Chapter 5 Summary: Strategic Supplier Selection
Chapter Aim
The chapter aims to provide an understanding of the challenges, techniques, and
processes involved in supplier selection.
Key Concepts and Processes
Importance of Strategic Supplier Selection
Traditional methods (choosing the lowest bidder) are no longer adequate due to
outsourcing, long-term collaborations, and supplier involvement in product
development.
Selecting the right supplier maximizes value creation and minimizes risks, as
demonstrated by the Ericsson case.
Stages of Supplier Selection
1. Initial Supplier Qualification: Screen suppliers to ensure they meet minimum
requirements for product standards, manufacturing capabilities, and financial
viability.
2. Agree Measurement Criteria: Identify relevant and appropriate criteria tailored to
the product or service.
3. Obtain Relevant Information: Collect data through RFQs, RFPs, RFIs, supplier
visits, and performance measures.
4. Make Selection: Use decision-making models like the Analytic Hierarchy Process
(AHP) to rank suppliers based on weighted criteria.
Criteria for Supplier Selection
1. Cost Criteria:
o Unit price, pricing terms (discounts, payment terms), and exchange rates.
o Total cost includes hidden costs such as delivery, quality issues, and
compliance penalties.
2. Quality Criteria:
o Focus on certifications (e.g., ISO 9000), quality systems, and continuous
improvement initiatives.
o Buyer visits and audits can evaluate production quality and organizational
culture.
3. Delivery Criteria:
o JIT (Just-In-Time) production demands on-time delivery, low lead times, and
small lot sizes.
o Geographic location affects delivery responsiveness and costs.
4. Flexibility Criteria:
o Volume flexibility: Adjusting order sizes based on demand fluctuations.
o Mix flexibility: Adapting product variety to meet market needs.
5. Other Criteria:
o Environmental sustainability, supplier diversity, ethical practices, and
innovation capabilities.
Key Decision-Making Models
Analytic Hierarchy Process (AHP)
A multi-criteria decision-making (MCDM) model that:
1. Prioritizes criteria based on pairwise comparisons (e.g., innovation vs. cost).
2. Assigns weights to each criterion.
3. Ranks suppliers by evaluating them against the weighted criteria.
Example: AHP comparison of three suppliers (S1, S2, S3) ranks S1 highest based on
its scores for innovation, quality, and price.
Limitations of AHP
Relies on subjective judgments, which may introduce bias or inconsistency.
Computationally intensive when adding new criteria or alternatives.
Best Practices
1. Use a mix of qualitative and quantitative data to assess suppliers.
2. Customize selection criteria to match the product's functional or innovative nature.
3. Focus on total cost rather than price alone.
4. Build strong relationships with strategic suppliers for mutual benefits.
Critical Case Example
Ericsson Fire Case: Highlights the risks of single-source supply and the importance
of contingency planning in supplier selection.
Differences Between RFQ, RFP, and RFI
1. Request for Quotation (RFQ)
Definition: A document requesting price and availability for a specific product or
service from potential suppliers.
Purpose: Used when the buyer knows exactly what they need and specifications are
clear.
When Used:
o The monetary value of the item is high.
o There is no existing supplier.
o A competitive bid is needed to compare prices.
Outcome: Provides cost information for negotiation and selection.
2. Request for Proposal (RFP)
Definition: A document seeking design input, pricing, and availability for a product
or service, often involving a complex solution.
Purpose: Used when the buyer needs supplier expertise in developing or designing
part of the solution.
When Used:
o Requirements are not fully defined.
o Non-price factors like innovation, R&D, or customization are critical.
o Negotiations rather than just competitive bidding are expected.
Outcome: Evaluates suppliers on multiple factors, including design, innovation, and
cost.
3. Request for Information (RFI)
Definition: A document used to gather preliminary information about a product,
service, or supplier.
Purpose: Helps the buyer understand supplier capabilities or market options.
When Used:
o The buyer has insufficient knowledge to issue an RFQ or RFP.
o A preliminary assessment of the market or suppliers is needed.
Outcome: Determines whether to proceed with an RFQ or RFP.
Stages of Supplier Selection and Their Importance
1. Initial Supplier Qualification
Purpose: Screen suppliers to ensure they meet minimum product, process, and
financial standards.
Key Activities:
o Use surveys or RFIs to assess capabilities and financial health.
o Eliminate unsuitable suppliers to focus resources on viable candidates.
Importance: Reduces the risk of working with unqualified suppliers and narrows the
selection pool.
2. Agree Measurement Criteria
Purpose: Establish relevant and appropriate criteria for evaluation.
Key Activities:
o Define criteria like cost, quality, delivery, and flexibility.
o Use a "total cost" approach to go beyond unit price.
Importance: Ensures selection criteria align with business goals and the product's
requirements.
3. Obtain Relevant Information
Purpose: Gather data to compare suppliers across criteria.
Key Activities:
o Issue RFQs, RFPs, or RFIs to suppliers.
o Conduct supplier visits to assess culture, processes, and capacity.
o Review performance data for incumbent suppliers.
Importance: Provides comparable, accurate, and up-to-date information for making
informed decisions.
4. Make Selection
Purpose: Use decision-making models to finalize the best supplier.
Key Activities:
o Apply multi-criteria decision-making tools like AHP.
o Evaluate suppliers based on weighted criteria.
Importance: Ensures a systematic and transparent process to select the most
suitable supplier.
The Significance of Total Cost Over Unit Price
Why Total Cost Matters
1. Hidden Costs: Unit price alone ignores hidden costs such as:
o Poor quality (rework or product failure).
o Delayed deliveries (production downtime or expedited shipping).
o Environmental penalties or compliance issues.
2. Long-Term Savings: A supplier with a higher unit price may offer:
o Better quality, reducing defects and returns.
o On-time delivery, avoiding production delays.
o Innovation, enhancing product development and competitiveness.
3. Case Study Evidence:
o Ericsson's reliance on a single supplier resulted in massive losses due to
unforeseen supply disruptions. Factoring risk management into total cost
models could have avoided this issue.
Example:
Supplier A offers a unit price of $10 but has a 10% defect rate and frequent delivery
delays.
Supplier B offers a unit price of $12 but guarantees high quality and punctual
deliveries.
Total cost analysis reveals Supplier B is cheaper in the long term due to fewer
defects, reduced downtime, and improved customer satisfaction.
Key Takeaway:
Total cost reflects the true cost of doing business with a supplier, enabling more
strategic decision-making. Focusing solely on unit price can lead to hidden costs that
erode profitability and operational efficiency.