Session 06: Supply Management: Part 1

Chapter Objectives

Discuss the rise of global sourcing and the important financial and operational performance impacts of supply management activities.
Calculate the profit leverage effect of effective purchasing versus sales.
Identify and describe the various steps of the strategic sourcing process:
- Step 1: Assess Opportunities
- Step 2: Profile Internally & Externally
- Step 3: Develop the Sourcing Strategy
- Categories of sourcing strategy:
  - Make
  - Buy
  - Insource
  - Outsource
  - Single Source
  - Multiple Source
  - Cross Source
  - Dual Source
- Total Cost Analysis – Basic Calculations
- Portfolio Analysis Quadrants

Supply Management Overview

Definition: A broad set of activities carried out by organizations to manage their supply chain effectively, including:
- Analyze sourcing opportunities
- Develop sourcing strategies
- Select suppliers
- Procure goods and services
- Measure and manage suppliers

Importance of Supply Management

Global Sourcing:
- Competing against world-class organizations necessitates the adoption of global sourcing strategies.
- Global competition requires considerations regarding:
  - Where and when goods and services are needed.
  - What suppliers have the best mix of performance characteristics.
- Advances in information systems facilitate efforts in global sourcing, applicable to both services (e.g., call centers, IT processing) and manufactured goods.
Performance Impact:
- Direct correlation between supply management and performance in key areas:
- Quality: Attributes such as performance, features, reliability, conformance, durability, serviceability, and perceived quality.
- Delivery: Ensuring the right quantity at the right time and place.
- Price: Direct influence on overall costs and profits.

Financial Impact

Importance of supply management on financial performance characterized by:
- Cost of Material versus Value of Shipments for various industries (1997 vs. 2011):
- Food: 53.5% (1997) vs 63.1% (2011)
- Chemicals: 46.2% (1997) vs 52.5% (2011)
- Plastics and Rubber: 49.0% (1997) vs 55.8% (2011)
- Computers and Electronics: 42.8% (1997) vs 38.8% (2011)
- Transportation: 60.5% (1997) vs 62.8% (2011)

Key Financial Metrics

Cost of Goods Sold (COGS): The total cost of products purchased from outside suppliers.
Merchandise Inventory: Balance sheet item reflecting the amount paid for inventory on hand.
Profit Margin: The ratio of earnings (profits) to sales (revenue).
Profit Leverage Effect:
- Decreasing purchasing costs impacts profits more rapidly than increasing revenue from sales through marketing.
- Saving $1$ in purchasing equates to lowering COGS by $1$ , directly contributing an equivalent $1$ to bottom-line profits.

Calculating Profit Leverage Effect

Key Formulas:
- Percentage of COGS = COGS / Sales Revenue
- Pretax Profit Margin = Pretax Profit / Sales Revenue
Examples of Effectiveness:
- Reducing COGS by $10$ increases Pretax Profit by $10$ .
- Example Calculation:
- If COGS = $100$ , reducing it by 10% results in:
  - $COGS - (100 \times 0.1) = 90$ and an increase in Pretax Profit of $10$ .
- To match the effects of savings in COGS on profits through increased sales, apply:
- Required Sales Increase = COGS Savings / Pretax Profit Margin.
- For a savings of $10$ with a 10% profit margin, sales must increase by $10 / 0.1 = 100$ .

Example Financial Calculations: Whole Foods Annual Financials (Millions)

Sales Revenue: $15,390 \text{ M}$
- COGS: $9,530 \text{ M}$
- Pretax Earnings: $878 \text{ M}$
Calculations:
- % COGS = COGS/Sales = $9,530 / 15,390$
- Pretax Profit Margin = Earnings/Sales = $878 / 15,390$

Strategic Sourcing Process

Definition of Strategic Sourcing: Identifying ways to improve long-term business performance through:
- Understanding sourcing needs
- Developing long-term sourcing strategies
- Selecting suppliers
- Managing the supply base.

Steps in the Strategic Sourcing Process

Assess Opportunities:
- Spend Analysis: The application of quantitative techniques to purchasing data to understand spending patterns and identify areas for improvement. This includes understanding:
  - Product/service categories that constitute significant spending
  - Financial breakdown by supplier
  - Cross-departmental spending
Profile Internally and Externally:
- Internal Category Profile: Detailed breakdown of a sourcing category’s aspects impacting sourcing strategy.
- External Industry Analysis: Understanding forces influencing the industry like pricing, competition, regulatory factors, and supply/demand trends.
Develop the Sourcing Strategy:
- Make or Buy Decision: Deciding whether to produce in-house (insourcing) or procure from external suppliers (outsourcing).
- Key Definitions:
  - Insourcing: Using internal resources to provide products/services.
  - Outsourcing: Delegating production to third-party suppliers.
  - Variants:
    - Off-shoring: Outsourcing to a foreign country.
    - Near-shoring: Outsourcing to a nearby country.
    - On-shoring: Keeping production within the home country.

Reasons for Insourcing or Outsourcing

Reasons to Buy/Outsource:
- Low volumes leading to higher costs, strategic flexibility, access to technology, cost/quality advantage, reliability of suppliers, established relationships, and short product life-cycles.
Reasons to Make/Insourcing:
- Better control over quality, improved visibility, managing social and environmental impacts, protecting intellectual property, focusing on core competencies, utilizing excess capacity, and reducing storage costs, particularly for stable product life-cycles.

Total Cost Analysis in Sourcing Decisions

Definition: A process identifying and quantifying major costs associated with sourcing options.
Types of Costs:
- Direct Costs: Tied directly to operations (e.g., labor, materials).
- Formula: $\text{Direct Costs} \times \text{Number of Units Needed}$
- Incremental Direct Costs: Incurred after producing a threshold number of products.
- One-Time Costs: Occur at initial production (e.g. design, mold purchases).
- Indirect Costs: Not directly tied to operations (e.g., administrative costs).

Example: Total Cost Analysis

Insourcing Costs: Calculate total cost per unit based on anticipated production and costs (e.g., labor, materials).
Outsourcing Options: Define potential costs per unit and calculate the most cost-effective route based on demand and delivery schedules (cost analysis may include trucking, mold procurement).

Kraljic’s Portfolio Analysis

Overview: A structured approach to develop sourcing strategies based on value potential and complexity/risk of sourcing opportunities.
Quadrants Overview:
- Routine Quadrant: Low value, readily available items.
- Leverage Quadrant: High spend on standardized items.
- Bottleneck Quadrant: Unique requirements met by few suppliers.
- Critical Quadrant: High-value items with complex requirements and limited supply.
Strategies Per Quadrant:
- Manage suppliers, simplify processes, increase competition, and utilize strategic partnerships to optimize sourcing.

Sourcing Strategies

Single Sourcing: Reliance on one supplier for a needed part or service, leading to potential volume discounts but also increased risk.
Multiple Sourcing: Sharing supply needs across different suppliers to cultivate competition; downside includes less supplier dedication.
Cross Sourcing: Using different suppliers for various needs, balancing risk and relationship engagement.
Dual Sourcing: A method with two suppliers to balance relationships and risks effectively.

Career Development Opportunities in Supply Chain Management

Events such as mixers, interviews, plant tours, professional workshops, networking, and social activities for improving SCM professional skills.

Conclusion

Supply management is crucial for optimizing financial performance, managing procurement costs, and employing effective sourcing strategies to sustain business growth and competitive advantage.