Purchasing and Supply Management by W. C. Benton Chapter Four Materials Management McGraw-Hill/Irwin Copyright ©2007 The McGraw-Hill Companies, All Rights Reserved Learning Objectives 1. To identify the activities of materials management. 2. To identify the four functions of inventory. 3. To understand the relationship between purchasing and materials management. 4. To determine how the materials management concept makes a contribution to profitability. 5. To understand why firms are moving toward materials management. 4-2 Materials Management ▪ The purpose of materials management is to support the transformation of raw materials and component parts into shipped or finished goods 4-3 Five Functions of Inventory ▪ The five functions of inventory are 1. 2. 3. 4. 5. Pipeline inventories (raw materials/in process) Cycle inventories Buffer stock Seasonal Decoupling ▪ These five basic functions of inventory are fundamental to achieving smooth flow, reasonable equipment utilization and materials handling costs, and maintenance of good customer service. 4-4 Suppliers ▪ The supplier is the source of raw materials and component part inventories. Customer service is a concept that applies to all suppliers whether they are external to the company or internal 4-5 Production Planning ▪ When planning to acquire materials, whether raw materials, component parts, or finished goods, the capacity must be considered for both the buyer and seller. ▪ Each materials acquisition must be translated into a capacity requirement by the supplier. ▪ For example, suppose we have a scenario as shown on the next slide 4-6 FIGURE 4.1 Production Inventory System (Purchasing) Information flows - (Purchasing) (Demand management) - -→ Physical flows → 4-7 Capacity Planning ▪ Say capacity is the potential to produce 50 assemblies an hour. Although the short-term capacity may be higher, effective capacity is a range of substantial output under normal conditions, that is, a rate. ▪ A manufacturing plant is designed to produce 1,000 units of product a day. Is it possible for the plant to operate at a rate of 10, 50, or 120 units a day? There is a lower limit beyond which it is not economical to run. ▪ At some point, management will decide to shut down rather than produce indefinitely at a rate that does not generate revenues to cover fixed and variable costs. 4-8 Capacity Planning ▪ The upper level of production is limited by the process technology and/or the disposition of the workforce. ▪ Can a plant manager exhort workers to produce, in the short run, at very high levels of production to satisfy a very important customer? Probably yes, but not very often. ▪ Pushing the plant (equipment, people, and suppliers) to produce at very high levels of output accelerates wear and tear on machines and people. Machine maintenance, quality, and morale suffer 4-9 Capacity and Inventory ▪ In general, inventory is stored capacity. ▪ If capacity is insufficient to satisfy peak demand for a product with seasonal sales, finished goods inventory can be accumulated during periods of low demand. 4-10 Throughput Time ▪ The delay between receipt of raw materials and the availability of the finished goods produced from them is throughput time (TPT). The concept applies also to single components of the supply chain; for example, we speak of the TPT for the plant or distribution center. ▪ For the whole system, TPT should be as short as possible. Consumers prefer to obtain goods or services in the shortest possible time. If TPTs are long, it is more likely that the customer’s requirements will change ▪ The longer an order for material stays in the plant, the larger the work-in-process inventory will be, the larger the storage area required, and the more likely the material will be damaged, lost, or stolen 4-11 Order Cycle ▪ The order cycle is both a link and a set of activities. As a link, the order cycle facilitates the flow of information and materials 4-12 Pipeline The pipeline is the means by which various resources flow 1. 2. 3. 4. Information (orders, billings, inquiries) Material Money (credit) Title 4-13 Integrated Materials System ▪ It is not necessary that all resource flows between components occur at the same time or in the same manner. ▪ This idea is called channel separation and is useful when designing supply-distribution systems. It really isn’t accurate to say that components are joined by a single link. 4-14 Integrated Materials System ▪ The order cycle has some important characteristics. First, an order cycle has “length.” The distance between supplier and customer determines, in part, how long it takes to transmit data and transport materials ▪ A customer may elect to have an order moved by various transportation technologies (modes): 1. Air 2. Rail 3. Truck 4. Water 5. Pipeline 4-15 Speed, Reliability, Inventory, and Cost Tradeoff Customer orders also may be transmitted by alternative technologies: 1. 2. 3. 4. 5. Telephone Postal service Internet Fax EDI The prices of these modes vary; although more rapid service usually implies a higher price, technologies such as the Internet have somewhat changed that paradigm. 4-16 Speed, Reliability, Inventory, and Cost Tradeoff ▪ The more rapid, the higher the price. The trade-off considerations are similar to those for transportation. ▪ The shorter the order cycle, the quicker the customer is served and the less inventory the customer needs 4-17 Order Cycle—Activities ▪ The order cycle is not only a link, but a set of activities. The principal activities and the locus of responsibility are Activity Responsibility _______________________________ Order preparation Order transmission Order processing Order transportation Order receipt Customer Customer Supplier Supplier Customer 4-18 ▪ Each activity is in turn a bundle of tasks. For example, the receipt of materials by the customer involves 1. 2. 3. 4. 5. 6. Physical receipt Unloading Inspection Storage location decision Move to storage Documentation 4-19 Lead Time ▪ If we represent the order cycle as a set of activities, we can identify an important property of the order cycle—lead time. ▪ Some may argue that lead time begins when the order is transmitted. ▪ We'll go a step earlier include order preparation, which begins when the need for material is recognized. 4-20 Customer Satisfaction ▪ The managers of integrated materials systems have two objectives: ▪ Customer satisfaction ▪ Minimum total materials costs 4-21 Material Availability ▪ Two cases must be distinguished. If a firm makes products to order, customer service is measured by the degree to which products are completed and shipped as promised. 4-22 Material Availability ▪ Conceivably, an order may be rescheduled at the request of the customer, in which case the revised date is used to determine whether the order was shipped on time, early, or late ▪ Many make-to-order (MTO) firms faithfully calculate the ratio of on-time to total shipments. ▪ When customer service is measured this way, we speak of a firm’s delivery performance 4-23 Service Level ▪ High delivery performance may only indicate scheduling inflexibility on the part of the supplier. ▪ The second case is the firm that produces standard products in anticipation of demand for them—a make-to-stock (MTS) firm. 4-24 Service Level ▪ If all customer orders are processed without delay, the level of service is 100 percent. Service level (SL) for an MTS firm is the ratio SL = (Orders shipped/Orders received) × 100 Unfilled orders are processed in one of three ways: 1. Backorder 2. Substitution 3. Cancellation 4-25 On-Time Shipment ▪ This element of customer service is a variation on the notion of availability. Ontime shipment has to do with the delivery promises made, and the ratio of orders shipped as promised to total orders. ▪ If an order is shipped on time, it is presumed that the customer is well served. Realistically, customers are more concerned about when the materials are received. On-Time Receipt ▪ Customers place orders based on need dates. The more imminent the calendar date, the more urgently material is needed. ▪ To say an item is needed on the 10th of the month means that, if the item is not actually in hand on that date, dire consequences ensue. ▪ Sometimes the need date is called the “drop dead date.” 4-26 Complete Shipment ▪ Orders commonly call for numerous items, sometimes in matched sets. ▪ A manufacturer of office furniture receives orders for matched desks, chairs, tables, and file cabinets. ▪ An order probably contains the requirements to furnish one particular office. The customer expects to receive all items at the same time. Quality of Receipt ▪ The quality of material can deteriorate between the time it leaves the production floor and the time it arrives at the customer’s storeroom. Packaging, loading, transport, and unloading can all take a toll. ▪ Although damages can be claimed, materials received in poor condition are unsuitable for processing. 4-27 Flexibility ▪ Flexibility is the extent to which a supplier can accommodate a customer’s requests. Perhaps the request is for special processing, packaging, or shipment. ▪ The name of the game, whatever the firm’s classification, is customer satisfaction. ▪ Note that the costs of these extras are borne by the customer. The question is not who pays, but the willingness and ability of suppliers to cost-effectively perform nonstandard tasks for the customer. Responsiveness to Inquiry ▪ Customers want assurances that their orders are on schedule, especially as the shipping date nears. ▪ This element of customer service is the timeliness and accuracy of the information a supplier provides a customer. ▪ Suppliers who can’t locate an order on the shop floor, or in the warehouse, or who answer all inquires with, “It just went out on the truck,” inspire little confidence. 4-28 Customer Satisfaction—The Balance ▪ To summarize, customers want 1. 2. 3. 4. 5. Short lead time Good quality High value Customized products Post-sale service ▪ The cost of satisfying a customer’s delivery time needs may not be entirely known, but we can argue that none of these elements of customer satisfaction are realized without cost. 4-29 Customer Satisfaction—The Balance ▪ If poor quality is produced, goes undetected, and is shipped, the costs to both supplier and customer are substantial. ▪ There are direct and measurable costs associated with poor quality. ▪ Yet the more important and difficult-to-measure costs are those associated with the damage to a supplier’s reputation, the loss of a customer’s capacity, and the dissatisfaction if the customer in the field vows never again to buy the product. 4-30 Customer Satisfaction ▪ We could describe the costs of providing the other elements of customer dissatisfaction similarly. The balance that management seeks is between 1. Cost of customer satisfaction—A 2. Cost of dissatisfied customer—B 4-31 Quality ▪ We hear so much about quality that it may come as a surprise that even experts don’t agree about how to achieve it. Fortune recently asked the gurus of industrial quality to define it and to assign responsibility for quality. ▪ To some, quality is a technical matter. It has to do with engineering—both the process technology and product design. ▪ To others, quality is a statistical measure that utilizes sampling to achieve process control and make certain that inferior quality material isn’t shipped from the plant. ▪ There is a third view—that quality depends upon motivation. This means making a slogan a rallying cry—“Zero Defects” or “Quality is Free.” 4-32 Quality ▪ Quality is neither good nor bad until consumers cast their ballots in the marketplace. ▪ Even though the technology of quality is steeped in statistics and manufacturing engineering, materials managers first need to consider quality as part of the expectations of customers, whether intermediate or final. 4-33 Quality ▪ Quality is a strategic decision. What should the quality of a product or material be? ▪ How do we compete with off-shore manufacturers who enjoy reputations for leadership in quality? ▪ What’s the quality level of domestic producers in our industry? ▪ Top management must decide the quality level of materials—high, low, or in between. 4-34 Quality ▪ Quality, in large part, is what people perceive it to be. ▪ Once formed, perceptions about the quality of a supplier’s materials are slow to change. 4-35 Quality ▪ To qualitatively evaluate consumer products and services, Consumers Union first identifies the relevant characteristics of a product. It then tests comparable products of various manufacturers and classifies products as ▪ Best buy ▪ Acceptable ▪ Not acceptable ▪ “Best buy” implies a product with high value. Value, in turn, is the ratio of quality and price. ▪ Value = Quality/Price 4-36 Lawn Mower Quality Example ▪ In a recent issue of Consumer Reports, low-price lawn mowers were evaluated. ▪ The quality-defining product characteristics were 1. Evenness of cut 2. Dispersal of clippings 3. Freedom from clumping 4. Handling 4-37 The Owners View ▪ The quality-defining characteristics of products are those that are important to the end user of the product. ▪ Owners of lawn mowers are not primarily concerned with detailed mechanical or electrical specifications. They want a product that leaves a good-looking lawn and provides relatively trouble-free operation. ▪ Owners look first at the way a product serves the purpose for which it was acquired. The perceptions of quality held by the consumer and the producer are both important. 4-38 Specifications ▪ Design means setting the specifications for a material or product. ▪ Specifications result in the functional and aesthetic characteristics of the product. ▪ The job of the materials manager is to ensure that products are made in the least-costly way so that the item qualifies as a best buy. 4-39 The Quality Level ▪ The process technology and experience of a supplier limits the range of quality possible. We wouldn’t expect a general machine shop to produce high-quality integrated circuit chips. ▪ The design of a product must “be producible” given the process capability of the supplier. Within that range, top management sets the quality level—the degree to which the product functionally satisfies customers. 4-40 Conformance to Specifications ▪ This is the degree to which material conforms to specifications. ▪ If conformance is high, the company can claim that product quality is high. Lawn mower specifications are complex. Hundreds of parts are produced and assembled. ▪ Each part has numerous dimensions and properties. Surfaces of mating parts are finished to extremely small tolerances to ensure proper assembly. ▪ Overall product specifications are fixed—engine size, weight, blade length, and so forth. 4-41 Objective Quality ▪ Is it possible that objectively a product is high quality but subjectively low quality? ▪ Too often the answer is yes. High-quality products must both 1. Conform closely to specifications. 2. Satisfy consumer expectations. 4-42 Can Quality Be Too High? ▪ Can a product’s quality be too high? Again, the answer is yes, but in this case we mean that objective quality can be too high. ▪ Tolerances are closer than need be, finishes are smoother than necessary—“the bottoms of the drawers are painted.” ▪ Customers have little difficulty accepting the product, but it’s much better than it needs to be, and very few customers would be willing to buy so high a quality item. It does in fact cost more to produce a Rolex watch than to produce a Timex. 4-43 Rolex Vs. Timex ▪ If accuracy, durability, and appearance are the quality-defining properties of wristwatches, the Rolex should meet the customer expectations better. 4-44 ▪ We should now be able to understand that conformance isn’t a sufficient test of quality. The design of the product must be satisfactory. We also can understand why two customers appraising the quality of the same item can have very different opinions about its quality. In Figure below only one of four outcomes results in a high-quality product. Quadrant Design Execution Quality 1 Good Good High 2 Good Poor Low 3 Poor Poor Low 4 Poor Good Low 4-45 Specifying Materials ▪ Disagreements between supplier and customer about quality often stem from misunderstandings about material specifications. ▪ Suppliers frequently interpret specifications in ways customers never intended. Qualified suppliers, given identical specifications, may come to quite different conclusions about what a customer wants. ▪ If one definition of quality is conformance to specs, the specifications must be unambiguous. The manner of specifying materials depends on the kinds of material ordered. 4-46 Raw Materials ▪ These are semi-processed materials intended for further processing—raw stock, crude oil, bituminous coal, paperboard, paper, lumber, copper, wheat, cotton, for example. ▪ The materials listed are called commodities. Their specifications result from agreements on standards, as, for example, the U.S. Department of Agriculture’s specifications for meat and grains. ▪ By definition, commodities are homogeneous. 4-47 Specification Examples ▪ Even though specifications are known, judgment is still a factor. ▪ For example, the beef buyer for a fast-food restaurant chain may specify “USDA prime beef.” The grade, priori, implies age, appearance, weight, and so on ▪ Recall the umpire calling balls and strikes. The strike zone is defined for each player. It can be measured. But once play begins, umpires rely on judgment to decide the location of a ball traveling 90 miles an hour as it passes in front of a batter. 4-48 Specification Examples ▪ Materials such as steel are specified by process (e.g., “hot rolled”), physical properties (hardness, strength), and dimension. ▪ Note that while specs are unambiguous, the quality of the material produced may fail to conform to the specifications. ▪ It’s the same problem we discussed earlier— poor execution of a good design. 4-49 Purchased Parts ▪ Purchased parts include semi finished items that will be further processed and finished materials that will become components of finished end items. ▪ The usual way of specifying purchased parts in a made-to-order environment is with a graphic description, that is, engineering drawings. 4-50 Purchased Parts ▪ Many parts can be purchased off the shelf. They are like commodities in the sense that they are standardized. In effect, they are made to stock according to specifications established by an industry, professional association, or independent testing organization. ▪ Many small mechanical parts, for example, fasteners, are manufactured to standards established by the Society of Automotive Engineers, SAE. The specifications for parts such as fixtures and wire are concerned with the satisfaction of safety standards. ▪ The buyer is assured that the part is safe to use in a particular application and that its correct installation complies with standards, for example, building construction. 4-51 Maintenance, Repair, and Operating (Mro) Supplies ▪ MRO materials are quite diverse; they are specified in various ways. The keys are quality and uniqueness. 4-52 Maintenance ▪ These are items that we expect to periodically replace in a piece of equipment. Over time, machine parts are subject to wear and are replaced. ▪ The original equipment manufacturer expects to re supply these parts during the life of the equipment. ▪ Maintenance also means the application or renewal of materials such as lubricants and coolants. Periodic maintenance (labor and materials) ensures longevity and satisfactory machine operation 4-53 Repair ▪ The distinction between maintenance and repair materials is not always clear. In theory, if good maintenance is practiced, events requiring repair will occur infrequently. ▪ Repair suggests the unexpected, which means the need to patch up or replace equipment components that we don’t expect to fail. Usually the parts are not carried as inventory by the equipment manufacturer. ▪ The more common event is repair of equipment failure in which the services of skilled craftsman are more important than specific materials. 4-54 Operating Supplies ▪ These supplies, also called “indirect materials,” become part of the end item and are essential for its production, but their unit value or size is too small to plan or control usage unit by unit. ▪ A good example is rivets used in airframe construction. Rivets are “counted” by weighing them. Bins of rivets are located throughout the plant and available to anyone on a “help yourself” basis. ▪ Generally speaking, operating supplies are standard items and are specified by manufacturer or industry codes. Nonstandard items should be questioned by the purchasing manager. 4-55 Tooling ▪ There are two kinds of tooling with respect to their specifications. ▪ The first kind is standard tooling. Various holding devices, partitioners, material cutting, and forming tools are standard with respect to their size and capacity. As with standard materials, tools are specified by the manufacturer’s part or model number, or by an industry code. ▪ The second, nonstandard kinds of tooling require elaborate specification. Tooling in this class is one of a kind and highly engineered. It is a make-to-order item. Detailed drawings of the tooling are necessary. 4-56 Tooling ▪ Whether the tooling is designed to position or hold material during processing, or to modify or extend the operation of processing equipment, the tooling must be built to specifications; otherwise, the quality of the material produced is unacceptable. 4-57 Purchasing and Supply Management by W. C. Benton Chapter Five Inventory Management McGraw-Hill/Irwin Copyright ©2007 The McGraw-Hill Companies, All Rights Reserved Learning Objectives 1. To learn the relationship between the purchasing function and inventory control. 2. To learn the primary reasons for holding inventory. 3. To identify the necessary requirements for effective inventory management. 4. To learn about ABC analysis. 5-2 Learning Objectives 5. To identify the cost components of the classical EOQ model. 6. To learn the basic assumptions of the EOQ model. 7. To learn about quantity discounts. 8. To learn about service levels. 9. To identify the differences between fixed-orderquantity and variable-order inventory systems. 5-3 Purchasing Raw Materials and Component Parts ▪ The purchasing function is taking on increasing importance in today’s industrial economy. ▪ Since materials constitute the largest single percentage of their purchasing dollars, profit oriented firms have turned to professionally operated purchasing departments to make sure they are getting full value for their outlays on materials ▪ The purchasing professional must be able to make profitable buying decisions under these conditions. The purchasing professional person must make profitable inventory management decisions. 5-4 Inventory Management ▪ Inventory is the life blood of any business. Most firms store thousands of different items. ▪ The type of business a firm is in will usually determine how much of the firm’s assets are invested in inventories. ▪ Hospitals carry beds, surgical instruments, food, pharmaceuticals, and other miscellaneous items. ▪ Manufacturing firms carry office supplies, raw materials, component parts, finished products, and many other industry-related items. 5-5 Dependent Versus Independent Demand ▪ In order to manage the various types of inventory, attributes of the items first must be analyzed in terms of cost, lead time, past usage, and the nature of demand. ▪ The nature of demand is perhaps the most important attribute. The nature of demand can be either independent or dependent. ▪ Independent demand is unrelated to the demand for other items. In other words, an independent item must be forecasted independently. ▪ Dependent demand is directly derived from demand for another inventoried item demand 5-6 Dependent Versus Independent Demand ▪ In order to manage the various types of inventory, attributes of the items first must be analyzed in terms of cost, lead time, past usage, and the nature of demand. ▪ The nature of demand is perhaps the most important attribute. The nature of demand can be either independent or dependent. ▪ Independent demand is unrelated to the demand for other items. In other words, an independent item must be forecasted independently. Dependent demand is directly derived from demand for another inventoried item demand. 5-7 Inventory Management Overview ▪ Management of inventories is a major interest of purchasing managers. ▪ In many industries, the investment in inventories comprises a substantial share of the firm’s assets. ▪ If the productivity of the inventory asset can be enhanced, the improvement will go directly to the bottom line. ▪ How does the purchasing professional know how much inventory to carry? ▪ How does the purchasing professional know when to place a replenishment order? ▪ Specifically, what guidelines should be used for making purchasing decisions? 5-8 Inventory Decisions ▪ In the area of inventory management, the purchasing professional should make explicit decisions regarding the following: 1. What to stock. The purchasing professional, at the very minimum, must meet the requirements and needs of the manufacturer on distribution operation. 2. How much to invest. The purchasing professional must first review the level of capital support for inventory. This decision is usually made at the vice president level. 3. How much service to offer. What level of protection against stockouts is acceptable for the competitive environment? It is impossible to achieve a service level of 100 percent 5-9 Inventory Decisions ▪ As can be seen, none of these decisions is independent of the other. Moreover, combining these decisions is complex and may be closely correlated with the industry and the type of firm within the industry. ▪ In the case of a manufacturing firm, you must consider whether the production process is make to order, make to stock, or some hybrid of the two. 5-10 Production Processing Strategy ▪ In this section, the production processing strategy is divided into two categories: 1. continuous systems 2. intermittent systems. 5-11 Production-Inventory Taxonomy ▪ The taxonomy is based on continuous systems producing standardized products through an assembly line, while intermittent systems are used to produce non standardized products through a job shop. ▪ Another subcategory (not shown in the taxonomy) associated with continuous systems is pure inventory systems. ▪ Pure inventory systems are distribution stocking points, such as warehouses or distributors. ▪ The purchasing manager must have a clear understanding of the role of inventory in the materials management system. 5-12 ABC Classification of Inventory Items ▪ The inventory items that are the most important for a specific industry or firm should be items that account for the greatest dollar value. ▪ To determine the usage value of an item, multiply the unit cost by annual sales volume. If a particular item costs $100 and 150 are sold in one year, then its usage value is $100 × 150, or $15,000. ▪ With only these two data points (sales and costs), you can not only rank all of your inventory items by importance, but also take the first step toward controlling independent demand and distribution inventories. 5-13 ABC Classification of Inventory Items ▪ If you analyze what sells the most and what cost the most, a predictable pattern will emerge with most distribution inventories. 1. Certain items are demanded by a great many customers. 2. Most items are only demanded by certain customers. 3. Some items are demanded by few customers. 5-14 ▪ The following procedure is one way of implementing an ABC analysis. 1. Calculate the annual dollar value for each item. 2. List all items in descending order. 3. Develop a cumulative percentage of the items that reflect roughly 60–80 percent of the total cost. 4. Determine the percentage of the items that represent roughly 60–80 percent of the total cost. These are considered A items. 5-15 Independent Demand ▪ In this section, we are concerned with the control of end items. The inventory management concepts covered in this section are also applicable to retailing and distribution. There are five primary functions of inventories: 1. Pipeline inventory. The supply pipelines of the entire system require a considerable investment in inventory. If the system’s volume is 1,000 units per week and it takes one day to transport from the supplier to the plant, there are 1/7 × 1,000, or about 143, units in transit on the average. 5-16 Independent Demand 2. Cycle stocks. When units are transported from one location point to another, how many units do we transport at one time? For example, say we place an order once each three weeks following a review of sales and projected needs. 1. Once the order is received, there is a two-day order processing delay at the suppliers plus three days for transit and receipt. Assume that the average unit sales volume is five units per week or 15 units in the threeweek order period. 2. Thus, the buyer must have no less than 15 units of cycle stock on hand when an order is placed, for an average cycle stock level of 15/2 = 7.5 units. 5-17 Independent Demand 3. Seasonal inventories. If demand follows a seasonal pattern, inventories can be accumulated during low sales periods and depleted during high usage periods to avoid problems associated with adjusting capacity. 4. Safety stocks. Safety stocks are designed to absorb random demand uncertainties. 5. Decoupling. Stocks of inventories at major stocking points throughout the system make it possible to carry on each activity independently. That is, the presence of inventories allows for each work center to begin at the same starting time. 5-18 Costs in an Inventory System ▪ The objective of an inventory system is the minimization of total operating costs. The unavoidable costs of operating pure inventory systems are ordering costs, stockout costs, and holding costs. ▪ To illustrate the cost behavior of a fixed-order-size system, let’s look at the simple classical economic lot size model (EOQ). The EOQ derives the optimal lot size for purchasing by minimizing the cost components involved (ordering costs and holding cost). 5-19 5-20 The EOQ Model • Once the most economical order quantity is known, several other measures can be taken: 1. The expected number of orders during the year, NO = A/Q 2. The expected time between orders, TBO = 1/NO = Q/A 3. The reorder point, R = (A/12) * L, where L is expressed in months. If L is expressed in weeks, R = (A/52) * L. 5-21 The EOQ Model ▪ The minimum total cost per year is obtained by substituting Q* for Q in equation (1). The classical EOQ model assumes the following: 1. Constant demand. 2. Constant lead time. 3. Constant unit price. 4. Fixed order cost per order. 5. Fixed holding cost per unit. 6. Instantaneous replenishment. 7. No stockouts allowed. 8. No demand uncertainty. 9. Quantity discounts are not available 5-22 Quantity Discounts ▪ From time to time, buying firms receive discounted price schedules from their suppliers. ▪ This usually means that the price per unit is lower if larger orders are purchased. It may or may not be to the buyer’s advantage to accept the quantity discount. ▪ The buyer must be careful not to compromise the economies of his or her firm’s cost structure. 5-23 Quantity Discounts ▪ The classical EOQ model assumes that the per-unit material price is fixed. The quantity discount condition invalidates the total cost curve. ▪ Quantity discounts induce a discontinuous total cost curve. ▪ Assuming the discount applies to all units (and not just in incremental units beyond the discount point), the minimum total cost point will be either at the point of discontinuity or at the traditional EOQ point compared with the original price. 5-24 Quantity Discounts ▪ A five-step method can easily be used for determining the minimum cost order quantity: 1. Calculate the economic order quantity using the minimum unit prices. If this quantity falls within the range for which the vendor offers the discount price, it is a valid economic order quantity and will result in the minimum cost for the particular item. 2. If the EOQ calculated in step 1 is not valid (i.e., is less than the break quantity), find the total annual cost for each price break quantity. 3. Calculate an EOQ for each unit price. 4. Calculate the total annual cost for each valid EOQ determined in step 3. 5. The minimum cost order quantity is that associated with the lowest cost in either step 2 or step 4. 5-25 5-26 Safety Stock ▪ When there is uncertainty in demand, safety stock must be considered. Safety stocks are extra inventory held to protect against randomness in demand or lead time. ▪ Safety stock is needed to cover the demand during the replenishment lead time in case actual demand is greater than expected demand. ----------------------------------------------------------------------------▪ The safety stock adjusted reorder point is ▪ ROP = (Expected demand during lead time) + (Safety stock) ▪ = DDLT + Z√(Lead time expressed as some multiple of forecast interval) * (Standard deviation of demand) ▪ = DDLT + Z√L * σd 5-27 5-28 Dependent Demand Systems ▪ Order-point (statistical inventory control) techniques are based on the assumption of uniform requirements per unit time. If this assumption of the demands is unrealistic, these techniques can lead to inappropriate inventory decisions. ▪ For components of assembled products, the demands are not usually constant per unit time, and depletion is anything but gradual. Inventory depletion for component parts tends to occur in discrete “lumps” 5-29 Dependent Demand Systems ▪ Customer demand is fairly uniform but, because of the build schedules, the requirements for the components are “lumpy.” ▪ The build schedule shows periods of zero requirements before a requirement of 50 component parts is encountered. ▪ This requirement sequence, very common to component parts, is not handled well with traditional non-time-phased order-point techniques. 5-30 Dependent Demand Systems ▪ MRP systems utilize substantially better information on future requirements than is possible by the traditional non-time-phased order-point system. ▪ MRP systems are helpful for companies with assembled products that have component requirements dependent on the final product. ▪ The system provides information to better determine the quantity and timing of component parts and purchase orders than is possible with the non-timephased order-point system. 5-31 The Material Requirements Concept ▪ The MRP concept provides the basis for projecting future inventories in a manufacturing operation. ▪ MRP can help improve the traditional non-time-phased order-point system because it allows the operating manager to plan requirements (raw material, component parts) to meet the final assembly schedule. ▪ That is, MRP provides a plan for component and subassembly availability that allows certain end products to be scheduled for final assembly in the future. 5-32 The General Lot-Sizing Problem ▪ The general lot-sizing problem for time-phased requirements for a component part involves converting the requirements over the planning horizon (the number of periods into the future for which there are requirements) into planned orders by batching the requirements into lots. FIGURE 5.11 Net Requirements for 12 Periods Order cost = $92 Inventory carrying cost = $.5/period/unit Period 1 2 3 4 5 6 7 8 9 10 11 12 Net requirements 80 100 124 50 50 100 125 125 100 100 50 100 5-33 Quantity Discounts for the Variable Demand Case ▪ It has been shown in the previous section that MRP provides time-phased requirements to determine planned orders using lot-sizing procedures. ▪ The general lot-sizing problem is to batch requirements to minimize the sum of ordering and carrying cost each time an order is to be placed. ▪ Up until now, conditions for quantity discounts have not been discussed. 5-34 Quantity Discounts for the Variable Demand Case ▪ The safety stock should be set to achieve a prespecified service level. Setting safety stock so as to achieve a prespecified service level enables fair comparison of the alternative lot-sizing procedures. The service level, S, is defined as ▪ S = (The number of units required that were in inventory)/(The number of units required) ▪ If a discount is available, there is a price differential (lower price) for ordering an increased number of units. In this chapter, the discount applies to all units provided an amount at least as big as the discount quantity is purchased. ▪ In situations where discounts are not available, the price per unit is constant regardless of the number of units ordered. 5-35 5-36 Illustration of Various Variable-demand Lot-sizing Models ▪ There has been a significant amount of attention given to the variable-demand order size lot-sizing problem. ▪ Both developmental and comparative literature will be discussed in this section. ▪ Among the better-known lot-sizing methods for the single item, nondiscount, time-phased, certain-demand models are (1) lot for lot, (2) economic order quantity, (3) periodic order quantity, (4) least unit cost, (5) McLaren’s order moment, (6) Silver-Meal, and (7) the Wagner-Whitin dynamic programming algorithm. 5-37 5-38 5-39 5-40 5-41 5-42 5-43 Purchasing and Supply Management by W. C. Benton Chapter Six Just-in-Time (Lean) Purchasing McGraw-Hill/Irwin Copyright ©2007 The McGraw-Hill Companies, All Rights Reserved Learning Objectives 1. To identify the differences between JIT and MRP. 2. To identify the relationship between JIT and purchasing. 3. To understand JIT purchasing. 4. To identify critical JIT-purchasing advantages. 5. To identify the activities needed to implement JIT purchasing. 6. To determine the role of culture in the implementation of JIT purchasing. 7. To critically analyze the impact of JIT purchasing on a buying firm. 6-2 Introduction to Lean Purchasing ▪ There has been a shift in manufacturing business processes in practically every American industrial setting. ▪ The lean thinking paradigm now includes the purchasing function. Lean concepts have had a significant effect on the profitability in almost all industrial settings. ▪ The key lean principles focus on people, the elimination of waste, postponement, and efficiency. All of these key business principles have a direct effect on the purchasing function. 6-3 Lean Purchasing ▪ The just-in-time (JIT) system is no longer an esoteric concept in the manufacturing world today. In the face of intense global competition, many firms in the United States are looking at improved techniques to manage their manufacturing operations. ▪ A comprehensive survey of just-in-time practices in the United States found that 45 percent of the firms contacted had implemented JIT programs and another 22 percent were planning to implement JIT the following year. ▪ JIT has evolved as a novel manufacturing concept based on a philosophy of trust and commitment of the entire organization. The benefits of implementing a JIT system impact all entities involved in supply-chain management 6-4 Significance Of Lean Purchasing ▪ The cost of raw materials has traditionally, been a serious concern of top management. ▪ Over the years, material cost as a proportion of total cost of the end product has risen sharply and is as high as 80 percent in some instances. ▪ Consequently, the role of the purchasing function in a manufacturing organization has become increasingly important. ▪ The just-in-time production control system focuses on reducing both raw materials and work-in-process inventories. ▪ Specifically, JIT requires that the right materials are provided to work stations at the right time 6-5 JIT PURCHASING ▪ The function of purchasing is to provide a firm with component parts and raw materials. ▪ Purchasing also must ensure that high-quality products are provided on time, at a reasonable price. ▪ A comparison of critical elements associated with JIT purchasing and traditional purchasing approaches follows: 6-6 Reduced Order Quantities. ▪ One of the most crucial elements of the just-in-time system is small lot sizes. ▪ Traditionally, long and infrequent production runs have in the past been considered beneficial for the overall productivity of a manufacturing organization. ▪ However, long production runs usually lead to high levels of raw-material and finished-goods inventories. 6-7 Frequent and “on-time” Delivery Schedules ▪ Supplier performance can be measured more accurately under the JIT purchasing approach compared to the traditional one. ▪ In order to obtain small lot sizes for production, the order quantity size needs to be reduced and corresponding delivery schedules need to be made more frequent. 6-8 Reduced Lead Times ▪ To be able to maintain low inventory levels, it is critical that replenishment lead times be as short as possible. ▪ The JIT philosophy inherently attempts to reduce lead times for order completions. Under traditional purchasing practices, the lead time is made up of the following components: paperwork lead time, manufacturing time for supplier, transportation lead time, and time spent on receiving and inspection. 6-9 Comparison between Traditional and Just-in-Time (Lean) Purchasing Approaches Traditional Purchasing JIT-Purchasing Order quantities Based on trade-offs between ordering and carrying costs Based on small lot sizes for production Delivery schedules Infrequent, primarily Frequent because of because of high ordering small lot sizes and low costs involved ordering costs Delivery windows Relatively wide Very narrow Delivery lead times Relatively long and relaxed Stringent and reduced significantly Parts quality Responsibility of the quality function in the organization Responsibility of supplier Supplier base Fairly broad Considerably smaller 6-10 High quality of incoming materials Reliable suppliers ▪ Lean manufacturers attempt to reduce incoming material inspection as much as possible. In order to eliminate the associated receiving inspection costs, a very high emphasis is placed on the quality of incoming materials under the JIT system. ▪ Since the JIT system does not provide for buffer stocks, unreliable supply, in terms of delivery time and quality of incoming material, may lead to frequent problems in production. ▪ The reliability of supply is a critical consideration in the selection of JIT suppliers. ▪ Since JIT purchasing has gained popularity within the United States, the purchasing function has been preoccupied with trimming the overall supplier base in quest of so called superior suppliers. 6-11 Purchasing Benefits ▪ Implementation of just-in-time (Lean) purchasing assists the purchasing function in its major objectives of improving quality of incoming materials and supplier delivery performance, along with reducing lead times and cost of materials. 6-12 1. Reduced Inventory Levels ▪ Lean purchasing facilitates reduction in inventory levels and the associated inventory holding costs. ▪ Firms like Toyota have been able to reduce inventory levels to such an extent that their inventory turnover ratios have gone up to over 60 times per year, compared to corresponding ratios of 5 to 8 reported by most American manufacturers. 6-13 2. Improved Lead-Time Reliability ▪ Compared to traditional purchasing approaches, delivery lead times under the JIT system are considerably shorter. ▪ Lead-time reliability is usually much better for justin-time systems. ▪ This implies higher levels of customer service and lower safety stock requirements for the company. ▪ Lower levels of safety stock contribute significantly to reduced working capital requirements for the firm. 6-14 3. Scheduling Flexibility ▪ JIT emphasizes scheduling flexibility by aiming for reduced purchasing lead times and setup times. ▪ Such flexibility prevents confusion in the manufacturing plant and offers unique competitive advantages to manufacturing firms since they are capable of adapting to changes in the environment more quickly. 6-15 4. Improved Quality and Customer Satisfaction ▪ JIT purchasing results in improved quality and corresponding levels of higher customer satisfaction . ▪ Since high-quality products are critical in achieving a competitive advantage in today’s global business world, manufacturers gain immensely by implementing the JIT production control system. ▪ High-quality incoming materials result in savings associated with reduced rework and scrap 6-16 5. Reduced Costs of Parts ▪ As cooperation and relationships between suppliers and manufacturers build up in a JIT system, so do the opportunities to conduct an extensive value analysis and focus on reducing the cost of parts purchased. ▪ A comprehensive JIT progress report indicates that supplier costs were reduced by 11 percent when they adopted the JIT system in cooperation with their customers. 6-17 6. Constructive Synergies with Suppliers ▪ A lean purchasing program involves close technical cooperation with suppliers. This particularly means the cooperation between manufacturing and design engineers. ▪ Because of smaller lot sizes and frequent delivery schedules, suppliers are in a position to receive quick feedback regarding any potential manufacturing or design problems. ▪ Also, manufacturing is in a position to implement engineering changes quicker because of the reduced inventory levels. ▪ The JIT progress report mentioned above indicates that supplier quality improved by 26 percent since the JIT system was adopted. 6-18 Cost Decreases It is well documented that JIT reduces physical inventory level Reductions in physical inventory will also have a favorable impact on: 1. Reduced insurance premiums associated with the storage of inventory. 2. Reduced inventory holding costs 3. Reduced labor cost in store rooms and material handing costs. 4. Reduced clerical and administrative costs. 5. Reduced waste from the manufacturing process. 6. Reduced obsolescence costs. 7. Reduced deprecation of handling and storage equipment. Each of the cost savings will result in a leaner more profitable operation. 6-19 Implementation of JIT Purchasing ▪ As attractive as the JIT purchasing philosophy might initially seem, it is quite difficult to implement. ▪ The switch to a JIT system presents formidable challenges. Marketing must be prepared to change their behavior when their customers are using the JIT system. ▪ Some of the common problems associated with implementing the JIT system are as follows 6-20 1. Lack of cooperation from suppliers In a detailed survey of U.S. firms involved with just-intime manufacturing, 47 percent of the respondents indicated that they had serious problems with some of their suppliers. The suppliers see little incentive in adopting the JIT approach when the primary benefits of the program go to the buyer 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. A long-term business agreement A fair return on supplier investment Adequate time for thorough planning Accurate demand functions Correct and firm specifications Parts designed to match supplier’s process capability Smoothly timed order releases A fair profit margin Fair dealings with regard to price A minimum number of change orders Prompt payment of invoices 6-21 2. Lack of top management support ▪ Implementation of the JIT philosophy requires a cultural change in the organization. ▪ Such a concept cannot be implemented successfully without total support from top management. ▪ However, another survey of U.S. manufacturing firms indicated that 48 percent of the firms did not receive total support from top management in their efforts to implement the just-in-time manufacturing system. 6-22 3. Lack of employee readiness and support ▪ Many firms report lack of support from their employees as being one of the major problems encountered in the implementation of JIT (Lean) purchasing. ▪ Very often, such resistance is encountered because the employees are required to change their longstanding work habits, or because they interpret the new system as being a threat to their jobs. ▪ Also, the JIT system requires most employees to assume more problem-solving responsibilities on the job, which may lead to additional frustration. 6-23 4. Lack of support from design engineering personnel ▪ Design engineering is responsible for making technical specifications for the materials a company buys. ▪ Quite often, the purchasing function in an organization does not receive adequate support from engineering functions, and, as a result, purchasing is often unable to advise suppliers on material quality design options. ▪ Thirty-nine percent of the firms surveyed using JIT practices in the United States indicated that they had serious problems regarding lack of support from engineering 6-24 5. Low product quality ▪ If suppliers fail to provide materials of adequate quality on a regular basis, production slow-downs and stoppages will occur regularly. ▪ The study reports that 53 percent of American manufacturing firms implementing JIT cited this factor to be a major obstacle 6-25 6. Lack of support from carrier companies ▪ The next slide show the huge sums of money that the purchasing function of some major firms spends every year in order to move materials in and out of the factory. ▪ Few buyers, however, work closely with carriers to develop long-term relationships that provide for highly structured delivery schedules that lower costs for the buying firm. ▪ Buyers have traditionally accepted terms offered to them by the carriers with regard to their inbound freight. 6-26 6-27 7. Lack of communication ▪ Effective development and implementation of the just-intime system requires integration of important functional areas such as purchasing, manufacturing, quality, production, and transportation. ▪ Lack of proper communication among these areas poses a major obstacle to the implementation of JIT. ▪ While there is no easy solution to this problem, the purchasing function in an organization must assume the responsibility of calling on top management regularly for leadership and support. 6-28 Role of Culture ▪ A crucial issue to be considered is the relevance of culture in the successful implementation of the just-in-time system in a country. ▪ Honda’s culture and its focus on group-oriented activities are particularly suitable to the implementation of the just-intime production control system in that environment. ▪ The need to have harmony in organizations provides for better manufacturer–supplier relationships at Toyota and Honda. ▪ Severance of a business relationship between manufacturer and supplier has a strong stigma associated with it, which both manufacturers and suppliers try to avoid as much as possible. 6-29 Critical Analysis of the JIT Concept ▪ Many companies turned to JIT looking for a relatively painless financial surgery that would yield substantial short-term benefits. ▪ Over the years, these companies have come to realize the tremendous effort and commitment required to make a JIT system run smoothly. 6-30 Critical Analysis of the JIT Concept ▪ The radical proponents of JIT manufacturing in the United States during the 1980s and 1990s, the socalled JIT revolutionaries, are to some extent responsible for this initial misunderstanding. ▪ The practitioners painted an extremely romantic picture of JIT emphasizing simplicity and efficiency, along with a state of affairs where employee morale would be high and relations between buyers and suppliers would be completely harmonious. ▪ It takes time to change attitudes of the workforce and nurture long-term relationships with suppliers. 6-31 Critical Analysis of the JIT Concept ▪ The transition to JIT has not necessarily been a smooth one for many companies in the United States. But this does not imply that switching from a pure MRP system to a JIT or hybrid system was a mistake for most companies. ▪ There are two serious drawbacks with the MRP production control system. – First, the master production schedule that drives MRP is based on estimated customer requirements; and second, MRP’s production control system utilizes a “push” system for manufacturing goods. 6-32 Critical Analysis of the JIT Concept ▪ Another critical issue for JIT manufacturers is the variability in product demand. ▪ JIT systems seems to work best when its smooth production and low inventory requirements are aimed at meeting a relatively stable product demand. ▪ However, demand patterns are not stable for all products. In order to induce a relatively stable demand, companies using JIT manufacturing often consolidate their product lines. ▪ Not all marketing strategies are compatible with the JIT system. 6-33 Purchasing and Supply Management by W. C. Benton Chapter Seven Purchasing Procedures, E-Purchasing, and Systems Contracting McGraw-Hill/Irwin Copyright ©2007 The McGraw-Hill Companies, All Rights Reserved Learning Objectives 1. To identify the steps in the conventional purchasing cycle. 2. To understand the differences between buying and purchasing. 3. To identify the main activities of a typical purchasing department. 4. To identify routine versus non routine purchasing/buying methods. 5. To identify technical requirements for e-purchasing. 6. To identify the differences between EDI and epurchasing. 7. To introduce the RFID technology. 7-2 Manual vs. Systematic Policies ▪ A typical purchasing department is responsible for the acquisition of a broad range of materials and supplies. ▪ Depending on the sales volume, the number of employees, and the functional sophistication, the purchasing activities can be either complex or simple. ▪ In most cases, large multidivisional firms like IBM, Ford, and General Motors usually establish a set of systematic policies based on the overall corporate missions. 7-3 The Purchasing Policy The driving force behind any purchasing corporate policy considers the following objectives: 1. Spend corporate funds wisely. 2. Operate in a professional manner. 3. Purchase the right materials in the right quantities, at the right time and price, from the right source. 4. Practice the highest level of ethical standards to ensure confidence among all parties 7-4 Purchasing Procedures The standard purchase order cycle is shown in the following slide. 7-5 7-6 Purchasing Procedures 1. Requisition material A. Storeroom requisition B. Purchase requisition C. Traveling requisition—eliminates separate purchase requisitions 2. Determine vendor A. Price card B. Traveling requisition—same information as on price card C. SAL (same as last) D. Inquiry of potential vendors—phone or e-mail (request for quotation) E. Evaluate bids and select vendor. Establish prices, quality, and delivery 7-7 Purchasing Procedures 3. Issue a purchase order A. 4. Follow and expedite delivery A. 5. Distribute copies (multiple) Open and close order files Document receipt of material A. Multiple copies required 6. Move to storeroom (or point of use) 7. Receive and handle invoice A. B. 8. Purchasing Accounts payable Issue payment 7-8 Details for the third purchasing objective became evident when the material requirements arose: 1. The right material: Vinyl three-hole binder. 2. The right quality: Standard. 3. The right quantity: 2,000 units. 4. The right place: The training area. 5. The right time: Now. ------------------------------------------------------------------------Thus, based on the above criteria specified by the using department manager, the main functions of the purchasing department are to: 1. Determine the supplier. 2. Negotiate the actual price. 3. Determine the delivery date. 7-9 Purchasing Procedures ▪ Most storerooms are full of inexpensive items and 90 percent of stores transactions are for low-value routine materials related to nonproductive requirements. ▪ Acquisition of supplies from the company storerooms in most cases is a relatively simple process. ▪ A standard three-part requisition form is usually used to initiate the transaction. Materials and supplies are usually received by the requisitioning department in less than 24 hours. – The inventory system is then updated. This process is continued until some predetermined reorder point is activated and storeroom replenishment occurs. 7-10 Traveling Requisition ▪ A traveling requisition is used to request repetitive materials/supplies. Sources of supply, the previous price paid, and the order quantity are some of the information on the traveling requisition.. 7-11 SYSTEMS CONTRACTING 7-12 What Is Systems Contracting? ▪ Systems contracting is a stockless inventory method for ordering and stocking MRO and related items. The use of systems contracting will aid the firm in reducing ordering and inventory costs. ▪ The systems contracting process requires the use of a negotiated agreement between buyers and sellers. ▪ The agreement includes the following terms: the type of material, scope of contract, price, billing policy, stocking policy, and delivery requirements. ▪ Systems contracting is an efficient form of purchasing that is based on reductions in processing and administrative costs. 7-13 Systems Contracting ▪ Systems contracting is a purchasing management technique that seeks overall reduction in the cost of an item from the time a need is recognized to the time that need is fulfilled. ▪ Recognizing that purchase price is but one element of the total cost picture, the scope of systems contracting goes far beyond the purchase price for any given item. ▪ To extend this commitment to increasing productivity in all departments within a given facility, many companies have adopted the concept of profit centers. – As a profit center, each department makes a direct contribution to the overall success of the total organization. 7-14 The Total Cost of Ownership • The purchasing function has become an indispensable part of modern management effectiveness. • Purchasing professionals are primarily charged with the responsibility for controlling the total cost of ownership (TCO) 7-15 The Total Cost of Ownership • The true cost of an item is its purchase price, plus fixed, variable, and overhead costs. Beyond the direct costs are the total procurement costs. • The cost of procurement includes the following steps: 1. 2. 3. 4. 5. 6. 7. 8. 9. Identify need. Requisition material. Inquire with potential suppliers. Evaluate bids/quotes. Issue purchase order. Expedite order. Document receipt of material. Receive and handle invoice. Issue payment. 7-16 REVERSE AUCTIONS 7-17 What Are Reverse Auctions? ▪ The Internet has revolutionized commodity purchasing. ▪ Firms routinely place orders with suppliers online and in real time, for example. Perhaps the most significant change in the purchasing process is the advent of reverse auctions. ▪ Businesses that use reverse auctions, or eauctions, have given testimonials of savings of more than 50 percent. 7-18 Reverse Auction (Example) ▪ As an example, General Electric reported savings of more than $600 million in savings by putting $12 billion in contracts up for bid online. ▪ The use of reverse auctions also has spread into the construction industry and governmental agencies ▪ The purpose of a traditional auction is to create competition between bidders. A seller offers a good or service and bidders compete with one another by increasing the current bid price. At the end of the auction, the highest bidder wins the item. 7-19 Reverse Auctions ▪ With reverse auctions, conditions are somewhat different. First, the buying firm initializes the auction by submitting a description of the product or service. ▪ Sellers then place bids based on their offer to fulfill the buyer’s needs. ▪ The competition between the sellers drives the price down, instead of up, so the buyer pays less at the expense of the seller. ▪ Despite that firms have made significant information technology investment on supply chain practices, firms have increasing needs to financially justify the information technology investment. 7-20 Implementing a Reverse Auction • Implementing the reverse auction process requires the following steps: 1. Define market specifications 2. Identify suppliers 3. Perform pre-award review 4. Approve suppliers listing 5. Identify specific terms and conditions 6. Invite suppliers 7. Set up auction 8. Conduct auction 9. Write up contract 7-21 Reverse Auctions ▪ Reverse auctions may not be the solution for all commodity buying. As an example, if there are too few sellers, reverse auctions will not yield the best price. ▪ By definition, the price in reverse auctions is driven down by competition, so if only limited competition exists, then the price will not decrease enough to save the buyer a substantial amount of money. ▪ A more devastating downside of reverse auctions is the buyer/seller relationship damage that may result from this method of buying. The buyer runs the risk of alienating both current and potential sources for the goods/services. 7-22 Reverse Auctions ▪ Reverse auctions should be used to gain market information (new suppliers, prices, new methods, etc.) but should not be used as a routine sourcing method. ▪ To maintain trust and cooperation between buying and selling firms, reverse auctions should be used carefully. ▪ Requests for quotes (RFQs) are less traumatic for maintaining healthy relationships between buying and selling firms. 7-23 ELECTRONIC DATA INTERCHANGE (EDI) AND PURCHASING 7-24 What Is EDI? ▪ EDI is the direct computer transmission of orders and other transaction information. ▪ In purchasing, EDI is usually used for the electronic transmission of orders, invoices, and payment between buyer and seller. ▪ The main elements of an EDI system are computer hardware, software, computer compatibility between the sender and receiver, and subscription to a common network. 7-25 EDI as a Competitive Strategy ▪ There are many benefits to using EDI. For a smaller company, EDI may help keep a valued trading partner or customer or even gain new ones. ▪ For larger firms, the main benefit is generally the cost savings, or to be known as a leading-edge company. 7-26 Benefits of EDI ▪ There are some definite benefits to utilizing EDI. The first major benefit is reduced labor. ▪ The overall reduction in document handling is one that saves time and allows more time for data analysis. ▪ Higher information quality due to a reduction in data entry errors also can be attributed to EDI. ▪ EDI capabilities can show potential customers a supplier’s willingness to cooperate, which improves relations and leads to better long-term relationships. 7-27 EDI Risks ▪ There are also some risks when using EDI that should be considered. EDI is not inexpensive. ▪ The machine and training cost will add up to a large amount, and cutting corners may cost a company more than it saves. ▪ Security is also an issue. Procedural safeguards have not kept up with technology in this area. ▪ The problem is exposure to outside users, which opens up a doorway to false messages. These messages may come in the form of a person who is not a supplier sending data or the data being interrupted and/or altered. ▪ A decision must be made whether to trade singularly through EDI or use both EDI and traditional methods. 7-28 Implementation of New Technologies • Introducing new technologies into organizations will almost always result in some combination of social, technical, psychological, and structural changes. • When managers or employers resist the logical arguments presented in support of EDI, they may not be resisting the technical aspects of the proposed change as much as the perceived social or psychological ramifications. 7-29 The Change Process for New Technologies A concise description of the change process consists of the following three steps: 1. Unfreezing. Creating an awareness of the need for change and a climate of receptivity to change. 2. Moving. Changing the magnitude or direction of the forces that define the initial situation; developing new methods and/or learning new attitudes. 3. Refreezing. Reinforcing the changes that have occurred, thereby maintaining and stabilizing a new equilibrium situation. 7-30 EDI Implementation Management ▪ The way in which the process of developing and implementing an EDI system is managed can greatly influence the success of implementation. ▪ Four key areas are top management support, commitment to the project, influence, and institutionalization. ▪ Top management support has long been recognized as one of the most important ingredients necessary for the introduction of any organizational change, and the same holds true for the introduction of an EDI system. ▪ Commitment to the project relates to management assurance that the problem the EDI system is designed to improve is understood and that EDI is the right solution to this problem. 7-31 EDI Implementation Management ▪ Management usually exerts only minimum influence during the early life cycle phases and very heavy influence immediately before final implementation. ▪ Unfortunately, it is at the implementation phase of systems development when changes are most difficult and costly. If a change costs $1 when feasibility is being considered, it would cost $16 at implementation. ▪ Thus, management tends to spend most of its time at a point in the development cycle when it will have the least influence on the overall direction of the system. It is also the time when exerting influence is the most costly. 7-32 The Implementation Team ▪ In order to orchestrate the various aspects of the implementation process, a steering committee guiding various project teams is recommended. ▪ The steering committee acts as the overseer of the entire project and represents the functional groups of the enterprise. ▪ Its primary concerns are setting policy, exercising control mechanisms to ensure that the desired results are achieved, and monitoring to measure the effectiveness of the EDI system. 7-33 EDI in Practice Possibly one of the largest users of new compute technology and EDI for purchasing purposes is Wal-Mart. To help in forecasting, Wal-Mart has developed a system called “traiting” that analyzes 2,500 traits of each store’s environment. – By using this system, they can accurately predict what products should be stocked and inventoried in each store. – Wal-Mart also is experimenting with sharing its point-of-sale data with vendors. – Wal-Mart currently allows five suppliers representing 700 fastmoving items to receive sales data directly from the point of purchase. – When an item is purchased, an EDI system is used to immediately trigger an automatic merchandise replenishment process. 7-34 FIGURE 7.4 e-Procurement Benefits by Category Indirect Direct Sourcing Price reduction Visibility of customer demand Unit cost reduction Improved contract compliance Visibility of supply chain capacity Enhanced decision making Shortened cycle times Accuracy of production capacity Improved market intelligence Reduced administrative costs Reduced inventory costs Enhanced inventory management Shortened process cycle times 7-35 RADIO FREQUENCY IDENTIFICATION (RFID) 7-36 What Is RFID and How Does It Work? ▪ Radio frequency identification, or RFID, is a universal term given to any technology that uses radio waves to identify and track items. ▪ Items such as a product, a container, an automobile, an animal, or a person can all be automatically identified and tracked through RFID technology. ▪ Wal-Mart now requires their top 100 suppliers to use RFID technology in shipping cases and pallets. ▪ Before this announcement, everyone questioned whether RFID technology really worked and offered competitive advantages, or whether it was all just hype. 7-37 RFID and Purchasing ▪ Wal-Mart believes it has the answer, but even if RFID is appropriate for the world’s largest retailer, others have to ask whether RFID is appropriate in their own unique environments, and what strategies should be used in implementing it. ▪ The RFID technology can be constructed in many ways, but the most common procedure is to store a serial number on a microchip and attach it to a coiled antenna. ▪ Through this process, RFID, often called inlays , is produced. Inlays in manufacturing applications can be built directly into the product, affixed with adhesive paper to form “smart labels,” or combined with packaging in a myriad of ways. ▪ Although the technical details vary with different designs, readers convert radio waves from the tags into data that are decoded and transformed into information. 7-38 Advantages of RFID An RFID system provides many advantages for companies suppliers, and retailers. Below is a list of some of the benefits RFID can offer: 1. Reduced labor costs. 2. Simplified business processes. 3. Improved inventory control. 4. Increased sales. 5. Reduced shrinkage. Unlike the barcode-based tracking system, a radio frequency identification system offers a no-contact, no-line-of-sight reading and tracking system. This automation provides reductions in the need for the manual scanning of products and the time required for labor-intensive duties, which, in turn, can reduce the overall labor costs for companies. 7-39 RFID Advantages ▪ Another advantage of reducing the labor required for monitoring goods movement and inventory flow is that it will free personnel that can be used to provide better customer support. ▪ RFID tags can be read through snow, fog, ice, paint, and crusted grime, unlike the barcode system. ▪ The tag also can be programmed to hold information such as the item’s serial number, color, size, manufacture date, and current price, as well as a list of all distribution points the item reaches as it moves before arriving at a store. ▪ This is an advantage for cross-docking, shipping, and receiving by efficiently locating items to complete shipments. 7-40 RFID Implementation ▪ As RFID systems are implemented, manufacturers will tag goods from production so information can be provided to suppliers, manufacturers, logistics teams, and, finally, end customers. ▪ With this implementation, everyone benefits from having access to the same information, which can be used to coordinate and promote supply chain interactions. ▪ Consumers also benefit from having RFID tags inserted in their products, such as increased availability information and reduced stockouts and prices 7-41 RFID Implementation Companies must ask themselves many questions before implementing an RFID system. Some such questions are 1.Does the company need RFID to keep pace with its competitors? 2.Will RFID offer a competitive advantage for the company? 3.Will the company have the power to manage its business without accurate information about its processes and inventory that could be gained from RFID? 4.Will RFID cost effectively improve the ability of the company to serve its customers? 5.Will RFID save the company money eventually (long term)? 7-42 RFID System Requirements 1. 2. 3. 4. 5. 6. 7. 8. 9. The item environment relates to the tagged item’s attributes and how it is used. What is the item to be tagged? In what ways will the tag be read? Will it be in groups or individually? Over what distances will we need to read? What is the environment to which the item is exposed? What about the temperature, damage potential, handling equipment, and so forth? What, if any, business processes need to be changed in order to work with the technology? What, if any, physical changes to the item or its dimensions need to be adjusted? 7-43 RFID System Environment ▪ System environment is the area in which the tagged items will be utilized. ▪ What is the configuration of the manufacturing facility, warehouse, store, shipping dock, and so on? ▪ What are the physical surroundings? ▪ Do the items sit for a long period or are they frequently moved? ▪ Is there machinery that can interfere with our system? ▪ What are the distances involved with reading this item? 7-44 Data Requirements ▪ Tag data storage ▪ Data transmission requirements. ▪ Back-end data storage. ▪ Tag data can be stored and edited. ▪ Storage size matters. ▪ Backup or copy of the data needs to be maintained. ▪ High speed transmission needs to be addressed. 7-45 Tag Structure ▪ Tag structure refers to the physical structure of the tag. ▪ Size (affecting performance and antenna positions, affecting performance). ▪ Formats (smart label, credit card style, hard tag). ▪ System environmental affects the antenna requirements for the tag. ▪ Item environment drives the requirements for the tag structure. 7-46 Tag Mounting ▪ The tag must be affixed to the item so that it survives the system environment. It must protect the tag and provide a required angle possibly needed by the system. ▪ Both the tag and the material that attaches it must be protected and properly positioned to facilitate optimal read rates. 7-47 Reader Capabilities Antenna Selection and Placement ▪ Readers may control multiple antennas. ▪ Multiple connectivity options must allow support needed in the company. ▪ Choosing placement of the right type of antenna. ▪ Consideration of the area of coverage desired. ▪ Balance of controlling the RF field and distance. 7-48 Software Support Functions ▪ Ability to handle multiple simultaneous reads of multiple items by multiple readers. ▪ Understanding of the expected number of items in a read zone. ▪ Coordination of timing and material flow. ▪ User feedback features. ▪ Event management. ▪ Backend systems update. 7-49 E-Sourcing and Purchasing ▪ As we look into the future the traditional purchasing approach will be transformed into e-sourcing. E-sourcing will be the tool that drives supply management.. ▪ As the world market for goods and services become a key competitive advantage e-sourcing is redefining the way companies manage their supply chains. ▪ Buyers and sellers located in different continents can meet electronically. E-sourcing will also lead to higher transactional accuracy and cost reductions for the entire supply chain. As shown on the following slide, E-sourcing creates value by : 1. Reducing the total cost of ownership 2. Streamlining the purchasing process and 3. Business innovation 7-50 7-51 Purchasing and Supply Management by W. C. Benton Chapter Eight Supplier Selection and Evaluation McGraw-Hill/Irwin Copyright ©2007 The McGraw-Hill Companies, All Rights Reserved Learning Objectives 1. 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 identify potential disadvantages of single sourcing. 5. To analyze how to reduce the number of suppliers. 6. To understand how supplier evaluation is accomplished in a variety of industrial environments 8-2 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. 8-3 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. 8-4 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. 8-5 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. 8-6 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. 8-7 Benefits of Outsourcing ▪ Outsourcing can produce many benefits for a firm that would normally produce a part internally. ▪ Vertical integration gives a firm more control over the part in question. However, the greater the percentage of internal parts an assembly firm produces, the greater their need to have competence in each of the areas involved. ▪ It is very difficult for a manufacturer such as an automobile company to have competence in areas of production of all parts that go into producing and assembling a car. ▪ Therefore, outsourcing to suppliers reduces the pressure on firms to try to do everything. 8-8 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. 8-9 Sources of Supplier Information ▪ Searching for the appropriate supplier for a specific material or component part is becoming a strategic issue in itself. ▪ In the new fast-paced and volatile buying environment, the purchasing firm must know where to look for each item. ▪ Buyers should be experts on the industry and in specific raw materials or component parts. ▪ There are many sources available for the buyer to consider when seeking out potential suppliers. ▪ The traditional buying source is the well-known Thomas Register. ▪ The Thomas Register categorizes potential suppliers as manufacturers, distributors, manufacturer representatives, or service. ▪ Trade journals are also a valuable source of information regarding potential suppliers. ▪ Two such journals are Purchasing World and Purchasing. Salespersons are not only important resources about materials, they can also be an excellent source of free consulting information. ▪ Local chambers of commerce, the Yellow Pages, trade shows, and city libraries are excellent sources of supplier data. 8-10 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. 8-11 Strategic Selection ▪ These functions must work as a cohesive strategic where each complements the other. It is from this perspective that supplier selection/reduction should take place. ▪ In order for good communication to exist between buyer and supplier, common ground should exist in management styles, control systems, quality philosophies, and technological abilities (eg. in engineering, design, EDI, RFID and etc.) 8-12 Strategy and Outsourcing • Since outsourcing is a delegation of responsibilities, it should be viewed as an extension of the OEM’s strategy. 8-13 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. 8-14 Criteria for Supplier Evaluation ▪ In addition, large buying organizations increasingly are demanding that their suppliers become certified through third-party organizations, such as ISO 9000 certification or Malcolm Baldrige National Quality Awards. 8-15 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. 8-16 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. 8-17 Advantages and Disadvantaged of the Categorical Method ▪ The advantages associated with implementing this sort of an evaluation program are that it can be implemented almost immediately and is the least expensive of the three evaluation systems discussed here. ▪ The method’s major disadvantage is its dependence on the judgment of its users. ▪ The system is largely dependent on the memories of personnel to explain what “unsatisfactory” or “good” means. With this method, there is no concrete supporting data. 8-18 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-ofownership rating,” developed by the director of corporate purchasing of Sun Microsystems. 8-19 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. 8-20 8-21 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. 8-22 Linear Averaging Method 1. 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. 8-23 Linear Averaging Method 2. After the weights have been assigned, the individual performance factor ratings are determined. This is done by summing the scores for each factor. 3. The third step is to multiply each performance factor rating by its respective weight as a percentage. Continuing the example, a quality rating of 95 would be multiplied by .50, if quality had a weight of 50 4. Finally, the results from step three are added to give a numerical rating for each supplier. 8-24 Example 8-25 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 singlesource policy, in which only one supplier is used to supply a particular part. 8-26 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. 8-27 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. 8-28 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. 8-29 Advantages of Dual Sourcing ▪ The advantages of multiple sourcing can be viewed as the disadvantages of single sourcing and vice versa. ▪ The best scenario would be one that can obtain the advantages of both. 1. This might be done by applying significant pressure to single-source suppliers or by providing significant certainty to suppliers in a multiple-sourcing environment. 2. This may be accomplished through the use of contract length. Short-term contracts regardless of single or multiple suppliers can be used as a source of punishment. In some instances, long-term contracts can be viewed as a reward. 8-30 Long-Term Issues ▪ Single sourcing advocates may want to address the following issues regarding long-term impacts of single sourcing. 1. In the long-run, if everyone reduces their supplier base, there will be fewer suppliers to deal with and overall competition will decrease as there are fewer suppliers. A supplier consolidation will give suppliers more power in the long run. 8-31 Long-Term Issues 2. Also, a supplier may be able to forward integrate and market the very subassemblies it sells to the OEM in the aftermarket, which is a very lucrative field. 3. This warrants using the Porter model to assess the supplier’s capability to do this prior to single sourcing. 4. The single-source movement became popular during the 1990s. The 1980s were a period of labor stability as strikes were not a major issue. 8-32 Long-Term Issues ▪ What is to prevent future labor unrest that could unravel single-source relationships and bring assembly lines to a halt? – This was the case as strikes crippled Ford and – Renault plants in Europe. ▪ Progressive and participative management style may be the answer, but management must be able to delivery on these new styles and be effective to prevent labor unrest. 8-33 Japanese Reality ▪ Many “pop” management techniques have emerged over the last decade by emulating the successes of the Japanese manufacturers, particularly in automobile production. ▪ Many managers believe that “if it works in Japan, it can work here.” That may be true, but one of the perceptions possibly leading to the popularity of single sourcing is the belief that all Japanese firms work closely with one supplier. ▪ Therefore, the common American response has been: Japan uses one source; we should too. In fact, over 98 percent of Ford’s outsourced parts are supplied by singlesource suppliers. 8-34 Cross-Sourcing ▪ The single-sourcing/multiple-sourcing issue does not have to be viewed as a “black or white” type of a decision. ▪ A hybrid approach can be used that is known as cross-sourcing. With this method, the supplier base is expanded without increasing the actual number of suppliers. 8-35 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. 8-36 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. 8-37 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. 8-38 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. 8-39 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. 8-40 Certification ▪ The certification criteria can be changed and updated as recertification may be required. Thus, the “hurdle” can be raised higher and higher until there are only one or a few suppliers left. ▪ In combination with certification are the price and productivity hurdles. OEMs can add these criteria to make it more difficult to be a “select” supplier. 8-41 Certification Example ▪ Certification programs are usually only as good as their designers make them. ▪ The attributes that determine certification must be well thought out and realistic. ▪ For example, requiring a 5 percent decrease in price annually may force suppliers to look for short-term cost reductions that may hurt long-term investments, which would make a partnership with a single source stronger. 8-42 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. 8-43 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. 8-44 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. 8-45 Apparel Industry ▪ The most important difference between industrial buying and retail buying is in the buyer’s responsibility for meeting the profit objectives of the firm. ▪ While industrial buyers are responsible for controlling costs, retail buyers are responsible for both controlling costs and generating revenue through their purchases. ▪ While industrial buyers purchase raw materials and component parts for use in production, retail buyers purchase finished goods for resale to the consumer. ▪ Consequently, the right goods for industrial buyers are those necessary to support the production process, while the right goods for retail buyers are likely to be those that the buyer expects to sell satisfactorily. . 8-46 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. 8-47 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. 8-48 Electronics Industry ▪ Delivery time is not a major factor due to the fact that the firm does not operate on a just-in-time basis. Instead, electronic companies order large quantities of goods and then put these goods into inventory. ▪ Once the product is received, an acceptable quality level (AQL) sample check is performed before the goods are transferred to stock. ▪ On the few occasions that samples do not conform to quality standards, the entire lot is sent back to the supplier. ▪ However, the likelihood of this happening is very minimal. Supplier evaluation is therefore primarily based on previous performance, not defects or delivery time. 8-49 Electronics Industry • In today’s market, an electronics supplier must have a quality product to survive. • Thus, electronics firms do not test the quality of the electronics suppliers. • Two decades ago, electronics firms tested each electronics product due to such poor quality, but now, due to Japanese and other foreign competition, quality has become a given for each product or the supplier simply will not survive in the electronics supplier market. 8-50 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 choosi...
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