Procurement Chain Management

A Strategic Implementation Process

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 Product supply management is nothing but Procurement Strategy, which is integral to corporate strategy. A corporations corporate strategy and procurement strategy must fit with each other or otherwise, both will fail. We will discuss the strategic decision making issues of procurement and also how managers make decisions related to both corporate and procurement strategy. The discussions should facilitate understanding of the issues of strategic implementation.

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The new global business environment

Fierce competition Introduction of products with shorter and shorter life cycles Heightened expectations of customer Continuing advances in communications and transportation technologies (e.g. mobile communication, Internet, overnight delivery)

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Cost impact of managing inventory

It is estimated that the grocery industry could save $30 billion (10% of its operating cost) by using effective logistics strategies. Compaq computer estimates it lost $500 million to $1 billion in sales because its laptops and desktops were not available when and where customers were ready to buy them (Compaq does not exist anymore).

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Managing costs in the supply arena

JIT, TQM, lean mfg. techniques have reduced manufacturing costs as much as they could. One area that yet requires improvement: Inventory Procurement. See the following examples: It takes a typical box of cereals more than 3 months to get from factory to supermarket. It takes a new car, on average, 15 days to travel from factory to dealership.
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The Success Stories

In 10 years, Wal-Mart transformed itself by changing its logistics system. It has the highest sales per square foot, inventory turnover and operating profit of any discount retailer. Dell Computer has outperformed the competition in terms of shareholder value growth over the eight years period, 1988-1996, by over 3,000%

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What exactly is procurement?

All stages and parties involved, directly or indirectly, in fulfilling a customer request Internally, the procurement process includes all functions involved in fulfilling a customer request (product development, marketing, operations, distribution, finance, customer service). Externally, it includes the suppliers, vendors, manufacturers, transportation, and distributors, that exist to transform raw materials to final products and supply those products to customers.
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A procurement or a supply example

Let us briefly go over how selling a simple box of detergent through a retail store involves so many parties and contractual arrangements and why each one must function effectively to make the process efficient.

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Buying Cereals from Wal-Mart

Timber Company Paper Manufacturer Tenneco Packaging

P&G or other Manufacturer

Wal- Mart

Customer

Corn manufacturer

Plastic Producer

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The Objectives of a Procurement Chain

Primary purpose is satisfying customer needs. Maximizing the overall value created Value, measured monetarily, refers to: the difference between what the final product is worth to the customer (price the customer is willing to pay) and the effort, collectively, the procurement chain expends in filling the customers request (the collective costs) Therefore, procurement profitability would be: the difference between revenue generated from the customer and the overall cost across the entire Procurement chain.

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While managing procurement process is important for managing costs and profits and delivering value to the customer, it is not easy to do.
It requires understanding, cooperation, coordination, and information sharing among several trading partners both internal and internal. And, given that there are so many parties, it is indeed a formidable task to make all of them work towards a common objective.

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Why should procurement be a challenging problem?

Procurement chain network is often very complex Procurement chain partners have conflicting objectives. Consequently, making everyone to agree is not an easy task.

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Conflicting Objectives in the Procurement Chain

1. Purchasing wants Stable volume requirements Flexible delivery time Little variation in mix Large quantities 2. Manufacturing wants Long run production High quality High productivity Low production cost Tell me why some of these objectives are conflicting.
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Conflicting Objectives in the Procurement Chain

3. Warehousing wants Low inventory Reduced transportation costs Quick replenishment capability 4. Customers want Short order lead time High in stock Enormous variety of products Low prices
Tell me why some of these objectives are conflicting.
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While we agree on the importance of procurement, how does it translate into a corporate strategy?

Achieving strategic Fit Matching multiple strategies

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Business strategies change over time

In the 1990s, outsourcing was the focus of many manufacturers. Example: Nike Shoes Nikes strategy: R and D on one hand and marketing, sales, and distribution on the other. Example 2: CISCO CISCOs strategy: Focus on Internet sales; increased productivity and save on business expenses. Example 3: Apple Computers Apple computers: outsourced most of its mfg.
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The Landscape changed

In 2001, Nike reported a profit shortfall due to inventory buildup, shortage for others, and late deliveries. In 2000, CISCO was forced to announce 2.25 B write-down for obsolete inventory. In 1999, Apple had huge customer dissatisfaction because of shortage of G4 chip supplied by Motorola.

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What went wrong?

In the examples, the difficulties reflect problems with procurement chain strategies. Nike, CISCO, Apple have short product life cycles. When technologies changed, uncertainties related to customer demand increased. Procurement landscape changed significantly with the introduction of independent, private, and consortium-based e-market places. With changes in procurement landscape, both problems and opportunities also changed. But, Nike, CISCO, and Apple were not able to react to these changes and formulate a new corporate and procurement strategy.
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The need for a good strategy

The most important requirement for sustainability is a well-formulated corporate strategy; A corporate strategy, in turn, requires forming sub strategies such as product strategy, procurement strategy, marketing strategy, and so on. And, A firm should continually evaluate its corporate strategy and its sub strategies and ensure that they are appropriate for a changing environment.

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Competitive Strategy let managers answer questions such as

Relative to competitors, how should my firm satisfy customers? What products and services should we offer? Should we focus on cost or should we focus more on service and quick response? How much customization should we allow on our products? Compare the competitive strategies of: Lands End and a local retailer.
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Competitive Strategy and procurement Strategy The relationship

Competitive strategy

New Product Development

Marketing & Sales

Operations

Distribution

Service

procurement Strategy

Supplier Strategy

Operations Strategy

Logistics Strategy

See the Dell example Matching competitive and procurement strategies

Suppose Dells competitive strategy is to deliver a product within 72 hours of receiving an order but is product suppliers, on average take 7 days to resupply inventory, then, Dell is not going to be able to accomplish its competitive strategy. There is a lack of strategic fit. Also, look at Dells competitive strategy.

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The Dells competitive and procurement strategies

Competitive strategy: provide a large variety of
customizable computer-related products at a reasonable price and to let customers select from thousands of configurations. procurement strategy: Two possible options: 1. Efficient procurement limiting variety and exploiting economies of scale or 2. High flexibility and responsiveness producing a large variety of products.

Dells procurement Strategy is No. 2

Consequently, Dell focuses on designing easily customizable products, common platforms and components that can be assembled quickly.
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Achieving Strategic Fit Achieved The steps involved

Step 1:
Step 2: Step 3:

Understanding the customer and procurement uncertainty Understanding the procurement capabilities Achieve strategic fit

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First, take a look at two types of uncertainties Demand Uncertainty and procurement chain uncertainty

Demand uncertainty: arises because of changing customer needs predicting demand for a product or service absolutely is impossible. This is an external factor controlled by the customer. Procurement chain uncertainty, in contrast, arises because of uncertainties within a procurement process. While a firm would like to meet 100% of customer demand, it may not be able to do so because its procurement is unable to because of multiple reasons that were listed under procurement uncertainty.
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Demand uncertainty (customer-induced)

Usually products that are less mature (electronics, computers) have greater demand uncertainty (unlike Salt or milk). Forecasting demand for such products is very difficult and usually not very accurate. With forecasting difficulties, matching demand against product and services supply is difficult. For uncertain demand products, prices are not steady and varies depending on demand levels. At the same time, a firm could earn greater margin from uncertain demand products.
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Procurement chain uncertainty, on the contrary, arises due to constraints within a procurement
procurement uncertainty: The portion of uncertainty introduced by procurement attributes such as: production breakdowns, low product yields, poor quality and rework, procurement capacity is limited (because of limited production facilities, availability of raw materials, labor, and numerous other factors); Supply capability is inflexible and cannot increase with increased product demand; Also, changes in production process could lead to bottlenecks.
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Step 1: Therefore, understand both demand and procurement chain uncertainties

Identify the needs of the customer segment being served (retail, wholesale, discount, high-end customers) Quantity of product needed in each lot (large, small) Response time customers will tolerate Variety of products needed Service level required Price of the product Desired rate of innovation in the product
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Step 2: Evaluate procurement capabilities

A procurement can rarely meet all demands of all of its customers. Why? How many of the following demands of customers can we meet?
Responding to wide range of product demands Meeting short lead times Handling a large variety of products Meeting high service level possible

Where do we compromise?
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Given procurement limitations, responding to customer demand would require a compromise

How responsive should a procurement be? Quicker response implies increased costs (responsiveness). Delayed response implies lower costs (efficient). Therefore, a firm must compromise between quicker response and lower costs and strike a balance that suits its objectives. See the graph.

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A comparison of cost and responsiveness

Responsiveness
High

Low High
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Low

Cost

Efficient and Responsive procurement chains A Comparison

Efficient Primary goal Supply demand at the lowest cost Min. product cost Responsive Respond quickly to demand

Product design strategy

Modularity to allow postponement Higher margins Capacity flexibility Buffer inventory Aggressively reduce even if costs are significant

Pricing strategy Mfg strategy Inventory strategy Lead time strategy

Lower margins High utilization Minimize inventory Reduce but not at expense of greater cost

Supplier selection strategy

Cost and low quality

Speed, flexibility, quality

Transportation strategy

Greater reliance on low cost modes

Greater reliance on responsive (fast) modes

3. Achieving Strategic Fit

Now that a firm has assessed customer needs, demand uncertainties, and procurement chain constraints and uncertainties, it is time to make the two fit with each other. How? In most cases, by offering high responsiveness to products with high demand uncertainties and Striving towards more cost efficiencies for products with low demand uncertainties. Compare these two products: computers and cheese.
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Let us revisit Dells strategy

Dell proposed a competitive strategy that it will ship ordered consumer products within 72 hours; a relatively high response rate. What are the factors that Dell must consider?

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Dell Achieving Strategic Fit

First, Dell should be able to forecast customer demand with some degree of accuracy (demand uncertainty). Decide how much of this demand uncertainty it can meet e.g. we can offer 72 hours shipment in the case of jackets and overcoats but not for school bags (implied demand uncertainty). Also, note other items that Dell must consider:

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Dell Achieving Strategic Fit

Decide whether its procurement chain from manufacturers to trucking companies to warehouses would be able to meet its goal of 72 hours shipment. Decide how much inventory Dell should carry and how much should its procurement chain partners carry. How soon can Dell inform manufacturers of changing fashions and demands? Ascertain the flexibility (in procurement of raw materials, mfg. capacity, labor, etc.) that its procurement chain partners have (or do not have)? Consider the cost of all of these factors and decide on the responsiveness spectrum or the zone of fit. See the next slide.

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Remember the following about Strategic Fit

Two key points there is no right procurement chain strategy independent of competitive strategy there is only a right procurement chain strategy for a given competitive strategy

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What did we learn

Formulating corporate strategy is easier than implementing strategy. Strategy implementation requires the cooperation of both internal and external parties and In turn, that requires common objectives and common benefits. Strategy is not an one time implementation but something that requires constant redesign. Procurement or supply management is one of the largest assets in an organization and The implication of managing it well has significant consequences to an organization.