firms involved and – neither organization achieves its goals.

• Counterproductive buyer-supplier relationships are not recommended.

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Transactional Relationships

• Transactional or competitive relationships are those relationships in which both buying and supplying firms strive to get the very best arrangement possible in their negotiations and fail to see the benefits of both organizations obtaining their goals and objectives.

• In transactional relationships, the buying and supplying firms will stop at nothing to make sure that they come out on top and do not care about the other organization’s well-being.

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Transactional Relationships

• A competitive relationship is almost required with transactional/tier-three suppliers and assumes that the buying firm can lower prices to help keep its competitive edge in the market.

• It does not matter if the relationship is not strong enough to last because by definition, transactional suppliers can be easily replaced at any time.

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Cooperative Relationships

• Cooperative relationships recognize the potential value of both organizations getting what they want and maximize the potential of having a long-term relationship.

• Although it is a strong relationship, a cooperative alliance lacks the teamwork that is needed between the various buying and supplying firms in order to optimize the benefits for all of the members of the supply chain.

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Cooperative Relationships

• Cooperative relationships are commonly found within a buying organization’s preferred/tier-two service providers and suppliers list.

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Collaborative Relationships• Collaboration or collaborative relationships, usually

found with the buying firm’s strategic/tier-one suppliers, include the team component that is missing in a cooperative relationship.

• In collaboration, the two organizations truly realize the benefits of working together to optimize outcomes for both organizations.

• The two firms work together to develop a strategy to deliver a high-quality product or service on time and under budget.

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Supplier Relationship Management Programs

• Many large buying firms are implementing supplier relationship management programs in their business plans to ensure that they maintain their competitive edge.

• Most supplier relationship management programs begin with some sort of ranking or categorization of potential suppliers.

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SRM Programs

• Once the system is developed, it then forces the various functions in the buying firm to evaluate which suppliers truly add value.

• The rankings are aggregated to enable a ranking of all suppliers.

• The company will then categorize the suppliers into one of three categories:

1. strategic, 2. preferred, or3. transactional.

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Three Categories of Suppliers

1. Strategic suppliers are those that are most important to the buying firm. They supply the buying firm with essential materials and capabilities that are not easily replaced.

2. Preferred suppliers are those that are important to the buying firm, but alternative suppliers could be found with some effort.

3. Transactional suppliers are those that can be easily replaced in a short time.

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Performance-based Evaluations

• Performance-based evaluations assess the company after its product or service has been delivered.

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Criteria for Supplier Evaluation• There are two main categories of supplier evaluations:

process-based evaluations and performance-based evaluations.

• The process-based evaluation is an assessment of the supplier’s production or service process. Performance-based evaluations are based on objective measures of performance.

• Typically, the buyer will conduct an audit at the supplier’s site to assess the level of capability in the supplier’s systems.

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Criteria for Supplier Evaluation

• In addition, large buying organizations increasingly are demanding that their suppliers become certified through third-party organizations, such as ISO 9001-2008 certification or Malcolm Baldrige National Quality Awards.

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Three Common Supplier Performance Based Evaluation Systems

• The three general types of supplier evaluation systems in use today are:– the categorical method,

– the cost-ratio method, and

– the linear averaging method.

• In general, the guiding factors in determining which system is best are ease of implementation and overall reliability of the system.

• It must be pointed out the interpretation of the results from any of these three systems is a matter of the buyer’s judgment.

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Categorical Method

• The categorical method involves categorizing each supplier’s performance in specific areas defined by a list of relevant performance variables.

• The buyer develops a list of performance factors for each supplier and keeps track of each area by assigning a “grade” in simple terms, such as “good,” “neutral,” and “unsatisfactory.”

• At frequent meetings between the buying organization and the supplier, the buyer will then inform the supplier of its performance.

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Cost-Ratio Method• The cost-ratio method evaluates supplier performance by using

standard cost analysis.

• The total cost of each purchase is calculated as its selling price plus the buyer’s internal operating costs associated with the quality, delivery, and service elements of the purchase.

• Calculations involve a four-step approach

• A hybrid of the cost-ratio method is the “total cost-of-ownership rating,” developed by the director of corporate purchasing of Sun Microsystems.

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Cost-Ratio Method• It includes five performance factors: quality (maximum of 30

points), delivery (25), technology (20), price (15), and service (10). A perfect supplier would receive a score of 1.00.

• This is calculated by deducting the amount of points received (100 if perfect) from 100, dividing by 100, and adding 1.

• The idea is to give a simple numeric rating to the so-called hidden cost of ownership—the additional product-lifetime cost to Sun.

• A score of 1.20, for instance, means that for every dollar Sun spends with that supplier, it spends another 20 cents on everything from line downtime to added service costs.

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Linear Averaging• The linear averaging method is probably the most

commonly used evaluation method.

• Specific quantitative performance factors are used to evaluate supplier performance.

• The most commonly used factors in goods purchases are quality, service (delivery), and price, although any one of the factors named may be given more weight than the others.

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Linear Averaging Method1. The first step is to assign appropriate weights to each

performance factor, such that the total weights of each factor add up to 100.

• For example, quality might be assigned a weight of 50, service a weight of 35, and price a weight of 15.

• The assignment of these weights is a matter of judgment and top management preferences.

• The weights are subsequently used as multipliers for individual

ratings on each of the three performance factors.

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Example

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Strategic Supplier Relationship Management

• For each strategic supplier, a key contact within the buying firm must be established to ensure that the relationship is being properly managed.

• This person is the individual within the buying that others in the buying organization should contact for information about specific strategic suppliers.

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Strategic Supplier Relationship Management

• Relationships with strategic suppliers need to be closely managed. One way to keep up on supplier relationships is for a buying organization is to compile supplier profiles for each strategic supplier.

• These profiles should include items such as key management contacts, a company overview, SWOT analysis, Porter’s five key financial figures, information on current contracts, “owners” of the relationship within the firm, and an organizational chart.

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The Strategic Supplier Performance Review Process

• A performance review is a set of expectations and measurements for controlling long-term relationships with existing strategic suppliers.

• It includes consistent measurements for establishing positive relationships with new suppliers and evaluating current performance of existing strategic suppliers according to the expectations of the buying firm.

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• The review process must have a standard template that is used as a guideline for informing a customized review process with criteria specific to each strategic supplier.

• The performance review template should include a personal meeting with the functional manager.

The Strategic Supplier Performance Review Process

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Review Categories• The buying firm should have various review categories

that are used in order to fully assess their strategic suppliers.

• Quality is a very important review category.

• Customer service should be expected to be proactive and flexible, and delivery performance needs to be optimized.

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Review Categories

• The most important attributes should be:* high quality and* on-time delivery.

• Technology and innovation are also important in order to stay ahead of or at pace with competition and help keep the buying firm at the top of their field.

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Strategic Suppliers

• It is necessary for the buying firm to have strategic suppliers who are open about their total costs.

• Cost reduction and continuous process improvement are necessary in order to keep costs down and create trust with strategic suppliers.

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Single versus Multiple Sources

• Much debate has taken place concerning the number of suppliers a firm should use.

1. One side of the debate is the multiple-sources side. This involves the use of two or more suppliers.

2. The other side of the debate is the single-source policy, in which only one supplier is used to supply a particular part.

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Advantages of Multiple Sourcing• The main arguments for multiple sourcing are competition

and assured supply. – It is commonly believed that competition between suppliers for a

similar part will drive costs lower as suppliers compete against each other for more of the OEM’s business.

• This sense of competition is in the very root of American thought as competition is the basis for capitalism and is the backbone of Western economic theory.

• Multiple sources also can guarantee an undisrupted supply of parts.– If something should go wrong with one supplier, such as a strike or a

major breakdown or natural disaster, the other supplier (s) can pick up the slack to deliver all the needed parts without a disruption.

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Advantages of Single Sourcing• The major arguments in favor of single sourcing are

that with the certainty of large volumes that the supplier can enjoy lower costs per unit and increased cooperation and communication to produce win-win relationships between buyer and seller.

• Naming a certain supplier as the single source and providing it with a long-term contract (three to five years) greatly reduces the uncertainty that the supplier will lose business to another competitor.

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Advantages of Single Sourcing• With this contract guarantee, the supplier is more willing

to invest in new equipment, or change its business/operating methods to accommodate the buyer.

• Single sources should be able to provide lower costs per unit compared to multiple sources by reducing the duplication of operations in areas such as setup.

• Spreading fixed costs across a larger volume should also result in an accelerated learning curve.

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Cross-Sourcing• Cross-sourcing works this way. If supplier A can produce

parts 1, 2, 3, 4, and 5 and so can supplier B, the advantages of both single and multiple sourcing can be achieved if supplier A produces all of parts 1, 3, and 5 and supplier B produces all of 2 and 4. If anything would happen to supplier A, supplier B can pick up the slack as it has the capability to produce 1, 3, and 5 as well.

• In sum, neither supplier suffers because overall volume remains the same. The reverse also can be done if a buyer wants to increase competition among the suppliers.

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Supplier Reduction• Regardless of one’s final analysis of the single/multiple

debate, it is recommended to reduce the supply base.

• If the perceived benefits outweigh the risks, and after careful analysis of both short-term and long-term needs, a single source may be appropriate.

• However, for operations that would be financially damaged when a supply stoppage occurs, then the use or development of a second source is wise.

• Assume that it is desirable to reduce the number of suppliers. The question now is which one (s)? The grade and hurdle methods are used to guide the supplier reduction analysis.

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Grade• “Grade” methods are those that are based on a score or grade

given to the supplier by the buyer for some attribute.

• The most common attributes are quality, price, and delivery.

• The supplier’s performances in the past are kept on record and the suppliers receive a “report card” as to how well they are doing compared to other suppliers.

• Many additional attributes an be added to the most common three such as frequency of delivery, but the method remains the same—for each attribute and purchase transaction, the supplier is given a grade.

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Hurdle• The second group of methods used to reduce the

number of suppliers a firm uses is what I have termed “hurdle” methods.

• In this type of situation, suppliers are required to “jump” over higher and higher hurdles to win the buyer’s business.

• Usually this is done through some sort of supplier certification program.

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Certification• Supplier certification programs are very useful tools to

evaluate the quality capabilities of a supplier.

• Since quality is one of the biggest concerns to many OEMs, this is a good way to control supplied part quality.

• Basically, certification involves the setting of criteria regarding quality levels as demonstrated through the use of SPC and such things as process capability studies of a supplier’s equipment, record-keeping abilities, and so forth.

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Designing Certification Programs

• When designing a certification program, careful attention should be paid to the selection of criteria.

• Good certification should include issues regarding equipment capability, quality assurance, financial health of the supplier, production scheduling methods, value analysis abilities, and cost accounting methods.

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Industry Examples• Consider the apparel, chemical, electronics, and

construction industries.

• A supplier with the lowest per-unit price may not have the best quality or delivery rating of various suppliers.

• The particular selection strategy may be acceptable in the apparel industry, where the highest emphasis is placed on price or price markup, but would be unacceptable in the chemical industry, where the highest priority is purity of the chemicals (i.e., quality).

• Each industry must analyze the various associated criteria trade-offs when selecting a supplier.

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Apparel Industry• Organizational buying can be broken down into two

categories: retail buying and industrial buying.

• There are distinct differences between retail and industrial buying.

• The most important distinction is that the retail buyer is unique in serving as both a purchasing agent and marketing manager.

• Successful retail buying depends on the ability to select suppliers who meet the perceived needs and wants of the firm and its customers.

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Chemical Industry• Industrial buying in the chemical industry mostly deals with

buying bulk chemicals for chemical production and synthesis.

• Overall, in ranking which criterion is considered most important in supplier selection, quality was number one. Reliability and dependability of the delivery ranked second, while price considerations ranked third.

• Purchasing managers send requests for quotes (RFQs) to prequalified suppliers.

• Maintaining quality is by far the most important competitive advantage of companies in the chemical industry.

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Electronics Industry• Industrial buying within the electronics industry is extremely

competitive.

• Some companies place higher emphasis on pricing and delivery. The companies also varied in their methods of purchasing.

• For example, Dynalab prefers to deal with a single source, while Tandy uses many suppliers to meet their needs.

• Supplier selection at Tandy Corporation is based solely on price. When Tandy sends out an RFQ, suppliers that lack a good reputation are ignored.

• Thus, the quality of the supplier chosen to bid is assumed to be high.

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Construction Industry• In the construction industry, material quality, delivery

dependability, and price appear to be the most critical criteria.

• However, the degree of importance that various construction firms place on the four criteria varies.

• The supplier selection process begins by choosing potential suppliers for each material type needed for a specific project.

• The selection process is usually based solely on past performance.

• Once a pool of potential sources is formed, RFQs are sent out, negotiations are conducted, and specific suppliers are selected.

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Supplier Evaluations

• As firms increasingly emphasize cooperative relationships with critical suppliers, executives of buyer firms are using supplier evaluations to ensure that their per formance objectives are met.

• Supplier evaluations, one type of supplier develop ment program (SDP), are an attempt to meet current and future business needs by improving supplier performance and capabilities.