Course: Strategic Procurement in SCM Lecture / Week #.

5 (9th September, 2011) Lecture Contents about: Suppliers Evaluation and Selection Book Chapter #. 10

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Today, we will cover:

1. The Supplier Selection Decision; 2. Identifying Potential Sources; 3. The Evaluation of Potential Sources; 4. Supplier Evaluation Methods; 5. Linking Sourcing with Strategy

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Suppliers Evaluation and Selection

(Chapter #. 10)
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Strategic Sourcing
Strategic Souring is about linking Sourcing

Strategy with Organizational Strategy.

First step in Strategic Sourcing is categorizing

purchases into strategic and non-strategic bucket.

Typically, a strategic purchase is one that is

mission critical.

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Strategic Sourcing
Issues to address:
Should we use single source, dual source, or more than

two?

Should we buy from a manufacturer or distributor?

Where should the supplier be located?

Relative to our organization, should the supplier be small,

medium or large?

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Preparing a Prospective Supplier List

You can search for the potential vendors by

looking at several information sources:

Past experiences

Interviewing with the salesperson of the supplier Catalogs published by the vendors Trade Directories

Classifies suppliers according to the products they make Includes names of company personnel, financial status, and location of sales offices
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Information sources
Trade Journals or Business Magazines
These are oriented towards specific industries

Fairs and Trade shows

Specific to industry. Ex: Computer, textile, etc.

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Types of Suppliers
In the search for suppliers, all available types (that

is, distributors, manufacturers, sources) should be considered.

and

foreign

The number of suppliers to be used should also be

considered.

Trade-offs between price, delivery, and service and

community relations and goodwill must be weighed when selecting various types of vendors.
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Local vs. National Suppliers There are inherent natural advantages

to buying from local suppliers whenever possible.

Among the most significant are the following:

1. There is usually a freight savings when the distance between firms is relatively short. 2. Local vendors tend to share the same political and tax concerns as the purchaser. 3. Close proximity permits many possibilities for communication and service; shorter lead times, and exchanges.
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Local vs. National Suppliers There are also considerations that favor national
suppliers:
1. National concerns may offer lower prices because of their ability to produce in mass quantities for large numbers of customers. 2. Technical assistance may be better from large firms that provide extensive research and development support. 3. Continuity of supply may be more certain with larger-volume producers, which exercise considerable raw material purchasing power and maintain large inprocess and raw materials inventories.
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Distributor vs. Direct

The buyer will often have to choose between

buying through a distributor or direct from a manufacturer.

Both options have their advantages and

disadvantages.

The manufacturer often offers lower prices than

the distributor; this difference usually depends on the volume of business.

SZABIST. MBA Fall-2011. 1111

Manufacturers generally prefer large-quantity

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Distributor vs. Direct

Manufacturers often find small-quantity purchases

unprofitable, considering the expenses involved, and charge a premium price to compensate.

Thus, a distributor may offer lower prices on

purchases of smaller quantities.

Since distributors are generally local firms, they are

often able to provide better service than manufacturers.

4/20/12 SZABIST. MBA Fall-2011. For instance, distributors are able to ship quickly 1212

Distributor vs. Direct

Another factor in the decision concerns

inventory levels.

Buying direct usually means buying in large

quantities, and the purchaser must hold these quantities in inventory.

In contrast, the distributor maintains a local

inventory, and the buyer can utilize it, making smaller, more frequent buys.
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Foreign Sources
The increasing industrialization of third-world

countries, coupled with lower labor costs, has made foreign purchasing increasingly attractive in recent years.
The quality problems formerly associated with

foreign goods have in many instances been transformed into quality standards that challenge domestic firms.
However, theSZABIST. MBA of foreign sources drawbacks Fall-2011. 4/20/12

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Foreign Sources
The first problem is long lead times. In addition to the actual travel time of the goods,

time is spent in customs.

A large volume of paperwork is necessary to import

goods, and there is a lack of service.

When a source has no domestic facilities, there are

few avenues of recourse if the supplier makes a mistake. 4/20/12 SZABIST. MBA Fall-2011. 1515

Foreign Sources
Another problem is currency fluctuation. With such long lead times, the price agreed upon

may rise or fall between purchase and payment simply because the foreign currency exchange rate fluctuates against the buyer countrys currency.

These problems can be dealt with in many ways,

and the supplier will often handle most of the import details.

4/20/12 SZABIST. MBA Fall-2011. 1616 Information about foreign sources can be obtained

Single vs. Multiple Sourcing

Because of quantity discounts or low shipping rates,

it may be more economical to concentrate purchases with a single supplier.

JIT and blanket orders lead to single sourcing. In other instances the total amount needed may be

too small to justify splitting the order among suppliers because it would increase per-unit handling and processing costs.

4/20/12 SZABIST. MBA Fall-2011. 1717 Other purchases that encourage the use of a single

Single vs. Multiple Sourcing In most cases, however, the buyer who utilizes

multiple suppliers has greater assurance of uninterrupted supply in the event of fire, flood, or strikes, which might disrupt the operations of a single plant.

Multiple sourcing also stimulates competition

among vendors in price, quality, delivery, and service.

Therefore, many buyers use multiple sources for

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most of the items purchased.

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How many suppliers?

The decision to use multiple sources prompts

questions about how many suppliers to use and on what basis to allocate the business.
Although these questions cannot be answered

universally, these decisions are influenced primarily by the amounts required, the relative size of the suppliers, and their past performances.

Most buyers split orders between two or three

suppliers. 4/20/12

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Supplier Evaluation Factors

After potential suppliers have been determined and

located, a qualitative evaluation and elimination process is used.

This process compares suppliers in terms of their

ability to provide the desired quality, quantity, price, and service.

In purchasing philosophy, quantity has a somewhat

specialized meaning, referring not only to the total amount required but also to the schedule according to which the goods must be received. 4/20/12 SZABIST. MBA Fall-2011. 2020

Supplier Evaluation Factors

Thus, a supplier who might be able to supply the

desired quantity during the specified period, but could not supply this quantity on specified dates, would not be a satisfactory supplier.
In purchasing, price is meaningless when

considered in isolation from other factors.

A price is good only if the item supplied has the

desired quality and quantity and is accompanied by sufficient useful services. 4/20/12 SZABIST. MBA Fall-2011. 2121

Location
The geographical location of the supplier is an

important consideration in evaluating service.

Shipments from distant suppliers are subject to

more and greater risks of interruption by accidents, strikes, and acts of nature.

The possibility of using substitute modes of

transportation is also lessened as distance increases.

4/20/12 SZABIST. MBA some of Companies may overcomeFall-2011. their

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Managing the Disadvantages of Location

Pool car shipment" refers to the practice of collecting a

number of small orders from a given geographical region and combining them into one shipment, thereby economizing on freight by obtaining the full-car rate rather than the much higher less-than-carload (LCL) rate.

Pool car shipments may be used in conjunction with

branch warehouses that act as distributing points for shipments originating at the home plant.

In make-and-hold service, the seller produces in

anticipation of a buyer's needs and stores the merchandise.

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Reserve Capacity
The reserve facilities of a supplier are another

consideration in evaluating service.

This issue is of special importance during

business booms.
A supplier with an adequate reserve of

productive facilities can respond to increased customer requirements.

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Inspection
The inspection methods and quality control

procedures used by the prospective supplier are also considered.

A supplier who is careless about inspecting finished

goods will ship items that must eventually be rejected and returned as unsatisfactory for their purpose.

If such a supplier is also careless in controlling

production quality, the problem is aggravated, because some imperfections may not be discovered until the item has been incorporated 4/20/12the finished product. Fall-2011. SZABIST. MBA 2525 into

Labor Relations
Another source of interference with the continuity of

production in a supplier's plant may be the workers themselves.

If relations of the supplier with its workers are poor,

there may be strikes or slowdowns in production.

The possibility of such delays can sometimes be

projected by determining the morale of the workforce, and reviewing the labor policies as expressed by general management.
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Warranties
Service also includes the kind and form of

warranties that accompany a supplier's products.

Relevant considerations include a vendor's ability

to provide installation wherever necessary and to provide replacement parts as needed.

The supplier should assure the buyer that the

product delivered will be maintained throughout its normal life.

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Vendor Sources
Vendor relations also influence a supplier's service

rating.

A good supplier has well-developed sources of raw

materials and components that will ensure continuity of production during periods of fluctuating business conditions.

The volume of raw materials carried in inventory and

the relationship between direct and distributor sources affect this evaluation.
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To the degree that the supplier has well-developed

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Plant visitations
Buyers perceive risk when deciding upon a choice

among alternative market offerings.

The uncertainty about the consequences of any

given selection heightens the anxiety or stress.

Hawes and Barnhouse examined how purchasing

executives handle personal risk.

They found nine important tactics in use for

handling 4/20/12

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Visit the supplier

The foremost tactic mentioned consisted in "Visit

the operations of the potential vendor, to observe its viability firsthand."

In addition to reducing buyer stress, visits to the

plants of suppliers are an important means of initial evaluation and periodic examination of existing vendors.

It is often desirable for a representative of the

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production or engineering departments to accompany the buyer on such visits, especially if the products are highly technical.
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Financial Status of Supplier

The financial status of the supplier directly affects

its ability to serve and should be carefully evaluated.

One way to perform this evaluation is through the

analysis of credit reports.

Credit reports contain information about suppliers'

financial standings.

These reports also provide information on the 4/20/12 SZABIST. MBA Fall-2011.

experience, management, and facilities of the

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Financial Status of the Supplier

A related supplementary procedure is

independent analysis of the vendor's financial statements.

The purchasing official can obtain

information regarding the vendor's financial stability, pricing policies, and general operating efficiency by applying the tools of ratio analysis to the vendor's balance sheet and income statements.
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Financial Status Popular Ratios

liabilities. one.

The current ratio relates current assets to current

The usual rule-of-thumb acceptable ratio is two to

Because current assets and liabilities are those that

can be turned into cash within a short period of time (a year or less), this ratio measures the financial ability of the firm to continue in the short run.

4/20/12 SZABIST. MBA Fall-2011. 3333 However, because in recent years companies have

Financial Status Popular Ratios

The acid test ratio is a variant of the current ratio

in that it relates current assets, excluding inventories, to current liabilities.

Inventories are omitted from current assets

because they are often difficult to liquidate.

An acceptable ratio here is one to one. Like the current ratio, it is a reflection of a

company's 4/20/12

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Financial Status Popular Ratios

The sales-receivable ratio represents sales divided by

accounts receivable.

It indicates whether customers are paying their bills

promptly or whether too much of the vendor's assets are tied up in receivables.

This ratio is related to the seller's standard terms of

payment.

For example, if the terms are 90 days, not much more than A firm with annual sales of $6 million and 90-day terms
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this amount of total sales should be in receivables.

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Financial Status Popular Ratios

Net profit to sales is an overall measure of

the firm's profitability after all expenses have been deducted.

The size of the profits gives an indication of

the possibility of successful price negotiations.

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Financial Status Popular Ratios

Cash flow is obtained by adding net profit after

taxes to depreciation charges, which are allocations against profits that do not reflect actual cash outflow.
It measures the amount of dollars the firm is

receiving.
Cash flow assists profit evaluation because it is a

measure of how much cash a company is likely to require for meeting short-term expenses. 4/20/12 SZABIST. MBA Fall-2011. 3737

Financial Status Popular Ratios

The inventory turnover ratio is the cost of goods

sold divided by the average inventory.

It indicates the degree of efficiency in inventory

management and the freshness and sale-ability of the inventory.

If the ratio is low, the firm is either over-inventoried

or undersold.

A high turnover ratio MBA Fall-2011. 4/20/12 SZABIST. is usually preferable to a low 3838

one.

Quality Management
Quality is the last, but the most important, factor on the

evaluation list.

Without good quality, the lowest-cost supplier in the world

will not be acceptable.

The ISO series (ISO 9001, 9002, 9003) of quality

standards is becoming more and more a requirement worldwide.

However, it is a quality systems and documentation

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specification, not a quality requirement.

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Supplier Evaluation Methods

its performance record.

The measure of a supplier's value is expressed in

In recent years buyers have emphasized the

setting of objective standards and procedures for evaluating and comparing existing suppliers.

The least precise evaluation technique is the

categorical method.

It relies heavily on the experience and ability of 4040 the 4/20/12 SZABIST. MBA Fall-2011.

individual buyer.

The Categorical Method

Basically, it is a procedure whereby the buyer relies on a

historical record of supplier performance.

Initially, a list of evaluation criteria is identified. The buyer then assigns a grade to each supplier, for each

criterion, based on past experience.

A simple marking system of plus, minus, and neutral

grades may be used.

4/20/12 4141 Evaluation lists SZABIST. MBA [Link] departments are often provided to

The Categorical Method

Vendors with composite high or low ratings are noted,

and future supply decisions are influenced by them.

Although this system is non-quantitative, it is a means

of keeping systematic records of performance.

It is also inexpensive and requires a minimum of

performance data.

However, the process relies heavily on the memory and

judgment of the individuals providing the ratings, and the ratings may become routinely performed without 4/20/12 SZABIST. MBA Fall-2011. 4242 much critical thought.

The Weighted Point Method

criteria.

Weighted-point method quantifies the evaluation

A number of evaluation factors can be included, and

their relative weights can be expressed in numerical terms so that a composite performance index can be determined and supplier comparisons made.

For example, following evaluation criteria have been

chosen: quality of shipments, accuracy of delivery, and price.

Assuming that quality and delivery are the most

4/20/12 significant,

SZABIST. MBA Fall-2011. 4343 a point rating system such as the following

Weighted Point Method

% Perf. (A) % Perf. (B) %Perf. (C) (A+B+C) Vendor Quality %40 Delivery %40 Price %20 Total Score A 90 36 70 28 60 12 76 B 80 32 60 24 80 16 72 C 70 28 80 32 90 18 78

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Weighted Point Method

The advantage of the weighted-point plan is

that a number of evaluation factors can be used with relative weights corresponding to the needs of the firm, thereby minimizing subjective evaluation.
If this individually assigned plan is used in

conjunction with the categorical method, suppliers can be evaluated on a quantifiable basis and many of the intangible aspects of service can still be considered.
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The Cost-Ratio Method

The cost-ratio method relates all identifiable

purchasing costs to the value of the shipments received from the respective suppliers.

The higher the ratio of costs to shipments, the

lower the rating for that supplier.

What cost categories are used depends on the

products involved.

Quality, delivery, service, and price are the overall

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categories, and respective costs are accumulated SZABIST. MBA Fall-2011. 4646 for each.

The Cost-Ratio Method

For example, costs associated with quality

normally include
plants,

the costs of unusual visits to a vendor's unusual inspection costs of incoming

shipments, and
all costs associated with defective products,

including rejected parts and the resulting manufacturing losses.

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Technical, engineering, manufacturing and

distribution strengths

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