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Strategic Sourcing

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Models of strategic sourcing and methods of selecting and evaluating suppliers.

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									Supply Chain Management

Strategic Sourcing

Prof. Upendra Kachru

Purchasing in a Supply Chain Context

Developing a lean supply organization: Energizing organizational teams through flexible structures and responsive information systems. Supplier-base management: Managing the structure and culture of supplier relationship that is denominated in strategic purchasing. Strategic Sourcing (procurement): Aligning procurement tasks and suppliers' performance with the corporate and business strategies of the firm.

Prof. Upendra Kachru

Operations Management

The Right Balance
Firms have to think strategically about supplier management. There cannot be a ‘one-size-fits-all’ concept. This means that there has to be a balance between the advantages and disadvantages of deciding on the relationship with suppliers.

Prof. Upendra Kachru

Operations Management

Strategic Framework

Prof. Upendra Kachru

Operations Management

Strategic Objectives
The nature of supplier relationship should be determined by the firm’s strategic objectives.

Cost Reduction

Value-added Benefits

Transactional

Cooperative

Alliance

To achieve the lowest possible price for a particular product transactional relationships are advantageous. Long-term partnerships are important when value creation is the objective.
Prof. Upendra Kachru

Operations Management

Why Single Sourcing?
Suppliers receive enough volume from the company be able to provide a cost advantage to the company in the long run. Suppliers are willing to make new investments in their own internal resources to optimize their production process and thus produce a component at a more competitive price. With the security of part-for-life agreements, suppliers are much more open to suggestions about cost reduction and are more willing to invest in optimizing their processes.
Prof. Upendra Kachru

Operations Management

Why Single Sourcing?
With multiple functional interfaces and relation-specific investments, organizational boundaries between supplier and buyer begin to blur. The partners’ destinies become tightly intertwined. Furthermore, the incentive compatibility of the partners is high because each party has made co-specialized investments that are of little value outside of the relationship.

Prof. Upendra Kachru

Operations Management

When Preferred?
Single sourcing is preferred as the purchasing method, when the strategic emphasis is on the supplier's availability of technical support, the reliability of the product, and the total cost of the product. Once the supplier and manufacturer begin working together and a long-term commitment is established, the need for additional suppliers also diminishes. Eliminating redundancy also reduces overall costs, cutting out dual sourcing, dual tooling, and dual process development, etc.

Prof. Upendra Kachru

Operations Management

Single sourcing

Single sourcing as a concept evolved from the Japanese. The purchasing objectives have a focus to consolidate a partnership or alliance with the supplier. The unprecedented success of the Toyota model has forced companies to reevaluate the basic tenants of the traditional model. Toyota was able to dominate the international automotive market basically due to its strategic sourcing policy. As companies gain experience with single-sourcing, they tend to move beyond individual parts to entire part families, further reducing the complexity of supplier management.
Prof. Upendra Kachru

Operations Management

Single sourcing has as its basis the success of the system in Toyota.

A study in 1995 showed the difference between US and Japanese companies in the strategic segmentation of suppliers.

Prof. Upendra Kachru

Operations Management

Toyota Model

Prof. Upendra Kachru

Operations Management

Maruti Vendor Strategy

Maruti has 220 approved vendors who supply the major components. The top 80 vendors supply 86 percent by value of their purchases. Of the 86 percent components supplied by vendors, joint ventures supply only 34 percent; the rest of the 52 percent by value is supplied by other vendors. These eighty vendors are considered strategic partners. Only 20 to 30 of them are Maruti joint ventures.
Prof. Upendra Kachru

Operations Management

Maruti Vendor Strategy
Maruti takes a major role in improving vendor productivity.. The strategy, in 2005-06, resulted in savings of 1580 man hours per day from their vendor’s, which resulted in a saving of over one crore rupees per annum. They were able to reduce component costs on the Alto alone, from 2001 to 2005, by 29 percent.

Prof. Upendra Kachru

Operations Management

Prof. Upendra Kachru

Operations Management

Network sourcing
Many firms have successfully consolidated their supplier bases by using a phased approach. In a majority of firms, the debate on multiple and single sourcing is bypassed using a hybrid model. This model overcomes the drawbacks of the two methods discussed earlier. This hybrid is often termed networking.
 Networking involves reducing the number of suppliers a firm does business with.  The final product is based on the skills and specialized knowledge of different tiers of subcontractors.

The supply network is a hierarchical pyramid. The top tiered suppliers are the most skilled and possess the most advanced technologies, while the suppliers at the bottom have adequate skills for their particular operations. Communication is shared between the buyer and all the suppliers within the network.
Prof. Upendra Kachru

Operations Management

Strategic Partnerships
Strategic partnerships (quasi-hierarchies) are necessary when supplying firms provide strategic inputs - inputs which are typically high value added and play an important role in differentiating the buyer’s final product. Because of the potential benefits of customization (e.g., higher quality, new features), strategic inputs require a high degree of coordination between supplier and buyer. Firms' today reduce their supply base to only the best suppliers, while further developing suppliers who are continuously improving their quality, delivery, service, price, and information performance.
Prof. Upendra Kachru

Operations Management

Strategic Sourcing - Analyze the source strategically

What is the core competence of the source?
What is the core competence of the firm?

How does the source contribute to the competitive advantage of the firm?
Can the relationship benefit both the firm and the supplier?

Prof. Upendra Kachru

Operations Management

Successful day-to-day collaboration between a company and its suppliers relies on a number of factors:  Supplier selection,  Supplier evaluation,  Supply base reduction,  Investment for improvements, and  Greater integration of suppliers.

Prof. Upendra Kachru

Operations Management

Factors on which to Evaluate Partners

Prof. Upendra Kachru

Operations Management

Traditional Concept
PPU is the traditional approach. TCA is an extension of the traditional approach. In both cases, supplier selection and ongoing evaluation are based on selecting and retaining a supplier based on price alone, or based primarily on price.

Upendra Kachru

Operations Management

Purchase Price per Unit (PPU) & Total Cost of Acquisition (TCA)

Reduction in cost paid per unit Reduction in cost of material acquisition
Upendra Kachru

Operations Management

When short term cost reduction is a priority, PPU and TCU are adequate measures of the firm’s advantages. When long term value creation is the goal, the value of strategic partnerships is based upon tools that reflect the real cost of the purchase to the organization.

Prof. Upendra Kachru

Operations Management

Some

Total Cost of Ownership (TCO)

Total cost of ownership (TCO) is a Definitionspurchasing tool and philosophy which is aimed at understanding the true cost of buying a particular good or service from a particular supplier. It is the total cost of a product or service throughout its lifecycle, from acquisition to disposal. TCO has three constituents: • Acquisition Costs • Ownership Costs, and • Post-ownership Costs This represents the total cost of a product or service throughout its lifecycle, from acquisition to disposal.

Upendra Kachru

Operations Management

Total Cost of Ownership Method

Visible Costs vary from Organization to Organization
Upendra Kachru

Operations Management

Product/Service purchase Cost
50

Purchase Price
Internal Business Cost Transportation Warehousing Inventory Carrying Cost Purchasing Administration Factory Yield Damaged Field Product

% of Purchase Price

40

30

20

10

Customer Lifetime Cost Production Capacity R&D Specifications Expediting

Costs incurred on Components by the Firm Upendra Kachru

Operations Management

Dollar Based System to determine TCO

A dollar-based system is one that relies on gathering or allocating actual cost data for each of the relevant TCO elements. Explaining the results of a dollarbased approach is relatively straightforward. However, determining which cost elements to include and gathering the data to determine the TCO may be complicated.

Upendra Kachru

Operations Management

Worked Example

Upendra Kachru

Operations Management

Value-based approach to TCO

These models are rather complex, as qualitative data are transformed to quantitative data. They often require very lengthy explanations of each cost category.

The supplier’s performance is scored within categories and points allocated among categories reflects the buying organization’s estimate of the cost of various performance discrepancies.
Upendra Kachru

Operations Management

Worked Example

Upendra Kachru

Operations Management

The model calculates the TCO based on the following formula: TCO = [(100 – Supplier Score) / 100] + 1

Upendra Kachru

Operations Management

The examples given are simple based just on acquisition costs, but different factors can be added to these TCO analyses that may be relevant to the analysis. These may also include factors related to ownership costs, post ownership costs, etc.

Prof. Upendra Kachru

Operations Management

Comparison between different Models

Upendra Kachru

Operations Management

The Analytical Hierarchy Process (AHP)

Prof. Upendra Kachru

By organizing and assessing alternatives against a hierarchy of multifaceted objectives, AHP provides a proven, effective means to deal with complex decision making. The goal is to structure the problem into manageable problems. The problem, which is unstructured, is broken up into sub-modules. Each sub-module is further divided into an appropriate level of detail till the unstructured problem transforms into a manageable problem. Now the issues can be organized both vertically and horizontally under the form of a hierarchy of weighted criteria.
Operations Management

AHP Method
The issues are organized both vertically and horizontally under the form of a hierarchy of weighted criteria.

Prof. Upendra Kachru

Operations Management

Let us choose these eight areas that need to be reviewed to qualify a supplier. The areas are:

Prof. Upendra Kachru

Operations Management

Prof. Upendra Kachru

Operations Management

The Principal Component Analysis (PCA)

The Principal Component Analysis (PCA) method is a multiobjective approach using multivariate statistical methods to vendor selection. It attempts to provide a useful decision support system with multiple vendors and trade-offs such as price, delivery, reliability, and product quality through a data reduction technique that identifies a small set of variable that account for a large portion of the total variance in the original variance. This technique requires advanced knowledge of statistics.
Operations Management

Prof. Upendra Kachru

The Neural Network Method

The neural network supplierselecting system includes two functions: one is the function measuring and evaluating performance of purchasing (quality, quantity, timing, price and costs) and storing the evaluation in a database to provide data sources to neural network. The other is the function using neural network to select suppliers. Most of the neural-network paradigms commonly used have three layers: input layer, output layer, and hidden layer.
Operations Management

Prof. Upendra Kachru

Managing Strategic Partnerships

In managing strategic partnerships, the buying firm must be effective at:
 Capabilities benchmarking to ensure that the best possible partners are chosen; Developing trust so that partners will be willing to make relation specific investments and share information; and Creating inter-firm knowledge sharing routines to effectively coordinate activities and optimize inter-firm Operations Management





Prof. Upendra Kachru

Benchmarking Capabilities

Internal risks arise from the quality of vendors. Vendors have to be benchmarked as they relate to the following characteristics:  Capability  Quality  Reliability  Costs, and  Compatibility
Prof. Upendra Kachru

Operations Management

Supply Chain Management


								
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