There is no single sourcing strategy that can fit all categories. Selecting the best sourcing approach starts with correctly evaluating the category or sourcing group. Supply management professionals need to understand both internal and external characteristics of a category or category segment to select a sourcing approach that can maximize results. The opportunity assessment steps in section 2, above, provide the guidance on how to evaluate category characteristics. Internal characteristics include level of spend, demand driver, business process, and so on. External characteristics relate to supply market complexity and other external constraints and restrictions. At a high level, a spend aggregation approach is the most appropriate when the supply market is competitive and the buyer has strong bargaining power to exploit. On the other hand, when faced with high supply market constraints, such as a monopolistic or an oligopoly supplier situation, process improvement could help buyers create additional advantages. In some cases, however, you must be creative in searching for the best approaches to meet the unique need of a category.
Best price evaluation
- Comparing the best prices among suppliers in a competitive bidding environment can be an effective way to gain leverage, if the prices are comparable in every important way. This means that all suppliers under consideration:
- Have essentially equal and acceptable quality.
- Meet your specifications for product and delivery requirements.
- Are equally flexible and represent about the same level of risk.
- Either include all their shipping costs or they are factored in.
This is essentially how best price evaluation is performed for e-auctions. The suppliers know they are in a competitive situation, so they must provide their “best and final offer.”
- Volume concentration, or spend aggregation, intuitively means pooling spend volume together to increase spend leverage and bargaining power. This can be done in one or more of the following areas:
- Pool spend across divisions or units.
- Consolidate the number of suppliers, giving each more volume.
- Combine volume from different commodity groups for suppliers.
- Redistribute volume among suppliers and optimize the supplier base.
While this approach may sound straightforward, it is surprising how many organizations’ purchases are still very fragmented, especially for services such as contingent labor and consulting. Therefore, spend aggregation can most often be employed to find easy savings opportunities. However, to what extent a spend can and should be aggregated depends on specific category characteristics. For example, office supplies can typically be aggregated to a very high level because of homogeneous product requirements and availability of suppliers with capabilities to cover wide product and geographic range. But packaging materials may only be consolidated to a regional level, due to significant logistics costs and/or different product specifications and requirements.
E-sourcing tools such as e-RFP, e-RFQ or Internet auctions are typically used to enhance the effectiveness of spend aggregation strategy. Not only do they provide a faster alternative to traditional methods, they can reach more suppliers and also increase competition among suppliers. In addition, best price negotiation and product optimization/simplification are only used together with spend aggregation.
Types of sourcing strategies
- Sourcing globally is a way to create greater competition, which can in turn provide more leverage. Suppliers in emerging economies may be more eager for business, and may provide better prices and service. Supply management professionals, however, should perform a TCO analysis and consider the added risk that can be a part of sourcing globally, factoring that in the evaluation of the bid.
Product specification improvement
- Improving internal product or service design/technical specification management and control processes can allow more suppliers to be qualified to compete for an item, and may create greater competition and market leverage. For example, when one organization needed research performed, it opened up the specifications of qualified research participants into broader bands of characteristics, and was able to reduce the price paid significantly while still meeting its needs. It had developed a costly habit of over-specifying its requirements.
Joint process improvement
- Joint process improvement (JPI) is a program for supply management professionals and suppliers to analyze all current and potential future aspects of their relationship across the entire value chain (research and development/product development, manufacturing, planning, customer service, procure-to-pay, and so on) to identify opportunities for mutually beneficial improvements. Process improvement strategies involve multiple functions, and working with suppliers to leverage their ideas is a joint process improvement project. Joint process improvements can cover a broad range of areas with suppliers, such as the following:
- Improving business process flow and collaboration among different functional areas, such as engineering and supply management. Often, organizations gradually lose control over key product components to suppliers due to lack of internal process controls, and collaborations among relevant functions. By improving internal business processes, such as adding appropriate controls, checks, and improving collaboration among key functions, organizations can minimize supply risks when they expose themselves to external markets and secure existing supply sources while providing the opportunity to search for alternatives.
- Improve collaboration with suppliers by re-engineering joint processes, integrating logistics, and supporting supplier operations improvement. When a supplier provides a unique product, service or technology that has strategic significance to an organization’s business, the use of an alliance approach to improve process integration and the sharing of information with the supplier may be the only valid approach to reaching a win-win goal.
- Relationship restructuring entails rethinking how you do business with a given supplier. Can activities currently performed in-house be shifted to the supplier to achieve better performance and/or lower costs? Would a supplier be willing to negotiate a better contract if the terms were extended, if risk was shifted, or if there were volume guarantees? Restructuring the relationship requires supply management to rethink its assumptions about the way it works with suppliers, to imagine what it is like to be in the supplier’s position, and to think about what the buying organization could do to add value for the supplier. Take for example a contract negotiation for specialized software. By extending the contract from two years to five, the buying organization experienced only a 10 percent increase in the total lifetime contract cost, with a significant drop in annual costs. The supplier needed to ensure that it covered its fixed costs and made a profit over the life of the contract. Most of its costs were invested upfront.
Clearly defined strategies are nice to have. Unfortunately, however, situations often call for innovative approaches. Supply management professionals are challenged to carefully examine every aspect of the supply chain to identify the best sourcing approach. The best approach often involves working with cross-functional teams and impacting more than just the supply management organization. Some examples include the following:
- Demand management and spend segmentation.
- Product re-engineering.
- Policies and procedures.
- New suppliers, supplier development and global sourcing.
- Mega-supplier approach.
- Should-cost modeling.
Again, none of these approaches should be treated as a stand-alone or a cure-all solution. Successful results come from identifying and selecting the right combination of approaches to address all key aspects of a category challenge.
- Demand management is a process in which supply management professionals work with internal stakeholders to reduce the use of products or services (Trowbridge 2014). It may be possible to redesign products or change processes to eliminate the purchase, or to reduce the amount needed. However, the total cost of ownership of any change needs to be evaluated to ensure that a change to a product’s specifications or procedures does not increase costs in other areas, such as quality. Supply management professionals must engage and collaborate with internal and external stakeholders to identify opportunities, and implement demand management.
When a purchase is needed, the sourcing cycle begins. For routine purchases or rebuys, internal customers communicate their needs to supply management in three different ways. One way is for an internal customer to complete an electronic form (a purchase requisition) to describe the products or services needed. Purchase requisitions follow a standardized format and contain information such as a complete description of the purchase, the quantity needed, the date the product or service is needed, special requirements, and the account to be charged. Based on knowledge of the organization’s previous and current purchases and the supply market, you may suggest changes to the requirements that will enhance value for the organization. For example, the internal customer may have asked for a specific brand name product. If available, you can suggest purchasing a lower-priced or more readily available non-name brand product of equal quality.
For repeat purchases, a purchase requisition can also be generated by the inventory control department. For example, an order may be issued automatically when the inventory level reaches a predetermined reorder point. A requisition may also be generated by an organization’s materials planning requirements (MRP) system based on a bill of materials. A bill of materials is like a “recipe” that provides the list of quantities and descriptions of all materials required to produce one unit of a finished product.
When the organization is developing new products or services or doing other major projects, such as outsourcing or process upgrades, needs are identified collaboratively with internal customers or as part of a cross-functional team. In these situations, a needs analysis identifies the purchase characteristics that will meet the organization’s business requirements.4 During the needs analysis, it is important to distinguish between the “needs,” which are required, and the “wants,” which are desired but not necessary. Requirements that are nice to have are not essential and can reduce the number of suppliers that are available, increase delivery lead time, and increase costs. For example, when purchasing a new machine, engineering may want a ten-year useful life. However, if the product and its technology are expected to change in three years, a useful life of three years is needed, which is likely to reduce the machine’s purchase price.
There are many different considerations when determining needs and the importance of each depends upon the type of purchase. The technical requirements of the product or service must be identified. What are the performance expectations, under what conditions, and for how long? What features are essential? What quality is required and how will it be measured? Are there regulatory issues that need to be addressed, for example, for food products, conflict minerals, or hazardous materials? What is the demand forecast and expected product lifecycle? How does the supplier need to package, label, and ship the product? What is the order frequency and delivery timeframe? Will vendor-managed inventory be used?
After the purchase needs are identified, the next step is to develop a sourcing strategy that is consistent with and meets the objectives of the category plan. There are many strategic decisions that must be made at this stage concerning the choice of suppliers. Should suppliers be internal to the organization or external? If the decision is to buy rather than to make, should existing or new suppliers be used? What supplier location is best (domestic or international) for the organization? What capabilities and supplier characteristics are needed? For example, should the organization purchase from a distributor, or would it be best for the organization to work directly with a manufacturer? The remaining sections in this section describe these decisions.
Internal Versus External Suppliers
When resources are needed, organizations can either make the resources themselves using internal suppliers or purchase resources from external suppliers. This strategic decision is called the “make-or-buy” decision or an “insourcing/outsourcing” decision. The world’s largest airplane assemblers, Boeing and Airbus, continually evaluate if they should make or buy components.5 Because of consolidation in the supply market and the lost revenue from after-sales service and maintenance contracts, Boeing and Airbus are moving some outsourced components back in-house.
Sourcing strategy example
The activities needed to produce resources are classified as core, enabling, and ancillary. Core activities are a source of competitive advantage and are typically done within the organization. For example, the e-commerce giants Alibaba and Amazon have invested heavily in developing their own internal distribution centers and logistics capabilities rather than outsource these activities to suppliers.6 Enabling activities are necessary to create value but are not core to the organization’s business. The decision to insource or outsource enabling activities is typically based on a thorough analysis of the benefits and drawbacks. Many manufacturers, such as the consumer packaged goods company Procter & Gamble (P&G), outsource the enabling activities of distribution and logistics to third-party logistics providers such as DHL. This allows P&G to focus on its core competencies of product innovation and brand management while outsourcing enabling activities to suppliers whose core competencies are distribution and logistics. Ancillary activities are those necessary for operations but often generic, such as janitorial services; they are typically outsourced. For example, most corporations and universities outsource their cafeteria operations. Outsourcing ancillary and selected enabling activities frees up internal resources for core activities.
Strategic Considerations. Insourcing/outsourcing decisions are strategic and are made by an organization’s executive management team considering both strategic issues and costs. The strategic issues that must be considered include the following:
- Core competencies: Activities that create current or future core competencies that are essential for a competitive advantage should be insourced. Thus, it is essential that supply management professionals understand their organizations’ business objectives and strategic plans.
- Long-term supply implications: How does insourcing change the nature of competition in the supply market? If there are limited suppliers, insourcing can increase competition in the supply market. For example, in the aerospace industry, mergers and acquisitions have created larger, more powerful component suppliers, which is driving Boeing and Airbus to insource.7
- Access to technology/capabilities: In some cases the supplier has patented or proprietary technology or unique capabilities that can only be accessed through outsourcing. For example, Apple turned to its competitor Samsung to provide the OLED display screen for the iPhone8® because of the technology.8
- Supply chain risk: If a high degree of control or physical or information security is needed, activities are typically insourced. Many supply chain risks are from upstream suppliers, often located in emerging markets. What is the visibility to these risks, and is your organization or the supplier’s best positioned to manage these risks?
- Total cost of ownership (TCO): What are all the costs related to making or buying the resource before, during, and after the transaction? In the case of outsourcing this includes supplier selection, supplier qualification, and managing the supplier relationship.
- Product lifecycle: Outsourcing is often preferred in the early and mature stages of the lifecycle. In the early stages, when sales volumes are low and the product is not yet proven, outsourcing can be more economical and lower risk if investment in new equipment or tooling is needed. Outsourcing may allow for quicker new product introduction. For mature products, there is more competition in the supply market, driving prices down, so outsourcing is typically more cost effective.
- Labor considerations: If an external supplier is used, how are existing employees and departments affected? Job reductions that may occur after outsourcing negatively affect labor and public relations. What are the implications for the organization’s institutional knowledge and experience base and how will this affect competitiveness in the future?
- Capital investment and assets: If the organization decides to insource, what is the investment and timing required? Typically insourcing requires an organization to invest in assets while outsourcing allows the organization to reduce its assets. Having fewer assets can improve financial measures of performance such as return on assets (ROA).
- Flexibility: Outsourcing increases an organization’s flexibility because it is generally easier to change volumes by adding or reducing suppliers or to change suppliers when a new technology is needed than it is to change internal operations. However, the buying organization may not be able to insource in the future if it has not developed the needed capabilities.
Conducting a Make-or-Buy Analysis. In addition to strategic considerations, costs are analyzed in make-or-buy decisions. To do a make-or-buy cost analysis, the total costs to make products internally are estimated and compared to the total costs to buy the products. A break-even analysis identifies the production volume at which the costs or revenues to make and the costs to buy are equal to each other. For example, Boeing’s decision to insource some components is based on the opportunity to capture more revenue from after-sales service and maintenance. Make-or-buy decisions are typically longer-term, covering three years or more. In this case, the net present value (NPV) of cash flows should be compared. Further, a sensitivity analysis should be done to see how the break-even volume changes if labor costs, materials costs, transportation costs, the cost of capital, or other key costs change.
All direct costs (materials and labor) and indirect costs (e.g., inventory, materials, handling, maintenance, process engineering, equipment depreciation, leases, licenses, taxes, and insurance) associated with making the product must be estimated. Other costs of insourcing that are more difficult to quantify, such as start-up problems, quality problems, opportunity costs, headcount if applicable, and lack of flexibility must be considered.
Supplier proposals are the starting point for estimating the costs to buy. Other outsourcing costs to estimate include transportation costs; costs of negotiating with, qualifying, and managing the supplier; costs of quality problems or delivery delays; and potential issues with customer service. If international sourcing is used then additional costs such as tariffs, currency exchange, increased travel, longer lead time, expedited delivery, and greater managerial complexity need to be considered. Often it is difficult to fully estimate the costs associated with outsourcing so true costs are underestimated.
Existing Versus New Suppliers
The decision to continue using existing suppliers or to find new suppliers depends on many factors including:
- Market conditions and supply competition.
- Product complexity.
- Technology changes.
- Urgency of need.
- Quality expectations.
- Supplier processes.
- Adequacy of competition.
- Cost versus value of sources.
- Short- and long-term requirements.
- Long-term relationships.
- Supply base rationalization and optimization.
- Change in the supplier’s organization.
- Supply continuity.
There are many reasons to use an existing supplier. If the product or service is needed more quickly, using a new source may not be viable. Selecting a new supplier involves time and expense for qualifying and learning how to work with the supplier. At one time, the supply management function of a major high-tech manufacturer was so inundated with requests to review new suppliers that it did a TCO analysis on the cost of qualifying suppliers. Between destructive testing of products, reviewing supplier financials, making site visits, verifying processes and more, the organization determined that (depending on the type of materials or components) it could cost between US$50,000 and US$250,000 to qualify a new supplier! The appropriate figure was used as part of the cost/benefit analysis before determining whether to seriously investigate new suppliers.
Remaining with existing suppliers is advantageous if they meet and will continue to meet standards of quality, service, and delivery at competitive prices over the long term. Existing suppliers know the buying organization and its requirements, and the longer the relationship, the more willing a supplier will be to invest in cost-saving activities or new innovations. If the product or service involves costly equipment, tooling, dies, molds, training, or setup charges, the expense of duplicating this equipment or service also will discourage using new suppliers. An existing supplier may be the sole owner of a certain patent or process, precluding the possibility of using other sources. However, by remaining with existing suppliers, an organization may miss out on opportunities offered by new technology. Using existing suppliers rather than adding new ones does not increase the size of the supply base and thus is consistent with supply base rationalization.
If the existing supplier has not been meeting performance requirements, has not been competitive, or does not have the capacity or capabilities needed, new suppliers should be considered. New suppliers create opportunities for expanded supply options and competition. For example, a new supplier may eliminate a sole-source situation. A new supplier may be eager to gain the business and may make special efforts to provide superior service. It may offer technical or other support not available from current sources.
Further, adding new sources of supply can protect the organization’s supply availability if an existing supplier is unable to meet its performance requirements. If an existing supplier undergoes a major change, such as a change in leadership, a merger, a purchase by a private equity organization, or a takeover, the likelihood of supply interruptions or lower quality may increase. When a single individual creates and manages a supplier organization, the organization often grows too large for the individual to manage, thus operations may be disrupted. These circumstances may warrant seeking new suppliers. This latter concern can be especially true when sourcing in emerging markets. Small suppliers in emerging markets can grow rapidly without a professional management structure evolving at the same pace.
However, it is important to be prudent when considering new sources. The new supplier may be underbidding to get the business, or perhaps it does not understand the requirements well enough to price the product or service appropriately. The purchase price of a product may be as little as one-third of the total cost of ownership. Continuity of supply is typically the most important objective with purchase price a lesser issue. Supply disruption with new suppliers may result from an inability to provide promised price, quality, delivery, and service because of a number of factors, including poor communication of requirements to the supplier, an inability of the supplier to meet requirements, capacity limitations, and an unexpectedly quick phase-out of the previous supplier. The more critical the product or service, the more carefully the potential new source should be evaluated. Use of thorough specifications and statements of work, appropriate contract clauses for future price negotiations, and careful evaluation of supplier cost data are just some of the tools available when considering a new supplier.
Supply disruption is an important consideration when deciding whether to use existing sources or buy from a new source. Supply continuity with existing suppliers can be enhanced with realistic risk management and contingency plans, multiple production facilities, effective production and quality control systems, and succession plans for management. In some instances, supply continuity problems with a current supplier may not be solved by seeking a new source. Working with the existing supplier may be the best alternative.
Domestic Versus International Sources
Sourcing strategies must address whether a company will elect to use domestic or international suppliers, or some combination thereof. The use of international sourcing is also referred to as “offshoring.”
Offshoring. In the 1990s, many organizations began pursuing “low-cost-country sourcing” (LCCS) to take advantage of lower labor costs in China, India, and other primarily Asian countries. Over time, wage rates and energy prices increased, as did the cost and risk of managing long and complex supply chains, thus reducing the low-cost-country advantage.9 While international sourcing continues, there has been a trend toward “nearshoring,” using suppliers in locations that are geographically nearer to the buying organization rather more distant supply choices (“farshoring”) usually to reduce costs (ISM Glossary 6th edition). An example is a German company deciding to use a supplier in Hungary rather than Vietnam. The results of a survey done by CAPS Research show many organizations have years of experience with international sourcing in emerging markets and expect to continue to do so. See Figure 3-1.
There are several benefits and risks associated with using international rather than domestic suppliers. In addition to lower purchase prices, buying from international sources creates greater competition, access to a wider range of products or services, access to local innovations and technologies, and the opportunity to expand sales internationally. The experience gained through global sourcing can expand an organization’s general knowledge about doing business within a country, enabling it to access markets to sell its products.
Although the purchase price offered by international suppliers can be much lower than for domestic suppliers, the total cost of a purchase must be evaluated. Some cost elements that should be considered when comparing proposals from international suppliers include the following:
- Unit price.
- Assessments needed for supplier selection.
- Degree of interaction needed for supplier management.
- Global transportation costs.
- Insurance (perhaps specific for international shipping).
- Brokerage costs and other fees.
- Letters of credit.
- Cost of money including currency exchange.
- Profit repatriation (moving profits from the foreign country back to the home country).
- Inland (domestic and international) freight cost.
- Risk of obsolescence.
- Cost of rejects and replacements.
- Damage-in-transit costs.
- Inventory holding costs.
- Costs associated with in-country transportation/infrastructure.
- Language skills support.
- Technical and communication support.
- Employee travel costs.
- Cost associated with length of supply chain.
- Political climate risks/costs.
- Complexity of technology or other regional infrastructure considerations.
It is important to assess the total landed costs. The ISM Glossary of Key Supply Management Terms (6th edition) defines landed cost as “the total accumulation of costs for an imported item including purchase price plus freight, handling, duties, customs clearance and storage to a designated point.” Administrative overhead, including fees paid to intermediaries such as brokers and agents, should be included in the landed cost analysis. Inventory costs such as in-transit and safety stock also should be included in landed costs. Because of their complexity, organizations often use software to develop landed cost models.
In addition to the potential for higher total costs, global sourcing also exposes the buying organization to increased supply chain risks. These include:
- Quality problems: Communication difficulties or lack of capabilities can lead to quality problems. Long lead times and the amount of inventory in-transit exacerbate the impact of quality problems when they occur.
- Security: Physical product and information security is often lower, especially in emerging markets. Local laws, regulations, and enforcement often do not provide adequate protection against physical and information security.
- Delays: Transport over long distances, infrastructure problems, and border crossings can result in costly delays.
- Supply chain disruptions: The lack of visibility into long, complex supply chains increases the chance of a disruption. Often international suppliers are located in regions with the potential for natural disasters and inadequate recovery capabilities or in countries with unstable governments. This is particularly a concern when considering suppliers further upstream in the supply chain.
- Sustainability: Laws and regulations protecting human rights and the environment are not as stringent in emerging markets. Further, there is a lack of compliance with and enforcement of the laws and regulations that do exist in many countries. For example, Bangladesh has had a persistent problem with factory safety and many workers have lost their lives in fires. Low-cost-country sourcing can be inconsistent with corporate social responsibility policies unless extensive supplier monitoring and supplier development is done.
Use of domestic suppliers can overcome the risks with international sourcing. In fact, some organizations are reshoring by switching from international sources to domestic ones (ISM Glossary 6th edition). Domestic suppliers can provide faster delivery at lower costs, usually are more willing to tailor their businesses to the buying organization’s needs, and may be interested in maintaining a higher level of service. Sourcing from domestic suppliers is less complex because the same culture, languages, laws, transportation links, and communications apply for the buying organization and the supplier. Sourcing from domestic suppliers also creates goodwill toward the organization within the community. Some governments have provisions requiring domestic sourcing. For example, in the U.S., the “Buy American” provision of the American Recovery and Reinvestment Act of 2009 contains rules about domestic sourcing.10 Advances in manufacturing technology, such as robotics, that increase production efficiency are making domestic manufacturing more cost competitive.11
Issues with Global Sourcing. To make effective sourcing decisions, supply managers must thoroughly analyze country-specific issues including infrastructure, political stability, regulatory, environmental, financial, economic, and cultural issues. This screening step will focus on characteristics of regions or countries rather than of specific suppliers. Some of the specific issues that must be addressed during a country analysis include:
- Infrastructure: Utilities, communications, and transportation infrastructure and reliability can vary widely across countries. Problems with infrastructure can lead to costly delays and increased expediting. Poor transportation infrastructure, such as bad roads, may also increase costs because of additional packaging requirements or damaged products.
- Government stability: An unstable government may be associated with frequent changes in laws and regulations and with corruption. In extreme cases, conflict can erupt disputing supply chains.
- Laws affecting contracts: In international sourcing, the laws of both the buying organization and suppliers’ countries affect transactions including restrictions on trade, costs, and documentation. The United Nations Convention on Contracts for the International Sale of Goods (CISG) has produced a body of law that brings some uniformity to the rules governing international sales. The CISG has had a significant effect on international sourcing and contracting.12
- Intellectual property protection: Many countries with emerging markets offer no effective protection against the piracy of intellectual property. Thus, caution is needed before sharing designs or other proprietary information with suppliers.
- Trade agreements: These are agreements between countries or groups of countries that are enacted to reduce trade barriers affecting taxes and tariffs, establish trading standards, and impact border security procedures. They can be bilateral, between two countries, or multilateral, between multiple countries, often, or within a region such as the ASEAN Free Trade Area (Association of Southeast Asian Nations).
- Duties: These are taxes levied by governments on the importation, exportation, or use of goods (ISM Glossary 6th edition). The three major types of duties are 1) ad valorem, which is determined based on the value of the goods and is most common; 2) specific, which is charged as a specified rate per unit (for example, 15 EUR for each crate); and 3) compound, which combines specific and ad valorem rates (for example, US$2.15 per gallon plus 8 percent ad valorem). Most goods entering into domestic markets anywhere in the world have duties assessed on them unless covered by trade agreements.
- Exchange rates: The price at which one currency can be bought with another currency normally fluctuates, often in ways that are unpredictable, creating uncertainty and risk. The currency used for international purchases may be the buyer’s, the supplier’s, or possibly the currency of a third country. The currency selected for payment can result in higher or lower purchase costs over the life of a contract due to volatile exchange rates. Exposure to exchange rate risk can be reduced by using risk-sharing contracts that stipulate that exchange rate losses (or gains) are to be equally shared by both parties or by using financial instruments for hedging.13
- Payment processes: There are two major forms of payment for international purchases: a letter of credit and a bill of exchange or a draft. To simplify payment transactions, many global organizations use subsidiaries located in the same country as the supplier for making and receiving payments.
- Transportation and logistics: The choice of a transportation mode depends upon available infrastructure and reliability. For example, shipments into Canada from Mexico can be transported over land via truck and rail, but other international shipments may have to be made by air or ship. Air transport is costly but is the preferred method for cross-border shipments of time-sensitive items such as electronic equipment and perishables (food, flowers, etc.). Ocean shipping containerization lowers transportation costs, but is inherently slower.
- Inventory: With international sourcing, inventory levels and carrying costs will increase because of the increased inventory in transit and higher levels of safety stock. Continuous use of an item requires an uninterrupted flow from the supplier to the buying organization, so long transit times increase in-transit inventory. In addition, more safety stock is needed because of longer lead times and higher levels of uncertainty.
- Country culture: Countries and even regions within countries have unique cultures that affect personal values, behaviors, and interpersonal interactions. Cultural differences can affect communication, time perceptions and sense of urgency, responsiveness, and collaboration. According to research by Hofstede, cultures can be classified using six dimensions: 1) power distance, 2) individualism, 3) masculinity, 4) uncertainty avoidance, 5) long-term orientation, and 6) indulgence.14
Other Supplier Characteristics
While assessing potential supply sources for a product or service, other supplier characteristics to consider are capabilities, size, and ownership, among other factors. Each presents distinct advantages and disadvantages.
Manufacturer Versus Distributor. When buying goods in large quantities on an ongoing basis, such as raw materials or components used in manufacturing, it is preferable to buy directly from manufacturers. Buying from manufacturers can lower purchase prices because there is no distributor’s markup and you may obtain a quantity discount. Another benefit is lower logistics costs as truck-load, container-load, or railcar quantities can be shipped from the manufacturer, reducing transportation costs. Manufacturers also may be willing to collaborate to develop customized products. However, if your organization has limited warehouse space and capability, needs only small amounts of a product, or needs to purchase a wide range of products made by many different suppliers, using a distributor is preferable. Many organizations use distributors such as Office Depot for office supplies and Grainger Industrial Supply for MRO items. Distributors typically provide additional value-added services such as easy-to-use online catalogs that are customized to the organization, vendor-managed inventory (VMI), and regularly scheduled deliveries.
Large Versus Small Suppliers. A supplier’s size also affects its capabilities and the nature of the supplier relationship. Small suppliers may be more able and willing to specialize in certain goods or services than are large suppliers. On the other hand, large suppliers usually can expand if the volume of business grows or becomes international. This is because larger suppliers have more access to capital and other resources needed for expansion. For example, large multinational organizations generally seek to work with large first-tier suppliers that can build and support facilities globally.
National Versus Local. Within a country, an organization may choose to source from a national or a local supplier. A national supplier typically has multiple operations and/or distribution centers within the country. Benefits of a national supplier often include greater competition, a wider range of products, lower prices, and better service and support. Local suppliers also offer distinct benefits. These include faster delivery, lower transportation costs, more responsive service, and increased community goodwill.
Small, Diverse, and Historically Underutilized Businesses. There are special programs to use small, diverse, and historically underutilized businesses as suppliers continue to grow and develop in the public, private, and not-for-profit sectors — especially in the U.S., Canada, and South Africa. A historically underrepresented business in the U.S. is one that is “at least 51 percent-owned by a person or persons who have been socially or economically disadvantaged due to color, ethnic origin, gender, physical disability, or other factors that result in barriers to the conduct of business” (ISM Glossary 6th edition). These supply management programs are undertaken for several reasons, including government legislation, a commitment to inclusion as part of corporate social responsibility goals, to increase sales, to increase innovation, and to develop alternative sources of supply.
Many organizations have supplier diversity programs, the purpose of which is to provide equal opportunity for small, diverse, and historically underutilized business to become suppliers. For example, Starbucks offers a supplier diversity program because “We believe supplier diversity is a smart business decision and business imperative in today’s business climate. It helps us identify and deliver high-quality products and services across all business channels, while driving value and economic development in the communities we serve.”15 Some organizations work with third-party service providers to develop and manage their supplier diversity programs. These companies can provide software solutions to help companies identify suppliers and track and report spend.16
Other Considerations. In some cases, supply management professionals must use a specific supplier because of customer requirements or their own organization’s policies. For example, buying from an internal supplier that is a strategic business unit (SBU) of one’s own organization is an example of being required to do business with a mandatory supplier. This practice is also called directed sourcing. In some industries such as automotive, the assemblers often require first-tier suppliers to use specific second-tier suppliers for safety, quality, or cost reasons.
Because operation downtime penalties and service provision disruptions can be extremely expensive and can result in consumer complaints, a contingency development program should be part of the overall managerial role of supply management. This program should include establishing backup or alternative suppliers. For example, consider the classic case of a fire at the Philips Electronics major microchip manufacturing facility in 2000. Both Nokia and Ericsson depended a great deal on this supplier’s plant for production parts. After the fire, Nokia responded quickly, moving production to other Philips plants and to other suppliers. Ericsson did not, so that by the time Ericsson responded, Nokia had secured most of the available capacity in the industry. As a result, Ericsson lost US$400 million in sales, with production disrupted for months. Nokia came out relatively unscathed, and with an enhanced reputation for supply chain risk management.17
Cooperative or consortium buying is typically used by supply management professionals to increase purchasing effectiveness. This involves two or more groups or organizations collaborating to prepare specifications and proposals, collectively receive bids, and make awards to the lowest bidders. Then, each organization issues its own contract and is responsible for administering the remainder of the sourcing cycle, including its own payments. This type of buying arrangement enables smaller users to secure the price and other advantages of large-volume purchasing. The national healthcare systems in many countries use this form of group purchasing.
A joint venture is an investment undertaken by two or more organizations. Joint ventures enable partners to share costs, technology, and intellectual capital; reduce financial, technical, and political risks; and achieve economies of scale that would not be possible individually. For example, the automakers Renault, Nissan, and Dongfeng formed a joint venture to design and produce electric vehicles in China.18 Risks of joint ventures include providing technical knowledge to partners that enable them to become competitors (loss of IP), less control over a project, or conflicts among the partners. Many forays by multinational organizations into the Chinese marketplace have required using joint ventures.19 Another choice is to determine the strategy for subcontractors or sub-tier suppliers. Many companies, especially in the automotive industry, source from a first-tier supplier that acts as a systems integrator rather than merely supplying individual parts that are then assembled by the company. Thus, rather than buying many single parts, the buying organization purchases complete modules or systems. Using a systems integrator can reduce the number of suppliers directly selling to the buying organization. The primary benefit is less managerial complexity for the buying organization, higher quality, and typically lower purchase costs.