Chapter 5: Sourcing Materials and Services
Introduction
Logistics and supply chain managers are looking for ways to drive more value from their purchasing
and procurement operations.
Purchasing: the transactional function of buying products and services.
Procurement: the process of managing a broad range of processes that are associated with a
company’s needs to procure goods and services that are required to manufacture a product or to
operate the organization.
Strategic sourcing: takes the procurement process further, focuses more on supply chain impacts of
procurement and purchasing decisions, and works cross-functionally within the business to help
achieve the organizations overall business goals.
Objectives of Procurement Management
Procurement Management is the function responsible for the interface with suppliers.
Procurement Management needs to ensure the business acquires the right quantities of
goods and services at the right time, the right place, the right quality and right price, all
from the right processes.
Low price is only one facet of the lowest total landed cost (TLC) and total cost of ownership
(TCO) of procured items.
All the rights are important, however, they can be in conflict with each other.
The Five Rights of Procurement
o Quality: Obtaining goods which are of satisfactory quality and fit for their purpose.
o Quantity: Obtaining goods in sufficient quantity to meet demand and maintain service levels
while minimising excess stock holding.
o Place: Having goods delivered to the appropriate delivery point, packaged and transported in
such a way as to secure their safe arrival in good condition.
o Time: Securing delivery of goods at the right time to meet demand, but not so early as to
incur unnecessary inventory costs.
o Price: Securing all of the above at a price which is reasonable, fair, competitive and
affordable.
Objectives of Procurement Management Continued
Improve competitive position of the business
Focus on contributing to the business objectives and strategy. Exploit opportunities to
enhance revenue, asset utilisation, reduce costs, gain access to innovative technologies, etc.
Provide uninterrupted flow of goods / services
Continuous flow is needed to support business activities. Stock ‐outs can be very costly due
to lost production, unhappy customers.
Minimise inventory investment and loss of revenue
Optimal inventory levels need to be determined and fine-tuned. Cost vs. Stock out situations.
, Maintain and improve quality
A certain level of quality needs to be maintained. Procurement processes are responsible to
make sure all products or services procured, which need to meet the minimum quality
requirements.
Find / develop best‐in‐class suppliers
Find suppliers that link in with your business strategy, and develop continuous improvement
programs with the suppliers.
Standardise (where appropriate) inputs and processes
Continuous focus leads to savings in bulk purchases, lower inventory, lower risks and
administration costs.
Aim for lowest total cost of ownership (TCO)
Not only the lowest purchase price, but the total cost of ownership. For example: Quality
levels, salvage value, durability of the goods, warranties, etc.
Achieve co‐operative, productive internal relationships
You need to work and coordinate with the other departments in the business.
Accomplish Procurement objectives efficiently
Achieve Procurement objectives at the lowest operating costs.
Buy/Make and Insourcing/Outsourcing Decisions
The make/buy decision continues to be one of the key strategic issues and options confronting the
supply management function. Outsourcing has become a way to increase an organisation’s flexibility
to meet rapidly changing market conditions, focus on core competencies and develop competitive
advantage. As a result, the need for world class Procurement has intensified and positioned supply
managers as agents of strategic change critical to supply chain success.
Outsourcing and Procurement – A Growth Industry
Outsourcing is increasing rapidly
Not just materials, many business functions are being outsourced
Outsourcing can enable:
Leveraging of the suppliers’ expertise
Increases in innovation
And result in:
Lower staffing levels
Reduced costs
More flexibility
Dangers of Outsourcing
Loss of control
Loss of cost control
Ineffective management
Loss of confidentiality
Double outsourcing
,Outsourcing and Procurement – Horizontal Integration
Outsourcing all non‐critical activities is a general trend (the idea is to achieve significant cost
leverage). To identify non‐critical activities, the firm’s core competencies must be defined. All other
activities are candidates for outsourcing e.g. Cisco outsources manufacturing, order fulfilment and
distribution thereby being able to provide its products faster and at a lower cost than its competitors
due to its flexibility.
Outsourcing and Procurement – What Should Note Be Outsourced
from a Strategic Level
Lean Manufacturing is a growing trend globally and it’s embraced for competitive purposes, i.e. lean
firms increasingly buy more and make less. Firms are becoming more aware of the strategic
dimension of the make‐or‐buy decision.
Three categories to consider:
1. An item that is critical to the success of the product.
2. An item that requires specialised design, manufacturing skills or equipment.
3. An item that fits well within the firm’s core competencies.
As technology advanced, most manufacturing firms have become much more specialised. Cost of
materials has continued to increase in many industries. Recurring make ‐or ‐buy issue must be
handled in a well‐organised, systematic manner and not dealt with on an ad ‐hoc basis.
Three forces will stimulate the change:
Pressures on profit margins are severe and will continue to increase.
Firms continue to become more highly specialised.
Computer modelling capability is becoming commonplace.
Sourcing Materials and Services
Procurement Process
A Five Stage Process
1. Identification of item or service required
2. Identification of best supplier
3. Establishment of a fair and reasonable price
4. Creation of an enforceable agreement
5. Management of the relationship
Procurement / Supply Management utilizes Strategic Sourcing.
The Main Stages in the Generic Procurement Process
1. Identify the need (Requisition or bill of materials)
2. Define the need (Specification)
3. Develop contract terms
4. Source the market (Identify potential suppliers)
5. Appraise suppliers
6. Invite quotations or tenders (Request for quotation (RFQ) or invitation to tender)
7. Analyse quotations and select most promising suppliers
, 8. Negotiate best value
9. Award the contract
10. Contract / supplier management (monitor, review and maintain performance)
Important to remember:
Pre‐contract award stages include identification and definition of need, procurement
planning, development of the contract, market survey and engagement, appraisal and
selection of suppliers, receipt and evaluation of offers and contract award.
Post‐contract award stages include activities such as expediting, payment, contract or
supplier management, ongoing asset management and post contract “lesson” learning.
Not every procurement will follow every stage of the procurement cycle (tactical / strategic
sourcing and/or straight re‐buy / modified re ‐buy / new buy).
Remember the difference between pre and post ‐contract stages, e.g. appraisal of suppliers
and supplier performance appraisal.
Strategic Sourcing
Strategic sourcing is understanding the markets you're purchasing from inside and out and learning
from your own organization and your suppliers' organizational processes, working as a mediator
between suppliers and your organization, and capturing information and using it to improve
relationships. Strategic sourcing requires two‐way continuous improvement process work from each
organization.
What it is and what it’s not
Definition: A systematic and fact‐based approach for optimizing an organization’s supply base and
improving the overall value proposition.
What it is What it’s NOT
Focused on the TCO incorporating customer Focused ONLY on cost
needs, organizational goals, and market
conditions
Getting the best product / service at the best Getting the cheapest product / service
value
Driven by a rigorous and collaborative approach Ad‐hoc activities involving only purchasing
Addresses all levers for savings Focused on “beating up suppliers”
Decisions based on fact based analysis and Decisions on opinion preference based opinion,
market intelligence unjustified, or complacency
A continuous process A one‐time project or decision
Unique Aspects of Strategic Sourcing
Consolidation and Leveraging of Purchasing power: If every department or division in an
organization were to make independent purchasing decisions, the end result would be costlier than if
the purchases were coordinated. Looking broadly at everything purchased by an organization,
