Strategic Sourcing

Dr. Kunal Ghosh

 Introduction

• Does the present purchasing strategy support our business?

• Does it meet our long term requirements?

• Do we have joint contracting for common materials

requirement? (taking into consideration the requirements of
multiple departments)

• What is the balance of power between our company and our

major suppliers?
 Introduction

• For which products / materials is the company dependent on

one single supplier?

• Are the strategic products and services currently sourced from

the best-in-class suppliers?

• To what extent have the purchasing requirements and volumes

been evenly spread over several suppliers and geographic
regions?
 Introduction

• What percentage of our purchasing requirements is covered by

spot market transactions or short-term contracts?

• What difficulties or interruptions in supply can be expected in

the near future and how can these problems influence the
profit and growth objectives of our company?

• What opportunities exist for collaboration with suppliers with

regard to product development, quality improvement, lead
time reduction and cost reduction? Are these opportunities
sufficiently being used?
 Kralijic’s purchasing product portfolio

• 20% of the products and suppliers will represent about 80% of

purchasing turnover.

• The above analysis is a first step in identifying the company’s

strategic commodities and suppliers.
 Kralijic’s purchasing product portfolio

• Y axis will represent .

• Purchasing function’s impact on the bottom line of the

company --- the profit impact of a given supply item
measured against criteria such as cost of materials, total costs,
volume purchased, percentage of total cost, or impact on
product quality or business growth.
• The higher the money or volume involved the higher the
financial impact of purchasing on the bottom line.
 Kralijic’s purchasing product portfolio

• X axis will represent .

• Supply Risk --- This is measured against criteria such as short

term and long term availability, number of potential suppliers,
competitive structure in supply markets, make-or-buy
opportunities, storage risks and substitution possibilities.

• Sourcing a product from just one supplier without an

alternative source of supply represents a high supply risk.
Supply risk is low when a (standard) product can be sourced
from many suppliers whilst switching costs are low.
 Kralijic’s purchasing product portfolio

Leverage Products Strategic Products

High
Alternate sources of supply Critical for end product’s cost
available Dependent on suppliers

Substitution available

Routine Products Bottleneck Products

Impact of Large Product Variety Monopolistic market

Purchasing High Logistics Complexity Large Entry Barriers
on Financial Labor Intensive
Results

Low / Low <<<< SUPPLY RISK >>>> High

 Kralijic’s purchasing
Leverage Suppliers product
Strategicportfolio
Suppliers
High (Buyer Dominated (Balance of Power may
Segment) differ among
buyer/supplier)

Routine Suppliers Bottleneck Suppliers

(Large Supply Base (Technology Leaders
Impact of Many suppliers with Few or no alternative
Supplier on dependent position) suppliers)
Financial
Results

Low / Low <<<< SUPPLY RISK >>>> High

 Kralijic’s purchasing product portfolio

• Routine Products have the following characteristics:

• Large product variety

• High logistics complexity
• Labor intensive

• Suggested action : (Systems Contracting + E-Commerce

Solutions)
 Kralijic’s purchasing product portfolio

• Bottleneck Products have the following characteristics:

• Monopolistic market
• Large entry barriers

• Suggested action : (Secure supply + Search for alternatives)

 Kralijic’s purchasing product portfolio

• Strategic Products have the following characteristics:

• Critical for end product’s cost price

• Dependent on suppliers

• Suggested action : (Performance based partnership)

 Kralijic’s purchasing product portfolio

• Leverage Products have the following characteristics:

• Alternate sources of supply available

• substitution possible

• Suggested action : (Competitive bidding)

 Kralijic’s purchasing product portfolio

• Leverage suppliers characterized by

• Many competitors
• Commodity products

• Basically this is a buyer-dominated segment

 Kralijic’s purchasing product portfolio

• Strategic suppliers characterized by

• Market leaders
• Specific know-how

• Balance of power may differ among buyer-supplier

 Kralijic’s purchasing product portfolio

• Routine suppliers characterized by

• Large supply
• Many suppliers with dependent position

• Suggested action:
• Reduce number of suppliers
 Kralijic’s purchasing product portfolio

• Bottleneck suppliers characterized by

• Technology leaders
• Few, if any, alternative suppliers

• This is supplier dominated segment

 Kralijic’s purchasing product portfolio

• Strategic products;

• These are high-volume products, which are often supplied at

customer specification.

• Only one source of supply may be available, which can not be

changed in the short term without incurring considerable costs.
 Kralijic’s purchasing product portfolio

• Strategic products;

• Usually these type of products represent a high share in the

cost price of the end product.

• Examples are engines and gearboxes for automobile

manufacturers, turbines for the chemical industry and bottling
equipment for breweries.

• Communication & interaction between the company &

supplier are usually intense.
 Kralijic’s purchasing product portfolio

• Leverage products:

• These are the products that can be obtained from various

suppliers at standard quality grades. They represent a relatively
large share of the end product’s cost price.

• A small change in price has a relatively strong effect on the

cost price of the end product.
 Kralijic’s purchasing product portfolio

• Leverage products:

• This is the reason why the buyer exerts aggressive sourcing

and tendering among a small sample of prequalified suppliers.

• Examples are bulk chemicals, steel, and aluminum profiles,

packaging, steel plate, raw materials & standard semi-
manufactured commodities.
 Kralijic’s purchasing product portfolio

• Leverage products:

• Switching costs are low to change suppliers.

• Abuse of this power can lead to cooperation between the

suppliers. Cartels and price agreements may develop in these
situations shifting the commodity to the right side of the
matrix.
 Kralijic’s purchasing product portfolio

• Bottleneck products:

• Represent a relatively limited value in terms of money but they

are vulnerable in regard to their supply.

• They can only be obtained from one supplier.

• Examples are catalytic products for the chemical industry,

pigments for the paint industry, and natural flavorings and
vitamins for the food industry.
 Kralijic’s purchasing product portfolio

• Bottleneck products:

• Spare parts for equipment also fall into this category.

• In general, the supplier is dominant in the relationship with the

manufacturer, which may result in high prices, long delivery
times and bad service.
 Kralijic’s purchasing product portfolio

• Normal products:

• Produce few technical or commercial problems from a

purchasing point of view.

• Have a small value per item.

• There are many alternative suppliers.

• In practice many or most items fall into this category.

 Kralijic’s purchasing product portfolio

• Normal products:

• Examples are cleaning materials, office supplies, maintenance

supplies, fasteners etc.

• The problem with this group of products is that the handling

often takes more money than the value of the products itself.
Usually 80% of the time and energy of purchasing is used for
these products – a reason why purchasing is often seen as an
administrative job.
 Kralijic’s purchasing product portfolio

• Buyer Dominated Segment:

• Requirements are imposed on the supplier by the

manufacturer.
• Suppliers experience the partnership relation as one-sided.

• Relationship is not a balanced one.

• Example – Automotive Industry.

• Manufacturers dictate their demand.

 Kralijic’s purchasing product portfolio

• Supplier Dominated Segment:

• Supplier has the customer ‘locked in’ a relationship through

the technology and carefully designed marketing strategies.

• Example: IT service providing industries (h/w, s/w & services)

• Customer has to accept the conditions of the supplier imposed

on him.
 Kralijic’s purchasing product portfolio

• Balanced Relationship:

• Neither of the two parties dominate each other.

• Partnership may develop over time.

 Basic Supplier Strategies

• Partnership:

• Strategic products together with the leverage products make up

80% of total turnover.
• Minor changes in price levels will have an immediate impact
on the end product’s costs so that the price and cost changes,
as well as the developments in the supplier market, must be
monitored closely.
• At the same time, the supply risks are high.
 Basic Supplier Strategies

• Partnership:

• These arguments justify a central or coordinated purchasing

approach.

• Depending on the relative power position of the different parties

involved, the purchasing policy for strategic products will be aimed
at partnership or collaboration.

• The goal is to create mutual participation based on planned co-

operation.
 Basic Supplier Strategies

• Partnership:

• A relationship based on ‘open costing’ is preferred.

• With the suppliers’, efficiency programs are developed to

achieve cost reduction, quality improvement, process
improvement, and improved product development.

• Such co-operation can in the end lead to the fading of borders

between the different companies.
 Basic Supplier Strategies

• Partnership:
• An essential aspect of this strategy is the thorough selection
process of the supplier.
• Early in the development, the market is scanned for the ‘best-
in-class’ suppliers.
• These suppliers are screened on their references, financial
stability, production capacities, the quality of their logistics &
their quality systems &
• of course their R&D and engineering capabilities.
 Basic Supplier Strategies

• Competitive bidding:

• For leverage products, a purchasing policy based on the principle of

competitive bidding or tendering will be pursued.

• Since suppliers as well as products are basically interchangeable,

there will be a few or no long-term supply contracts.

• Long-term contracts & annual agreements will be combined with

‘spot purchasing’.
 Basic Supplier Strategies

• Competitive bidding:

• Buying at a minimum price & maintaining the required quality

level and continuity of supply will be the priority here.

• Small savings (small in terms of percentages) represent a large

sum of money.

• This justifies an active market scanning through continuous

market and supply research.
 Basic Supplier Strategies

• Competitive bidding:

• Regularly, outsiders will be introduced so as to avoid price

arrangements between the present suppliers.

• Buying of leverage products justifies a corporate or

coordinated approach where corporate agreements with so-
called preferred suppliers are negotiated which can be used by
decentralized units.
 Basic Supplier Strategies

• Competitive bidding:

• Price changes caused by, for example demand and supply

changes, are monitored closely in order to estimate the effect
on the cost price.
 Basic Supplier Strategies

• Securing continuity of supply:

• The purchasing policy concerning bottleneck products has

focused on securing continuity of supply, if necessary at
additional cost.

• At the same time activities are conducted with the aim of

reducing the dependence on these suppliers.
 Basic Supplier Strategies

• Securing continuity of supply:

• This is done by developing alternative products and suppliers.

• However, the costs involved in these actions (for example tests

in laboratories) often exceed the price profits obtained, which
is why management often has difficulty in approving this type
of action.
 Basic Supplier Strategies

• Securing continuity of supply:

• A risk analysis to determine the most important bottlenecks in

the short, middle and long-term supply is necessary.

• Based on this analysis, contingency plans are made.

• With contingency planning, measures are prepared in case one

of the established risks actually occurs.
 Basic Supplier Strategies

• Securing continuity of supply:

• Examples are VMI ( consigned stock agreements aimed at

keeping stock of the materials concerned at the supplier’s or
the company’s own premises, preparing alternative modes of
transportation and actively investigating product alternatives).
 Basic Supplier Strategies

• Systems contracting:

• Routine products require a purchasing strategy which is aimed

at reducing administrative and logistic complexity.

• Buyers will have to work out simple but efficient ordering and
administrative routines with the suppliers in the form of
systems contracts.
 Basic Supplier Strategies

• Systems contracting:
• A few aspects relevant to the policy for these products are
• standardizing the product assortment,
• reducing the number of suppliers,
• pursuing systems contracts for groups of MRO items
• (i.e., office supplies, technical maintenance products, catering,
etc.), working with electronic catalogues and ordering through
Internet.
 MRP Concepts

• MRP is a computer-driven materials planning system.

• It uses bill of materials (BOM) structure of a discrete product

and master production schedule (MPS) to forecast the
requirement of dependent subassemblies, down to component
level.

• It also uses the inventory status information and lead time

information to indicate the order release date (ORD).
 MRP Concepts

• The order release date (ORD) ensures that the components and
sub-assemblies are available on time to meet the requirement
of assemblies as per MPS.

• Lead time offsetting is done to determine order release date

from the required date.

• Lead time is generally taken as deterministic in the simplest

form of MRP.
 MRP Concepts

• Any engineering changes are incorporated to update the BOM.

• Primary outputs of MRP are order schedule and changes in the

planned orders.

• Secondary outputs include planning reports, performance reports,

and exception reports.

• MRP time buckets are usually 1 week, but if lead times can be
reduced & material flow situation is improved, even daily time
buckets can be used.
 MRP Concepts

• MRP is often called “push” system where the material

requirements are calculated ahead of time-planned order
releases & pushed out to the production system as a production
order.

• Net Requirement = Gross Requirement – (Inventory-on-hand –

Safety stock – Inventory allocated to other users).
 Limitations of MRP

• Lead time is taken as deterministic. This may not be true in many

cases.

• In such a case, lead time variability may have to be absorbed by

maintaining safety stock.

• Alternatively, the concept of safety lead time may be invoked by

offsetting the planned order release by mean lead time plus K times
the standard deviation of lead times.

• But this makes the MRP process cumbersome.

 Limitations of MRP

• 100% quality is assumed in determining net requirements and

planned order quantities.

• If this is not true, some scrap allowance will need to be

incorporated which will inflate the planned order quantity.

• MRP can only be efficiently managed on a computer. For

multiproduct structure using some common requirements
makes the problem complex and cannot be handled manually.
 Limitations of MRP

• MRP requires disciplined approach to planning. Inaccurate

data on lead times, inventory status, and BOM structure (not
updating design changes) can cause a lot of disturbances on
the functioning of an MRP system.

• Planned order release ignores the capacity of the

manufacturing facility or the supplier to produce or supply that
order quantity in the time frame required.

• This may make MRP process infeasible. To circumvent this,

MRP must be integrated with capacity requirement planning.
 Limitations of MRP

• Capacity requirements planning (CRP) is the process of

determining in detail the amounts of labor and machines
required to achieve the desired production level.

• Capacity required is checked with the capacity available.

• Closed-loop MRP incorporates integration of MRP, CRP and

interfacing of purchase and production activities control
modules with MRP module dynamically.
 Limitations of MRP

• However, even closed-loop MRP does not provide a link with

other functional areas of business such as finance and
marketing.

• This may lead to non-coordinated functioning of production

and procurement system.

• In order to further refine the process, MRP II (manufacturing

resources planning) & ERP have been developed.
 Limitations of MRP

• ERP is a s/w architecture that facilitates the flow of

information among different functions of an enterprise.
• It encompasses a broad set of activities supported by multi-
module application s/w that helps a firm to manage its
activities including
• product planning,
• purchasing,
• inventories,
• vendor / customer service, and
• tracking of orders.
 Limitations of MRP

• Finance, HRD, Logistics and Manufacturing and Supply Chain

are some of the commonly available application modules with
most of ERP vendors.

• ERP uses a client/server environment supported with GUI

(graphical user interface) technology.

• The core of ERP is integration of commonly designed

applications and consolidating all business operations into
uniform system environment.
 Strategies for Lean Materials Management

• Lean means very little “fat” in the form of inventory.

• A supply chain is an integrated flow of material from the

vendor through manufacturing or service operations to the
customer.

• A supply chain integrates the material flow “into”, “through”,

and “out” of the system.
 Strategies for Lean Materials Management

• A lean materials management strategy provides for efficient,

coordinated material flow throughout the supply chain with
very little inventory in the chain.

• Increasing flow velocity of material, information, people,

money, and other resources is critical to make the supply chain
lean.

• Weakest link of a chain determines its reliability.

 Strategies for Lean Materials Management

• A lean chain expects entire links to operate on the philosophy

of being lean without unacceptable risk of supplies getting
delayed due to low inventory.

• Lean philosophy seeks to shorten the time between customer

order and delivery by eliminating waste.
 Strategies for Lean Materials Management

• Reduce Variability of Demand and Lead time

• Need to reduce variability of demand through better

forecasting and consumption planning

• Need to reduce variability of lead time through better vendor

selection, monitoring, and development and going for a
reliable local source of supply at various links in the supply
chain.
 Strategies for Lean Materials Management

• Buffer stock actually provides protection against shortages

“just in case” , and hence

• We need

• to reduce all those “just-in-case” possibilities through efficient

systems and processes

• to leverage information technology (IT) to cut down or

eliminate demand and lead time uncertainties.
 Strategies for Lean Materials Management

• Avoid More Service Level Than Desired

• The choice of factor “K” in the formula for determining the safety
stock is correlated with desired service level, and

• Beyond a point value of K increases nonlinearly for even extra

0.5% or even 0.1% in service levels.

• This is called as “99 percent syndrome” where for every material,

the materials manager aims at 99% or 99.99% service level.
 Strategies for Lean Materials Management

• Avoid More Service Level Than Desired

• A supply chain can never be “lean” if these kinds of service

levels are aimed at and if the standard deviation of demand and
lead time are significant.

• Hence the procurement process must use ABC-VED matrix to

fix up more reasonable service levels for each item contingent
upon their mapping.

• Very substantial inventory reduction is possible if this aspect is

kept in mind by the managers.
 Strategies for Lean Materials Management

• Simplify Procurement Processes to Reduce Average Lead

Time

• Try to reduce the value of average lead time in addition to

standard deviation of lead time.

• This can be achieved through value stream mapping of the

procurement process by knocking out non-value added
activities from the procurement process.
 Strategies for Lean Materials Management

• Simplify Procurement Processes to Reduce Average Lead

Time

• Develop local and smart-enlightened vendors, adopting

• e-governance,
• e-procurement, and
• e-tendering systems leveraging information technology.
 Strategies for Lean Materials Management

• Reduce Excessive Variety Through Simplification /

Standardization

• Excessive variety of materials due to lack of standardization

and codification is a major cause of excessive inventory.

• Lean inventory systems require fewer varieties by

standardization of parts and machines (for spares inventory).
 Strategies for Lean Materials Management

• Reduce Excessive Variety Through Simplification /

Standardization

• If n varieties can be standardized into 1, we can mange with

1/√n inventory in the system.

• Thus if 4 parts can be standardized into 1, a 50% reduction in

inventory is possible without eroding service levels.
 Strategies for Lean Materials Management

• Reduce Excessive Variety Through Simplification /

Standardization

• Even a very modest goal of variety reduction of reducing 2 parts

into 1 can lead to about 30% reduction in inventory.

• Therefore as a long-term strategy, this can be instrumental in

making a supply chain “lean”.

• Like variability, variety is also a culprit in inventory management

systems.
 Strategies for Lean Materials Management

• Vendor Development and VMI

• An enlightened and dependable vendor is a critical success

factor in lean materials management.

• Vendor development is a strategic intervention in cultivating

few trusted vendors located nearby and helps them in training,
quality, testing facilities, technology transfer, and assured long
term contract.
 Strategies for Lean Materials Management

• Vendor Development and VMI

• Being local, trustworthy, and capable vendor with positive

motivation to supply are the key factors in vendor
development.

• If trust and high technology are present in the vendors, then

VMI can be a very useful strategy to create a lean supply
chain.
 Strategies for Lean Materials Management

• Vendor Development and VMI

• We need to find the best vendor and engage them early in the
design process.
 Strategies for Lean Materials Management

• Lean Purchasing and Logistics :

• Lean supply chain requires lean purchasing in smaller

quantities more frequently, lean transportation and logistics.

• For example, direct supply from the source of supply to the

point of use through trucking, and employing cross-docking
if possible.
 Strategies for Lean Materials Management

• Lean Purchasing and Logistics :

• To design fast material flow, we need to plan regular and

repeatable (closed-loop) flow pattern to make lean logistics
possible.

• Pull-based supply is another feature of lean logistics.

 Strategies for Lean Materials Management

• Centralization of Expensive Slow-Moving Inventory and

Risk Pooling

• Risk pooling is powerful strategy to cut down inventory.

• For the multi-location slow-moving but expensive items,

centralizing the location of inventory can be very useful for
inventory reduction.