7 Factors for Prioritizing Decision Making of sourcing strategy in Supply Chain Management

Which categories to tackle first and which strategies to implement are determined by multiple factors. Even though organizations often look at savings potential in establishing sourcing priorities, other factors such as compliance, quality, organizational capacity, culture, and other internal and external constraints will impact implementation feasibility and/or the results of a sourcing strategy.

1. Compliance factor for decision making of sourcing strategy in supply chain management

  1.  For sourcing strategies to be effective, it is important that internal customers agree to the changes. This is especially important if the strategy involves switching suppliers. Internal customers have relationships with suppliers, and may be unwilling to make a change even if it would benefit the entire buying organization. Thus, processes and systems should be in place to ensure that internal customers comply with the sourcing strategy.

2. Quality factor for decision making in sourcing strategy and supply chain management

  1. Sourcing strategies should ensure that any changes do not affect product or service quality. For example, obtaining a lower price, but for a product that has more defects, can increase the total cost of ownership. Thus, true savings are not obtained.

3. Savings factor for decision making of sourcing strategy in supply chain management

  1. A commonly used and effective method is the 2×2 sourcing prioritization chart, with savings potentials on the vertical axis and ease of implementation on the horizontal axis. Savings potential is one of the key factors in determining priority for sourcing groups, with greater savings potentials indicating higher priority. However, this methodology also suggests that savings cannot be used in isolation in deciding which categories should be addressed first. A category with the greatest savings potential may well be the most difficult to implement.

It is critically important to evaluate savings from a total cost perspective rather than only as acquisition costs or unit costs. The significance of this point is best illustrated by looking at low-cost-country sourcing.

Outsourcing nonstrategic business processes such as accounts payable and expense report reimbursement to countries or even regions of the United States with lower labor rates, or obtaining services from countries or regions with lower labor rates can produce savings for the buying organization. It is important to identify all costs associated with potential staff reductions in the buying organization. Such costs include retraining current employees, providing outplacement services, and the wages associated with severance agreements.

The concept of total cost of ownership is equally important to domestic sourcing. But often, organizations ignore indirect or hidden costs. This may be because these are more difficult to identify and quantify. It may also be because the performance evaluation criteria are not appropriately established, where savings on unit costs or acquisition costs become the only incentive or target.

4. Organizational capacity factor for decision making of sourcing strategy in supply chain management

  1.  Organizational capacity has a significant impact on the effectiveness of any sourcing initiatives. The following are some typical issues that companies must address to maximize results of sourcing strategies:
    1. Lack of spend visibility and real-time data due to poor information system infrastructure or procurement process.
    1. Decentralized organization structure, with a lack of formal effort to explore opportunities and leverage knowledge across the organization.
    1. Paper-based transactions and inconsistent procurement practices.
    1. Unaligned organizational incentive structure across units or functions.

5. Organizational culture factor for decision making of sourcing strategy in supply chain management

  1. Organizational culture can impact the success of sourcing strategies. Because organizational culture is usually deep-rooted and more difficult to change, supply management professionals need to take this into consideration when selecting and developing sourcing strategies. For an organization with a highly decentralized organizational culture, mandating a centralized procurement policy would probably fail. A center-led strategy with local execution and integration may be a better solution.

6. Constraints factor for decision making of sourcing strategy in supply chain management

  1. External and internal constraints may determine how easy or difficult it will be to implement a sourcing strategy. Some common constraints to consider include the following:
    1. Existing contracts and exclusive agreements with incumbent suppliers.
    1. Incumbent suppliers’ control of product design specifications.
    1. Lack of viable alternative suppliers.
    1. Lack of consistent standards across the organization’s units.
    1. Lack of organization receptivity.
    1. Possible disruption of critical business operation.
    1. Specific expertise to perform a service.

Some additional constraints for sourcing from a lower-cost country include the following:

  • Different technical standards.
    • Existing gaps in technical capabilities.
    • Exporting and importing policies that may prevent sourcing certain products from certain regions.

If one or more of these constraints exist, supply management professionals need to either take actions to address these constraints first, such as working with the engineering department to standardize product requirements or to identify substitute products, or come up with alternative approaches, such as supplier development or expanding the time horizon or geographic targets.

7. Alignment to organizational goals: factor for decision making of sourcing strategy in supply chain management

  1. The role of supply management is to add value to the buying organization. To accomplish this, sourcing strategies must be aligned with and support the buying organization’s overall goals.

Sourcing Strategy Recruitment

After supplier proposals or bids have been received, they must be reviewed to ensure they meet the specifications and requirements outlined in the solicitation. If any discrepancies are found they must be communicated to all key internal stakeholders to see if the differences are acceptable. Not meeting specifications or submitting an alternate statement of work can have either a positive or negative effect on the supply management professional’s business. At best, it can result in an alternate design or service at a lower cost, which may be acceptable to the internal stakeholders. At worst, it may cause quality concerns, or it may not meet the minimum requirements defined by the buying organization. Supply management professionals have the responsibility to ensure that (1) suppliers are quoting to specification, or (2) the quoted exceptions are acceptable to the entire organization. To fairly evaluate all the quotes received, suppliers must quote based on a comparable set of specifications or a comparable statement of work. Otherwise it is extremely difficult to determine which supplier offers the most competitive package.

Buying organizations often will not consider an alternative proposal unless the supplier also has quoted the specific item or service requested. In addition, presale technical service is offered by some organizations as a part of the quotation process, particularly when technical products or services are being purchased. Supply management professionals must ensure that their organizations do not take unfair advantage of suppliers offering presale technical assistance prior to award. Acceptance of more presale service than is customary in the industry may obligate the organization to more than is anticipated.

Most solicitations include a set of contract terms and conditions (Ts & Cs) that the supply management professional has developed to match the risks and issues related to the product or service being purchased. Including Ts & Cs in the solicitation allows the supply management professional to consider contractual issues along with other aspects of the evaluation. Suppliers typically respond with alternative language in Ts & Cs to reduce their own risks. Thus, the Ts & Cs must be carefully reviewed during the supplier evaluation process.

Supply management professionals should check the supplier’s references from both past and present customers. For example, many buying organizations not only ask for references from existing customers but also from any customers that have ceased doing business with the supplier in the past year. These buying organizations prefer to speak with customers that have decided to take their business elsewhere.

For major purchases, a cross-functional team with members from key stakeholder departments collaboratively determines the appropriate supplier selection criteria and weights. The stakeholder departments differ depending upon the type of purchase. For example, for a component that is used in manufacturing a product, the internal stakeholders may include operations, process engineering, design engineering, quality, sales and operations planning, inventory management, and receiving. The team members carefully evaluate each supplier’s offer relative to the selection criteria. This helps to ensure that all stakeholders are aligned with the sourcing decision.

Sourcing strategies in supply chain management

Categories of Selection Criteria. Generally, with the exception of routine purchases, choosing the best supplier involves evaluation of many factors. Selection criteria range widely in scope and number. Major categories of supplier selection criteria are summarized in Figure 4-3. These can include (1) financial conditions, (2) consistency in quality and delivery performance, (3) nature of relationship, (4) operational capabilities and flexibility, (5) technological capability, (6) service, (7) continuous improvement capabilities, (8) total cost of ownership, (9) transportation and logistics, (10 ) information security, (11) supply chain risk, and (12) managerial capabilities.8 The solicitation must ask that the supplier provide information to allow key factors to be evaluated. In some cases, supplier site visits will be done to gather in-depth information about important categories.

Figure Supplier Selection Criteria

FinancesFinancial conditions, profitability of supplier, financial records disclosure, performance awards
ConsistencyConformance quality, consistent delivery, quality philosophy, prompt response
RelationshipLong-term relationship, relationship closeness, communication openness, reputation for integrity
FlexibilityProduct or service volume changes, short setup time, short delivery lead time, conflict resolution
Technological CapabilityDesign capability, technical capability
ServiceAfter-sales support, sales representative’s competence
Continuous ImprovementIncremental improvement, product or service reliability
Total Cost of OwnershipPurchase price and additional costs incurred before or after product or service delivery
Transportation and LogisticsCosts of shipping, packaging, customs, and risk of loss. Depends upon Incoterm® for international shipments.
Information SecurityProcesses and procedures used to ensure all information in paper or digital form is secure
Supply Chain RiskLikelihood and impact of disruptions and other risk
Managerial CapabilitiesStrategic goals as well as the ability to plan, organize, and manage all aspects of their operations

Source: Adapted from T.Y. Choi and J.L. Hartley, “An Exploration of Supplier Selection Practices Across the Supply Chain,” Journal of Operations Management (14:4) 1996, 333-44.

Some additional factors that should be considered depending upon the purchase situation are:

  • Past performance — The past performance of a supplier on similar jobs and implications for performance on future contracts should be carefully evaluated.
  • Capacity — Determine the supplier’s capacity to take on additional business.
  • Skills — Learn whether the supplier has the skills needed to provide the specific product or service in question.
  • Integrity — Review the supplier’s integrity and conduct in past business dealings.
  • Time in business and market — Research the length of time in business as well as the supplier’s track record and evidence of business sustainability.
  • Certification and licensing — Verify that the supplier has the appropriately documented certifications and licenses. For example, these could include ISO 9000 or ISO 14000 certification or “right to use” for software or other intellectual property that is part of a proposal.
  • Business continuity plans — Business continuity planning (BCP) is an ongoing and comprehensive process for ensuring the continuity or uninterrupted provision of operations and service, including risk or contingency planning, disaster planning, disaster recovery, business recovery, business resumption, and contingency plans (ISM Glossary 6th edition). The plans address how an organization will resume partially or completely interrupted critical functions within a predetermined time.

Multi-Attribute Evaluation Tools. Typically, some of the factors that make up the set of supplier criteria will be more important than others. To support the supplier selection decision, supplier proposals may be compared using a decision matrix such as a weighted point method. To use this method, the key supplier attributes are identified and these are weighted relative to each other, usually in a percentage that adds up to 100. Then, each supplier is rated on each attribute. Supplier ratings can be relative to a baseline. For example, 0 is the baseline, +1 exceeds the baseline, and -1 is below the baseline. Another approach is to use a scale of 1 to 5 or 1 to 7, with the higher score being the better performance on the attribute. The final step for each supplier is to multiply its rating on each attribute by the weight for the attribute to get a composite score. An example of a weighted point method model is shown in Figure 4-4. Based on this method, Supplier A — which has the highest composite score — should be selected.

Figure Example of Weighted Point Method

Quality Systems50%420315
Technical Support30%51539
Composite Score  39 34

Rating: 1 worst to 5 best

Types of Sourcing Strategy

A standardized process should be used to manage supplier bids. The time and date that each bid is received should be recorded. The bids should be reviewed for completeness, and any areas that need clarification should be noted. The supply management professional should prepare a brief summary of the bids on a chart or spreadsheet. Each situation should be handled in the manner best suited to the circumstances at hand, but a common process framework can be applied. The extent and focus of analysis for supplier selection depends on factors such as risk and spend level. The evaluation of a supplier offer to provide office supplies is likely to be relatively simple and focus on price, breadth of product line, and delivery speed. A supplier offer for design and engineering services is likely to undergo a much more extensive evaluation process. For engineering services, technical capabilities, past experience, and reputation are likely to be very important. Five types of analysis that may be used to evaluate supplier proposals are: technical analysis, operational analysis, price analysis, cost analysis, and risk analysis.

Technical analysis involves determining if the supplier’s proposal will satisfy the specifications or statement/scope of work. Supply management professionals should actively involve the engineering, manufacturing, materials control, operations, marketing, and other internal stakeholders in the technical analysis of the bid.

Operational analysis consists of evaluating the feasibility of the product or service being purchased. Though a supplier may be technically capable of accomplishing the work, organizations often conduct an operational analysis to verify the economics, ease of use, and functioning feasibility of the product or service.

Price analysis is the examination of a supplier’s price proposal or bid by comparison with reasonable benchmarks, without examination and evaluation of the separate elements of the cost and profit making up the price (ISM Glossary 6th edition). Prices are compared with competitive price proposals, catalog or market prices, or historical prices, or independent cost estimates are used.

Cost analysis determines the reasonable cost of a good or service based on an evaluation of actual or anticipated cost data (material, labor, overhead, general and administrative, and profit). Typically cost analysis will be done by a cross-functional team. At the outset of manufacturing a new product or delivering a new service, the supplier may use extra time or material. As time progresses or volume increases, the “learning curve” allows the supplier to reduce costs and offer more attractive pricing. For capital equipment purchases, life-cycle cost analysis determines the net present value of the purchase price and all anticipated operating and related costs over the life of the item, including maintenance, downtime, energy costs, and salvage value.

To maintain good supplier relations, it is important to provide the supplier with a reasonable profit to pursue the business in the first place, and to continuously deliver future products or services. Analysis of costs versus profits is important to assess the viability of the supplier and, subsequently, its quotation. The total costs of ownership must also be considered. In addition to purchase price, other costs associated with selecting a supplier may include acquisition expenses, transportation, duty and brokerage fees, costs of quality programs, accounting costs, late delivery, warranty, service, and customer support. Analysis of the total cost provides a clearer picture of the complete financial implications of a purchase and can help to identify immediate cost savings or cost savings from increased efficiencies over time.

Risk analysis is the process of identifying risk elements or factors and determining the probability that their occurrence could lead to injury, damage, loss, or failure (ISM Glossary 6th edition.). Assessment of risk can be measured both internally (within the organization) or externally (within the marketplace). When evaluating suppliers, the sourcing team must identify the risk, assess its likelihood of having an impact on the buying organization if the potential risk was to occur, and develop mitigating actions to avoid the risk if the supplier is selected. While some risks from the item characteristics or the supply market will likely be the same across suppliers, others are supplier-specific and should be carefully evaluated during the supplier selection process. These include:

  • Capacity constraints — Suppliers may not be able to meet demand for goods and services due to their own internal constraints if buying organizations cannot forecast accurately or if demand for a good or service grows unexpectedly.
  • Inability to reduce cost — Supplier’s fixed costs may prevent them from reducing costs further. Sustainable price decreases must be accompanied by efficiencies in the supplier’s operations.
  • Incompatible information systems — Difficulties in communicating between the buying organization and supplier due to information systems difficulties may result in the inability to share key information, which impacts the supply chain.
  • Information security — Suppliers many not have processes in place to protect information.
  • Quality problems — Suppliers that cannot consistently meet quality requirements for the goods and services they sell are at risk of losing customers and may find it difficult to attract new customers, which can lead to the supplier discontinuing operations.
  • Unpredictable cycle times — Volatile cycle times create forecasting errors in the supply chain and can cause a buying organization to underbuy or overbuy products and services.
  • Volume and mix requirement changes — Volume and product or service mix changes place a supplier at risk for not responding to customer requirements; risk is further increased when other characteristics such as capacity constraints, limited production or service flexibility, volatile cycle times, and inaccurate forecasts are present.
  • Inventory management — A supplier’s difficulty in managing raw materials, work in process, finished goods, and materials needed to provide service all contribute to supply risk.
  • Financial health — A supplier with poor financial health, such as limited cash flow, may have difficulty paying invoices on a timely basis, which can impact supply and the supplier’s overall operations.
  • Disasters — Acts of nature and other unplanned events can negatively impact a supplier’s ability to provide goods and services.
  • Legal liabilities — Suppliers may be subject to legally enforceable restrictions, such as patent and trademark infringements, which may prevent the sale of their goods and services.

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