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Procurement Chain Management
A Strategic Implementation Process
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• Product supply management is nothing but Procurement
Strategy, which is integral to corporate strategy.
• A corporation’s corporate strategy and procurement
strategy must fit with each other or otherwise, both will
fail.
• We will discuss the strategic decision making issues of
procurement and also how managers make decisions
related to both corporate and procurement strategy.
• The discussions should facilitate understanding of the
issues of strategic implementation.
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The new global business environment
• Fierce competition
• Introduction of products with shorter and shorter
life cycles
• Heightened expectations of customer
• Continuing advances in communications and
transportation technologies (e.g. mobile
communication, Internet, overnight delivery)
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Cost impact of managing inventory
• It is estimated that the grocery industry could save
$30 billion (10% of its operating cost) by using
effective logistics strategies.
• Compaq computer estimates it lost $500 million to
$1 billion in sales because its laptops and desktops
were not available when and where customers
were ready to buy them (Compaq does not exist
anymore).
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Managing costs in the supply arena
• JIT, TQM, lean mfg. techniques have reduced
manufacturing costs as much as they could.
• One area that yet requires improvement:
Inventory Procurement. See the following
examples:
• It takes a typical box of cereals more than 3
months to get from factory to supermarket.
• It takes a new car, on average, 15 days to travel
from factory to dealership.
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The Success Stories
• In 10 years, Wal-Mart transformed itself by
changing its logistics system. It has the highest
sales per square foot, inventory turnover and
operating profit of any discount retailer.
• Dell Computer has outperformed the competition
in terms of shareholder value growth over the
eight years period, 1988-1996, by over 3,000%
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What exactly is procurement?
• All stages and parties involved, directly or
indirectly, in fulfilling a customer request
• Internally, the procurement process includes all
functions involved in fulfilling a customer request
(product development, marketing, operations,
distribution, finance, customer service).
• Externally, it includes the suppliers, vendors,
manufacturers, transportation, and distributors,
that exist to transform raw materials to final
products and supply those products to customers.
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A procurement or a supply example
Let us briefly go over how selling a simple box of
detergent through a retail store involves so many
parties and contractual arrangements and why each one
must function effectively to make the process efficient.
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Buying Cereals from Wal-Mart
Timber
Company
Paper
Manufacturer
P&G or other
Manufacturer
Corn
manufacturer
Plastic
Producer
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Tenneco
Packaging
Wal- Mart
Customer
The Objectives of a Procurement Chain
• Primary purpose is satisfying customer needs.
• Maximizing the overall value created
• Value, measured monetarily, refers to: the difference
between what the final product is worth to the customer
(price the customer is willing to pay) and the effort,
collectively, the procurement chain expends in filling the
customer’s request (the collective costs)
• Therefore, procurement profitability would be: the
difference between revenue generated from the customer
and the overall cost across the entire Procurement chain.
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While managing procurement process is important for
managing costs and profits and delivering value to the
customer, it is not easy to do.
It requires understanding, cooperation, coordination, and
information sharing among several trading partners – both
internal and internal.
And, given that there are so many parties, it is indeed a
formidable task to make all of them work towards a common
objective.
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Why should procurement be a challenging
problem?
• Procurement chain network is often very
complex
• Procurement chain partners have conflicting
objectives.
• Consequently, making everyone to agree is
not an easy task.
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Conflicting Objectives
in the Procurement Chain
1. Purchasing wants
• Stable volume requirements
• Flexible delivery time
• Little variation in mix
• Large quantities
2. Manufacturing wants
• Long run production
• High quality
• High productivity
• Low production cost
Tell me why some of these objectives are conflicting.
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Conflicting Objectives
in the Procurement Chain
3. Warehousing wants
• Low inventory
• Reduced transportation costs
• Quick replenishment capability
4. Customers want
• Short order lead time
• High in stock
• Enormous variety of products
• Low prices
Tell me why some of these objectives are conflicting.
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While we agree on the importance of
procurement, how does it translate
into a corporate strategy?
Achieving strategic Fit –
Matching multiple strategies
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Business strategies change over time
• In the 1990s, outsourcing was the focus of many
manufacturers.
Example: Nike Shoes
• Nike’s strategy: R and D on one hand and
marketing, sales, and distribution on the other.
Example 2: CISCO
• CISCO’s strategy: Focus on Internet sales;
increased productivity and save on business
expenses.
Example 3: Apple Computers
• Apple computers: outsourced most of its mfg.
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The Landscape changed
• In 2001, Nike reported a profit shortfall due to
inventory buildup, shortage for others, and late
deliveries.
• In 2000, CISCO was forced to announce 2.25 B
write-down for obsolete inventory.
• In 1999, Apple had huge customer dissatisfaction
because of shortage of G4 chip supplied by
Motorola.
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What went wrong?
• In the examples, the difficulties reflect problems with
procurement chain strategies.
• Nike, CISCO, Apple have short product life cycles.
• When technologies changed, uncertainties related to
customer demand increased.
• Procurement landscape changed significantly with the
introduction of independent, private, and consortium-based
e-market places.
• With changes in procurement landscape, both problems
and opportunities also changed.
• But, Nike, CISCO, and Apple were not able to react to
these changes and formulate a new corporate and
procurement strategy.
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The need for a good strategy
• The most important requirement for sustainability
is a well-formulated corporate strategy;
• A corporate strategy, in turn, requires forming sub
strategies such as product strategy, procurement
strategy, marketing strategy, and so on. And,
• A firm should continually evaluate its corporate
strategy and its sub strategies and ensure that they
are appropriate for a changing environment.
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Competitive Strategy let managers answer
questions such as
• Relative to competitors, how should my firm
satisfy customers?
• What products and services should we offer?
• Should we focus on cost or should we focus more
on service and quick response?
• How much customization should we allow on our
products?
• Compare the competitive strategies of: Lands End
and a local retailer.
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Competitive Strategy and procurement Strategy –
The relationship
Competitive strategy
New Product
Development
Marketing &
Sales
Operations
Distribution
procurement Strategy
Supplier
Strategy
Operations
Strategy
Logistics
Strategy
Service
See the Dell example – Matching competitive and
procurement strategies
• Suppose Dell’s competitive strategy is to deliver a product
within 72 hours of receiving an order but is product
suppliers, on average take 7 days to resupply inventory,
then, Dell is not going to be able to accomplish its
competitive strategy.
• There is a lack of strategic fit.
• Also, look at Dell’s competitive strategy.
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The Dell’s competitive and procurement
strategies
• Competitive strategy: provide a large variety of
customizable computer-related products at a reasonable
price and to let customers select from thousands of
configurations.
• procurement strategy: Two possible options: 1. Efficient
procurement limiting variety and exploiting economies of
scale or 2. High flexibility and responsiveness producing a
large variety of products.
• Dell’s procurement Strategy is No. 2
• Consequently, Dell focuses on designing easily
customizable products, common platforms and
components that can be assembled quickly.
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Achieving Strategic Fit Achieved –
The steps involved
• Step 1:
• Step 2:
• Step 3:
Understanding the customer and
procurement uncertainty
Understanding the procurement
capabilities
Achieve strategic fit
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First, take a look at two types of uncertainties – Demand
Uncertainty and procurement chain uncertainty
• Demand uncertainty: arises because of changing
customer needs – predicting demand for a product or
service absolutely is impossible. This is an external
factor controlled by the customer.
• Procurement chain uncertainty, in contrast, arises
because of uncertainties within a procurement
process.
• While a firm would like to meet 100% of customer
demand, it may not be able to do so because its
procurement is unable to because of multiple reasons
that were listed under procurement uncertainty.
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Demand uncertainty
(customer-induced)
• Usually products that are less mature (electronics,
computers) have greater demand uncertainty (unlike
Salt or milk).
• Forecasting demand for such products is very difficult
and usually not very accurate.
• With forecasting difficulties, matching demand
against product and services supply is difficult.
• For uncertain demand products, prices are not steady
and varies depending on demand levels.
• At the same time, a firm could earn greater margin
from uncertain demand products.
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Procurement chain uncertainty, on the contrary, arises
due to constraints within a procurement
• procurement uncertainty: The portion of
uncertainty introduced by procurement attributes
such as: production breakdowns, low product
yields, poor quality and rework, procurement
capacity is limited (because of limited production
facilities, availability of raw materials, labor, and
numerous other factors);
• Supply capability is inflexible and cannot increase
with increased product demand;
• Also, changes in production process could lead to
bottlenecks.
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Step 1: Therefore, understand both demand and procurement
chain uncertainties
• Identify the needs of the customer segment being
served (retail, wholesale, discount, high-end
customers)
• Quantity of product needed in each lot (large,
small)
• Response time customers will tolerate
• Variety of products needed
• Service level required
• Price of the product
• Desired rate of innovation in the product
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Step 2: Evaluate procurement capabilities
• A procurement can rarely meet all demands of all
of its customers. Why?
• How many of the following demands of customers
can we meet?
–
–
–
–
Responding to wide range of product demands
Meeting short lead times
Handling a large variety of products
Meeting high service level possible
• Where do we compromise?
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Given procurement limitations, responding to
customer demand would require a compromise
• How responsive should a procurement be?
– Quicker response implies increased costs
(responsiveness).
– Delayed response implies lower costs (efficient).
• Therefore, a firm must compromise between
quicker response and lower costs and strike a
balance that suits its objectives.
• See the graph.
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A comparison of cost and responsiveness
Responsiveness
High
Low
High
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Low
Cost
Efficient and Responsive procurement chains – A Comparison
Efficient
Responsive
Primary goal
Supply demand at the lowest
cost
Respond quickly to demand
Product design strategy
Min. product cost
Modularity to allow
postponement
Pricing strategy
Lower margins
Higher margins
Mfg strategy
High utilization
Capacity flexibility
Inventory strategy
Minimize inventory
Buffer inventory
Lead time strategy
Reduce but not at expense of
greater cost
Aggressively reduce even if
costs are significant
Supplier selection strategy
Cost and low quality
Speed, flexibility, quality
Transportation strategy
Greater reliance on low cost
modes
Greater reliance on responsive
(fast) modes
3. Achieving Strategic Fit
• Now that a firm has assessed customer needs, demand
uncertainties, and procurement chain constraints and
uncertainties, it is time to make the two fit with each
other.
• How?
• In most cases, by offering high responsiveness to
products with high demand uncertainties and
• Striving towards more cost efficiencies for products
with low demand uncertainties.
• Compare these two products: computers and cheese.
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Let us revisit Dell’s strategy
• Dell proposed a competitive strategy that it will
ship ordered consumer products within 72 hours;
a relatively high response rate.
• What are the factors that Dell must consider?
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Dell Achieving Strategic Fit
• First, Dell should be able to forecast customer
demand with some degree of accuracy (demand
uncertainty).
Decide how much of this demand uncertainty it
can meet – e.g. we can offer 72 hours shipment in
the case of jackets and overcoats but not for school
bags (implied demand uncertainty).
• Also, note other items that Dell must consider:
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Dell – Achieving Strategic Fit
• Decide whether its procurement chain – from manufacturers to
trucking companies to warehouses would be able to meet its goal of
72 hours shipment.
• Decide how much inventory Dell should carry and how much
should its procurement chain partners carry.
• How soon can Dell inform manufacturers of changing fashions and
demands?
• Ascertain the flexibility (in procurement of raw materials, mfg.
capacity, labor, etc.) that its procurement chain partners have (or
do not have)?
• Consider the cost of all of these factors and decide on the
responsiveness spectrum or the zone of fit.
• See the next slide.
•
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Remember the following about Strategic Fit
• Two key points
– there is no right procurement chain strategy
independent of competitive strategy
– there is only a right procurement chain strategy
for a given competitive strategy
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What did we learn
• Formulating corporate strategy is easier than
implementing strategy.
• Strategy implementation requires the cooperation of
both internal and external parties and
• In turn, that requires common objectives and common
benefits.
• Strategy is not an one time implementation but
something that requires constant redesign.
• Procurement or supply management is one of the
largest assets in an organization and
• The implication of managing it well has significant
consequences to an organization.