m4 Strategy Procurement

ITC
Module 4
Coverage: The Total Supply

Chain
Managing
Inventory
Measuring Specifying
& Evaluating Requirements
Performance & Planning
Supply
Analysing
Supply
Markets
12
11
Managing
International
Logistics
10
Managing
the Contract
& Supplier
Relationships
Understanding
the Corporate
Environment
Preparing
the Contract
Suppliers
7
Negotiating
ITC
Supplementary
Modules
&
5 Appraising
Shortlisting
1
8
Developing
Supply
Strategies
6
Obtaining &
Selecting
Offers
M4:Preface:1
This Module will help you to:

Develop appropriate supply
strategies for a companys
different categories of
products and services.
Spend your time and effort
where it is most needed when
managing the supply process,
and therefore achieve the best
results.
ITC
SUPPLY
STRATEGY
M4:Preface:2
Definitions
Figures
Key
Points
Further Learning Sources:
www.ipscm-learningnet.net
Learning
Objectives
Action
Points
ITC
Learning
Check
M4:Preface:3
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
RelationRelationships
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
By the end of this Unit, you should be able to:

List the main elements of a supply strategy.
ITC
M4:U1:1
Module 4 - Developing Supply Strategy
ITC
Unit 2
A Framework for Supply Strategy
Unit 3
Supplier Relationships and Contract Types
Unit 4
Supply Strategy for Routine Items
Unit 5
Supply Strategy for Leverage Items
Unit 6
Supply Strategy for Bottleneck Items
Unit 7
Supply Strategy for Critical Items
Unit 8
Supply Strategy for Commodities
Which
strategy?
M4:U1:1.2-1
Having a supply strategy

means knowing:
How many supply market segments to buy from
How many suppliers to buy from
What type of relationship to have with your
suppliers (arms length or collaborative)
What type of contract to have
Which operational procurement strategies to pursue
ITC
M4:U1:1.1-1
The Supply Positioning Model

Helps you to:
Prioritise your time and effort

Develop your supply strategies
ITC
M4:U2:2.2-3
The Supply Positioning Model:
4 types of purchase items
M
Impact/
supply
opportunity/
risk rating
Bottleneck
Critical
Routine
Leverage
80% of items = 20% of value
20% of items = 80% of value
Expenditure
ITC
M4:U2:2.2-4
What do these
quadrants mean
to you?
Routine
Leverage
Bottleneck
Critical
ITC
M4:U2:2.2-5
Summary of typical quadrant characteristics

of the Supply Positioning Model
Routine
Impact/supply
opportunity/ risk
to your company
ITC
Low
Leverage
Bottleneck
Critical
Low
High
High
Often nonstandard, but
could be either
Standard or nonstandard purchase

items
Standard
Standard
Often nonstandard, but

could be either
Number of
suppliers
Many
Many
Few
Few
Level of
expenditure for
your company
Low
High
Low
High
Attractiveness of
your business to
suppliers
Low
High
Low
High
M4:U2:2.2-6
Action Point
2.2-1
Positioning purchases
Write down two examples of each
Routine purchases
Leverage purchases
Bottleneck purchases
Critical purchases
ITC
M4:U2:2.2-7
The Supply Positioning Model - some examples
Bottleneck
Critical
Routine
Leverage
I/SO/R
rating
Expenditure
ITC
M4:U2:2.2-8
Moving Around the Supply Positioning Model

Classic
bottleneck
Almost
critical
Almost
bottleneck
Critical
Bottleneck
I/SO/R
rating
Almost
routine
Almost
critical
Leverage
Routine
Classic
routine
Almost
leverage
Elements of
all quadrants
Almost
bottleneck
Classic
critical
Almost
leverage
Almost
routine
Classic
leverage
Expenditure
ITC
M4:U2:2.2-9
Your overriding objective...

...is to increase leverage!
Reduce Risk
I/SO/R
rating
Critical
Reduce Risk
Bottleneck
Increase expenditure
Routine
Leverage
Expenditure
ITC
M4:U2:2.2-10
Identify different items that can

be grouped together (e.g., office &
computer consumables)
Group the requirements of
different sites and users
Group your requirements with
those of other companies (e.g.,
amongst SMEs)
Increase expenditure
ITC
M4:U2:2.2-11
Review the specifications and go

for standards where possible
Work with suppliers to develop

their capabilities
ITC
Reduce Risk
Identify new sources through

supply market analysis
M4:U2:2.2-12
Action Point
2.2-2
Moving towards the leverage quadrant

Routine item: Ways to increase expenditure and/or reduce risk
Bottleneck item: Ways to increase expenditure and/or reduce risk
Critical item: Ways to increase expenditure and/or reduce risk
ITC
M4:U2:2.2-13
Single or multiple
market segments?
Disadvantage of multiple segments:
By splitting your requirements you lose leverage
Costs & inefficiencies of moving up the learning
curve
You may need to go for multiple segments if:
One segment cannot reliably meet your
requirements
You have multiple sites, and buying from only one
market may not be possible
ITC
M4:U2:2.3-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Explain the meaning and implications of using the following 6 main types of
buyer-supplier relationships:
- spot buy
- regular trading
- call-off contracts
- fixed contracts
- partnerships
- joint ventures
Explain the benefits and drawbacks of making a product or providing a service
internally as opposed to purchasing it.
Describe how suppliers perceptions and your relative bargaining position will affect
your supply strategy and your relationships with suppliers.
ITC
M4:U3:1
The supplier-buyer
relationship
/ contract continuum
Spot
purchase
ITC
Regular
trading
Call-off
contracts
Fixed
contracts
Partnership
Joint
ventures
Internal
provision
M4:U3:3.1-1
Select the best overall deal at the time of purchase

Focus on price
No personal relationship
Expect low priority & low motivation from supplier
Using many different suppliers will involve high costs
Good for one-off requirements
Good for standard products with low switching costs and
when annual expenditure is high
ITC
M4:U3:3.1-2
Repeated spot purchases

You need to ensure that the supplier remains competitive
Frequent interaction will lead to mutual understanding
Suppliers used frequently tend to give you higher priority - you
may also have one preferred supplier
Good when you dont know requirements in advance and/or
when each requirement is different
ITC
M4:U3:3.3-1
Are also called framework agreements,

blanket contracts or standing orders
Supplier agrees to provide items at agreed prices and within
agreed timescales on as needed basis over a period of time
Saves time and effort for you and allows end-users to call-off
requirements directly
Good for frequently required products & services and when it is
difficult to predict amounts in advance
Building in supplier performance measurements can be useful
ITC
M4:U3:3.4-1
4
You commit to purchase a certain volume or value
This type of contract is more attractive to the supplier
and you may therefore get better conditions
Good for frequent requirements when volumes can be
predicted in advance
ITC
M4:U3:3.5-1
Action Point
3.5-1
Call-off and fixed contracts

Items purchased
ITC
Fixed or calloff contract?
Why or why not?
M4:U3:3.5-2
A successful partnership is characterised by:

Mutual interdependence
High levels of trust
A high degree of interaction and information sharing
A focus on costs rather than price
Teamwork
Investment in the relationship
ITC
M4:U3:3.6-1
GOAL
Partnerships are appropriate for critical and

bottleneck items and where the focus is on longterm product development
They can allow you to achieve a better result than
you could have achieved alone
Partnerships require time and effort so selecting
the right partner is fundamental
ITC
M4:U3:3.6-2
Comparison between arms-length relationships and partnerships

Arms-length relationships
Partnerships
No collaboration
Collaboration is the main reason
Short-term focus
Long-term focus
Focus on negotiating the price down
Focus on understanding and reducing costs
Opportunistic
Joint optimisation
Low level of trust
High level of trust
Minimum information sharing to hide

positions
Much information sharing to promote optimal

decision-making
No investment in the relationship
Investments made to improve the efficiency

and effectiveness of doing business
Disputes resolved by reference to

contracts
Disputes resolved by discussion
No personal relationships
Strong personal relationships
Little effort required to manage supplier

relationships
Involves significant effort to manage the

relationship
ITC
M4:U3:3.6-3
How to develop a partnership:

Becoming aware of the need for a partnership
Conceptualising the partnership
Pursuing the partnership
Confirming the partnership
Implementing and administering the partnership
Assessing the partnership
Terminating the partnership
ITC
M4:U3:3.6-4
Determining if a partnership is working:

Adherence to standards
Operational co-operation
Partner co-ordination
Organisational compatibility and style
Power imbalance
The level of strategic co-operation
ITC
M4:U3:3.6-4a
Partnerships sometimes fail because:

The buyer is unable to adjust to the partnership culture
One party is more dependent on the relationship than the other
Key people are replaced
The level of time and investment needed was underestimated
The relationship loses commercial focus
ITC
M4:U3:3.6-4b
Action Point
3.6-1
Partnership and your organisation

Three of your purchase products where you are you using a
partnership approach:
How do you benefit?
For which three other of your purchase items could you envisage
developing a partnership?
What would make you ready/prevent you from doing this?
ITC
M4:U3:3.6-5
A joint venture is a separate unit formed and owned by

two or more organisations
More direct influence than in a partnership...
..but also more expensive to set up and manage
For products or services which are significant to your
competitive advantage
ITC
M4:U3:3.7-1
Internal provision means making rather than buying

Gives you maximum control over
supply and reduces supply risk
But:
Developing or acquiring the capabilities to provide can be
very costly
Your fixed costs will increase
You may not reach an efficient scale of production
ITC
M4:U3:3.8-1
Action Point
3.6-1
Which approaches to supplier relationships does your company

use?
Type of relationship/contract
Approximate number of suppliers involved
Spot purchase
Regular trading
Call-off contracts
Fixed contracts
Partnerships
Joint ventures
ITC
M4:U3:3.8-2
The Supplier Perception Model

-how suppliers see your company as a potential client
High
Level of
attractiveness
Low
ITC
Develop
Core
Marginal
Exploit
Value of
business
High
M4:U3:3.9-1
Supplier Perceptions
Develop
Core
Marginal
Exploit
ITC
M4:U3:3.9-2
Marginal
Low priority & low supplier motivation
No development potential
Your bargaining position will be weak
ITC
M4:U3:3.9-3
Exploit
Your level of purchases may be important but the supplier

sees no reason to develop a long-term relationship
The supplier will not make any particular effort or give you
priority
If the supplier is sure of your business it may exploit you by
raising prices
ITC
M4:U3:3.9-4
Develop
Your business may be small but the supplier sees a long-term
development potential or wishes to be associated with your
company for other reasons
The supplier is willing to invest time & effort in the relationship
This quadrant is suitable for long-term and cooperative
relationships
ITC
M4:U3:3.9-5
Core
The supplier consider your company to be part of its

core business (in terms of current business as well as
development potential)
Suppliers will make a significant effort to sell to you
and to retain your business
This quadrant is suitable for partnerships
ITC
M4:U3:3.9-6
The effect of Supplier Relationships

Implications of suppliers perceptions of your business
for supplier relationships
Suppliers perceptions of
your companys business
Low
Medium-high
Very high
ITC
What to do as a buyer
Be a good customer
Develop a partnership
Dominate the relationship, but be fair and
reliable
M4:U3:3.9-7
The effect of Supplier Relationships

Being a good customer means:
Paying on time
Being efficient & effective
To avoid being bothersome
Having an account manager for the supplier
Responding swiftly to queries
Handling administrative formalities yourself
Being professional & ethical
ITC
M4:U3:3.9-8
Linking the Supply Positioning Model...

Develop
Marginal
Core
Bottleneck
Critical
Routine
Leverage
Exploit
... and the Supplier Perception Model...

ITC
M4:U3:3.9-8a
Reverse marketing
The buyer makes a proactive effort to
itself to the supplier by:
sell
Taking the initiative to develop the relationship

Uses persuasion to convince the supplier
Suggesting attractive prices, terms & conditions
Being involved in product development with the supplier
Improving the suppliers capabilities (and motivation) to
supply the required goods
ITC
M4:U3:3.9-8b
Action Point
3.9-1
Suppliers perceptions
Put yourself in the shoes of potential suppliers:
Which are your positive points?
Which are your negative points?
How could you become more attractive to suppliers?
ITC
M4:U3:3.9-9
your options...
GOAL
4
ITC
M4:U3:3.10-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Define supply strategies for specific Routine items in terms of:
l
l
l
l
l
l
l
ITC
Number of suppliers to use

Type of supplier relationships
Type of contract to use
General operational strategies
Specific operational strategies
Ideal supplier characteristics
Types of individual buyers to be involved
M4:U4:1
The 4 categories of items

Leverage
Routine
Critical
Bottleneck
ITC
M4:U4:4.1-1
For each type of item well look at:

How many suppliers to use?
What type of a relationship to have?
What type of contract to use?
What operational strategies to have?
What type of supplier you should look for?
What types of buyers need to be involved?
ITC
M4:U4:4.2-1
Routine Items
What are they?
Many suppliers & the item is readily available
Standard item
Your annual expenditure on the item is low
The item is low risk to your company
Your expenditure only represents a small part of the
suppliers turnover
ITC
M4:U4:4.2-2
Routine Items
You would therefore like to:
Have simple procurement processes

Minimise administrative costs
Minimise intervention with the supplier
Delegate actual buying to end-users
ITC
M4:U4:4.3-1
Routine Items
Using many different suppliers for routine items means
unnecessary high efforts and costs
Try to use one single preferred supplier
Try to have long-term, call-off or evergreen contract
which covers as many items as possible
You can link prices to an index or use cost-reduction
clauses
ITC
M4:U4:4.3-2
Action Point
4.3-1
Routine purchases
Purchased
item
ITC
Current
number of
suppliers
Current
contractual
basis
Is the approach satisfactory? If

not, what would you propose, and
why?
M4:U4:4.3-3
Operational Strategies
for Routine Items
Operational Strategies can only be implemented once a
supplier has been chosen
Generic operational strategies cover all or most routine
items
Specific operational strategies are set for the purchase of a
specific item
ITC
M4:U4:4.4-1
Generic Operational Strategies

for Routine Items
Process re-engineering - simplifying your
procurement processes
Process automation - use of computers and special
software
Eliminate inspection
Delegation of call-off responsibility to end users
Use of purchasing cards
E-commerce
ITC
M4:U4:4.4-2
Action Point
4.4-1
Generic operational strategies

What operational strategies do you use for your routine items?
Which could you use?
ITC
M4:U4:4.4-3
Specific Operational Strategies

for Routine Items
Holding inventory
Consolidated billing
E-commerce
Secure a customer account manager
within the suppliers organisation who is
responsible for your companys account
ITC
C.A.M
M4:U4:4.4-4
Which operational strategy to use?

Operational strategies for routine items
Strategy
Holding
inventory
Supply targets
typically
affected
Availability
Circumstances when appropriate

Requirements must be satisfied immediately.
Frequent requirements frequent.
Stock holding costs are less than the cost of setting
up an alternative supply source).
Consolidated
billing
Cost of
acquisition
Many invoices to process.
E-commerce
Cost of
acquisition
A small number of users have a high number of

transactions with a particular supplier.
Customer
account manager
ITC
Responsiveness
Where there are emergency requirements or where

support of some kind may be required.
M4:U4:4.4-5
Action Point
4.4-2
Specific operational strategies for routine items

Specific
operational
strategy
Routine products or
services:
Issues involved in applying the strategy:
Holding
inventory
Consolidated
billing
Currently using
the strategy
E-commerce
Would benefit
from the
strategy
Customer
account
manager
ITC
M4:U4:4.4-6
Suppliers of Routine Items

- desirable characteristics
Able to provide a wide range of items and
to supply these over the long term
Have processes which are simple, consistent & reliable
Be responsive and effective
Able to provide consolidated monthly bills
Willing to designate a customer account manager
Able to accept purchasing cards and/or trade electronically
ITC
M4:U4:4.5-1
Buyer Characteristics
Good understanding for how processes work

and how they can be simplified
Junior level may be sufficient
More senior buyers need to be involved in the
setting up of call-off contracts
ITC
M4:U4:4.5-2
One-time or infrequent purchases

of Routine Items
Try to use suppliers that you are already buying

from
If possible, let end-users buy the items directly
(under clear rules and guidelines)
Use purchasing cards
12
3
9
6
ITC
=
M4:U4:4.6-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Define supply strategies for specific Leverage items in terms of:
Operational strategies
Identify the costs of switching from one supplier to another.
Identify the differences in supply strategies for leverage items on the basis of
different levels of switching costs
ITC
and of supplier prices.
M4:U5:1
Leverage Items
What are they?
Many suppliers & the item is readily available
Standard item
Your annual expenditure on the item is high
The item is low risk to your company
Your relatively high expenditure makes your purchases
attractive to suppliers
ITC
M4:U5:5.1-1
Leverage Items
Since the value is high & risks are low,

you will focus on price
Price changes can have a significant
impact on your company
Since the value is high, a degree of
switching costs can be tolerated
ITC
M4:U5:5.1-2
Leverage Items
Supply strategy options depend on:
The volatility of the market
Your knowledge of the supply market
The degree of price variation amongst suppliers
The level of switching costs
ITC
M4:U5:5.1-3
Switching costs
Switching costs are the costs associated with
changing suppliers
ITC
M4:U5:5.2-1
Switching costs
Can be:
Costs related to negotiating a contact
Re-training of staff
Changes in processes & design
Obsolescence of old stock
Penalties for terminating the previous contract
Inefficiencies in start-up phase, etc.
ITC
M4:U5:5.2-2
Action Point
5.2-2
Switching costs
Think of a purchase for your company in the leverage quadrant and
complete the table below:
Type of switching cost
Approximate magnitude of the cost
Total switching cost:

ITC
M4:U5:5.2-3
Switching costs
Suppliers may try to build in switching costs by:
Offering benefits & discounts for customer loyalty
Developing strong links with your executive
and/or technical staff
Providing free training and other services
ITC
M4:U5:5.2-4
Action Point
5.2-3
Switching costs - part two

Think of a purchase for your organisation that would be very costly
to move to a new supplier.
Has the current supplier been successful in building in
additional switching costs? Could these have been prevented?
Has your company built in other switching costs as a result of its

own strategy?
ITC
M4:U5:5.2-5
The relative bargaining position of buyers and

suppliers changes over time
Supplier
High
Bargaining
Buyer
power
Low
Contract
being
negotiated
ITC
Early part
of contract
term
Middle
of contract
term
Contract
becoming due
for renewal
M4:U5:5.2-6
Supply strategy for leverage items

Case 1: Very high switching costs
Type of relationship:
Co-operative (should not exploit

dominant position once the
buyer is locked in:)
Type of contract:
Term contract - typically

long term
Type of supplier to seek: Lowest cost over the contract

term
ITC
M4:U5:5.2-7
Price variation
Reasons:
Products may be differentiated
Suppliers are operating at different levels of capacity
Suppliers exploit the market ignorance of buyers
Suppliers costs are different
(e.g., distribution)
ITC
M4:U5:5.3-1

Case 2: Low price variability
a) If switching costs are negligible and allow you to exploit even small price differences
amongst suppliers, and if this is better for you than the additional leverage of placing all
your business with one supplier over a period of time, your strategy should be:
Number of suppliers:
Many
Nature of relationship:
Arms-length
Type of contract:
Type of supplier to seek:
Spot (purchase order)

Lowest price at time of purchase
b) If placing all of your business with one supplier gives you a price advantage (e.g., due to
quantity discounts):
One
Arms-length (buyer-dominant)
Type of contract:
ITC
Term contract
Lowest cost over the term of the contract
M4:U5:5.3-2

Case 3: High price variability & low switching costs
Many
Arms-length
Type of contract:
ITC
Spot (purchase order)

Lowest cost at time of
purchase
M4:U5:5.3-3
Case 4: High price variability & non-trivial switching costs

Two or three (regular trading)
Co-operative
Type of contract:
ITC
Framework/call-off
Lowest cost over the contract term
M4:U5:5.3-4
Action Point
5.3-1

Situation & strategy
proposed above
Examples of
leverage purchase
items in your
company
Your company s
current supply
strategy
If the two strategies are

different, which is more
appropriate? Why?
Low price variability

Spot purchase/term
contract
High price variability/
negligible switching costs
Spot purchase
High price variability/

significant switching costs
Regular trading
(framework/call-off
contract)
ITC
M4:U5:5.3-5
for Leverage Items
E-commerce
Benchmarking against industry norms
Demand forecasting
Process re-engineering /automation forecasting
Use of purchasing cards
Delegation of call-off responsibility to end users
Consolidated billing
C.A.M
Inspection
Customer account manager
ITC
M4:U5:5.4-1

Strategy
Supply targets
Circumstances
Demand
forecasting
Purchase price
Price is sensitive to volume
Benchmarking
Purchase price
Availability
Responsiveness
Reliable benchmarking data is available
E-commerce
Purchase price
Cost of acquisition
A website is available
Internet auctions exist
High number of transactions with single
supplier
Delegate
call-off
responsibility
Cost of acquisition
Priced call-off contract and appropriate

controls
ITC
M4:U5:5.4-2

(Cont d)
Strategy
Process reengineering
Supply targets
Circumstances
Availability (lead-time) High frequency of transactions

Cost of acquisition
Consolidated
billing/
purchasing
cards
Cost of acquisition
Inspection
Cost of acquisition
When items are non-standard or sensitive

to quality/quantity variations
Customer
account
manager
Responsiveness
Where emergency requirements or

support may be required
ITC
High number of invoices to process

Risk of purchasing card misuse is low
M4:U5:5.4-3
Action Point
5.4-1
Operational strategies for leverage items

Operational
strategy
Demand forecasting
Currently using
the strategy
Benchmarking
Would benefit
from the
strategy
E-commerce
ITC
Leverage products
or services:
Issues involved in applying

the strategy
M4:U5:5.4-4
Suppliers of Leverage Items

Basic capabilities (spot purchases)
Cost competitive suppliers in the short- & medium- term (term
contracts)
Suppliers that wouldnt exploit their strong bargaining position
once the contract has been awarded (long-term contract)
ITC
M4:U5:5.5-1
Strong negotiators who are comfortable with
arms-length relationships (spot purchases and
when entering into term contracts)
If switching costs are high, the person
managing the contract need to be good at
establishing and maintaining a co-operative
relationship
ITC
M4:U5:5.6-1
Implications of a poor
bargaining position
Use regular trading or longer-term contracts to
attract more supplier interest
Use negotiators who are good relationship
builders and can use a win-win approach
ITC
M4:U5:5.6-2

of Leverage Items
Spot buy focusing on price
Try to use e-commerce (e.g., electronic
auctions)
ITC
M4:U5:5.7-1
Supply strategy for continuously required leverage items

Case 2:
Element of
strategy
ITC
Case 1:
Very high
switching
costs
Case 3:
Low price
variability /
negligible
switching
costs
Low price
variability /
non-trivial
switching costs
Many
One
Number of
suppliers
One
Type of
contract
Term contract
typically long
term
Spot
Type of
supplier
Lowest cost
over the
contract term
Nature of
relationship
Co-operative
(will not
exploit
dominant
position once
buyer is
locked in)
Case 4:
High price variability
/low switching costs
Case 5:
High price variability /
non-trivial switching
costs
Many
Two or three
Term contract
Spot
Term (framework)
contract typically over
medium term
Lowest cost
today
Lowest cost
over contract
term
Lowest cost today
Lowest cost over the

contract term
Arms-length
Arms-length
(buyerdominant)
Arms-length
Co-operative
M4:U5:5.8-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Define supply strategies for specific Bottleneck items in terms of:
ITC
M4:U6:1
Bottleneck Items
What are they?
The item is high risk to your company
There are few suppliers
It is not a standard item
Your annual expenditure on the item is low
Your relatively low expenditure is likely to make your
purchases unattractive to suppliers
ITC
M4:U6:6.1-1
Bottleneck Items
What to do (I):
Focus on reducing risks - price & cost of acquisition is
of secondary importance
If possible, buy the item from one supplier for increased
leverage
If needed, use two suppliers to have a back-up option if
problems arise
ITC
M4:U6:6.2-1
Bottleneck Items
What to do (II):
Develop a close & long-term relationship with the

supplier(s)
Negotiate a guaranteed volume (e.g., per month) to
reduce risks & sign a long-term contract
Be a good customer
ITC
M4:U6:6.3-1
Action Point
6.3-1
Supply strategy for bottleneck purchases

Give examples of bottleneck items from your company
Current
Current number of
Purchased item
contractual
suppliers
basis
ITC
Appropriateness of the
proposed strategy
M4:U6:6.3-2
Operational Strategies for Bottleneck Items
Holding stock
Quality planning
Designating a supplier account manager
S.A.M
Business process re-engineering/

e-commerce to be a better customer
ITC
M4:U6:6.4-1

Operational strategies for bottleneck items
Strategy
Demand
forecasting
Phased release
of specification
information
Supply targets typically

affected
When to use which strategy
Purchase price
Where price is sensitive to volume.
Lead-time
Where capacity is limited or lead-times are

long.
Lead-time
Where lead-times are long.

Where items are complex and made to order
Availability
Wherever required (all bottleneck purchases).
Quality planning
Conformance to specification
When product or service quality is variable

and important t o you.
Supplier account
manager
Can indirectly affect various

supply objectives by making the
supplier more responsive.
All bottleneck purchases.
Holding stock
Business process
re-engineering /
e-commerce
ITC
Where doing things the supppliers way will

result in inc reased goodwill.
M4:U6:6.4-2
Action Point
6.4-1
Operational strategies for bottleneck items

Give examples from your company
Operational
strategy
Bottleneck products or
services:
Demand
forecasting
Phased release
of specification
information
Holding stock
Quality planning
Currently using
the strategy
Would benefit
from the
strategy
Supply account
manager
Process reEngineering / Ecommerce
ITC
M4:U6:6.4-3
Suppliers of Bottleneck Items

The supplier should be reliable and not
behave opportunistically or exploit its
strong bargaining position
It should be able to supply the required item for the long term
If the risks are upstream the supply chain, the supplier needs to
have sufficient clout & sound strategies with its suppliers
ITC
M4:U6:6.5-1
- Bottleneck Items
The buyer should be a team player who can
work with other functions in your company to
reduce risk
It is important to maintain a good impression of
the supplier and to be a good customer
The buyer should be more of a relationship
manager than a hard negotiator
ITC
M4:U6:6.5-2

of Bottleneck Items
Buy from the lowest risk supplier
Dont buy at the last minute
Use effective quality & time planning and
phased release of specification if relevant
QUALITY
ITC
M4:U6:6.6-1
Supply Strategy for Bottleneck Items

- Summary
Supply strategy for continuous bottleneck items
Type of contract:
One or two
Be a good customer
Term contract (probably
for a significant period)
Type of supplier
Must be particularly capable in the areas which pose the greatest
risk to your company
Will not exploit its strong bargaining position with your company
Will continue to supply the required products for the long term
ITC
ITC
M4:U6:6.7-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Define supply strategies for specific Critical items in terms of:
ITC
M4:U7:1
Critical Items
What are they?
They are non-standard
There are few suppliers
Few alternatives exist
The risk to your company is high
Your annual expenditure on the item is high
Your relatively high expenditure makes your purchases
attractive to suppliers
ITC
M4:U7:7.1-1
Critical Items
Suppliers will typically have a small number of large

customers
The numbers of suppliers to switch to will be limited
Partnership is the ideal relationship
ITC
M4:U7:7.2-1
Developing a partnership:
Partnerships involve time & effort and are based on trust
You need to be willing to work closely with the supplier and to
share information
Select a partner with which you can develop a competitive
advantage
The contract is more of an expression of
long-term commitment and one that
states the ground rules
ITC
GOAL
M4:U7:7.2-2
Action Point
7.3-1
Supply strategy for critical purchases

Give examples of bottleneck items from your company
Current
Current number of
Purchased item
contractual
suppliers
basis
ITC
Appropriateness of the
proposed strategy
M4:U7:7.3-1
for Critical Items (I)
Value analysis
Engineering
Value Analysis/Value Engineering

Process re-engineering & optimisation for both parties
Demand forecasting
Phased release of specification information
ITC
M4:U7:7.4-1
for Critical Items (II)
Organisational learning & communication strategy - how to
continuously develop and improve the relationship?
Capture the suppliers expertise & innovation capabilities to
optimise design
Protect future costs & availability (e.g., of replacement items &
spares for capital goods)
Joint approaches to quality assurance
ITC
QUALITY
M4:U7:7.4-2
for Critical Items (III)
Supplier and/or buyer development
Supplier account manager
S.A.M
Total cost of ownership modelling

Contingency planning
Holding stock (balance benefits against costs)
On-site supplier support & training
ITC
M4:U7:7.4-3
Which operational strategy to use? (I)

Selecting operational strategies for critical items
Value
Analysis/
Value
Engineering
Cost
Lead-time
Conformance to
specification
E.g.: new product development, high cost

elements or subject to quality
problems and business processes
Process reengineering
Lead-time
Conformance to
specification
Processes account for a significant

proportion of total lead-time or are
ineffective
Demand
forecasting
Purchase price
Lead-time
Price is sensitive to volume

Capacity is limited or lead-times long
Phased release of Lead-time

specification
information
ITC
Long lead-times and short time
M4:U7:7.4-4
Which operational strategy to use? (I)

(Cont d)
Selecting operational strategies for critical items

Communication Can indirectly
strategy
contribute to
many supply
targets
All partnerships
Capture
supplier
expertise &
innovation
See Value
Engineering
See Value Engineering
Protecting
future costs
Cost
Capital spares
ITC
M4:U7:7.4-5
Which operational strategy to use? (II)

Strategy
Supply targets
Quality
assurance
Conformance to
specification
Product or service quality is poor or

variable
Supplier
development
Cost
Lead-time
Conformance to
specification
Where your company has knowledge &

expertise that can help the supplier to address
an area of poor performance
Supplier
account
manager
Can indirectly
affect various
supply targets
All partnerships
Total cost of
ownership
modelling
Cost
Capital items with significant post-purchase

costs
ITC
Circumstances
M4:U7:7.4-6
Which operational strategy to use? (II)

(Cont d)
Strategy
Supply targets
Circumstances
Contingency
planning
Can impact many

supply targets if a
serious supply
problem occurs
For the most serious risks
Holding cost
Lead-time
Conformance to
specification
Long lead-time items that could result

in significant delays if delivered late
Cost
When frequent interaction with the supplier

required and skills need to be transferred
On-site
supplier
support/
training
ITC
Items that would cause significant cost

if they failed
is
M4:U7:7.4-7
Action Point
7.4-1
Operational strategies for critical items

Operational
strategy
Critical products or
services:
Value
engineering
Communication
strategy
Protecting
future costs
Currently using
the strategy
Supplier
development
Would benefit
from the
strategy
Total cost of
ownership
modelling
Contingency
planning
ITC
M4:U7:7.4-8
Suppliers of Critical Items

Be financially stable and have a sustainable
market position
Understand & agree to the concept of partnership
Not seek to exploit their situation
Not have a similar relationship with a competitor
Be cost & technologically competitive in the medium and long term
Have a business strategy that is compatible and aligned with yours
Be able to benefit from the relationship
Be able to reduce any upstream supply risk if applicable
ITC
M4:U7:7.5-1
- Critical Items
The buyer needs to be highly creative and a

relationship builder
It is important that negotiators are strategically
oriented and dont damage the relationship
Supply decisions for critical items should be
made at the highest level
ITC
M4:U7:7.5-2
Exceptions to the proposed strategy

Your business is not attractive to suppliers:
this will create a bottleneck situation
Suppliers are unwilling to enter into partnerships: this could be the
case in certain industries or supply markets
Exceptional reliance of the supplier on your company - dont
destroy creativity & innovation by using power
Unpredictable supply market leaders: you may not want to have a
partnership if technology leaders change frequently
If you cant find a suitable supplier: use joint ventures and
backward integration
ITC
M4:U7:7.6-1

of Critical Items
Include financial incentives & encourage innovation and
joint problem-solving in the contract
Communicate early and review progress regularly
Try value engineering workshops involving both parties
to optimise design
ITC
M4:U7:7.7-1
Supply Strategy for Critical Items

- Summary
Supply strategy for continuous critical items
Type of contract:
One
Partnership
Long term partnership contract
Type of supplier
Must be particularly capable in those areas which pose the greatest risk to your company.
Must have the ability to be a very low cost provider and/or technological leader in the long term.
Your required products and services must be core business to the supplier.
The suppliers business strategy must be compatible with your companys business strategy.
The supplier must be financially stable and have a sustainable market position.
It must not have any preferential relationship with your companys competitors.
It should not seek to exploit your companys position.
ITC
M4:U7:7.8-1
Module 4
ITC
Ed. 2002
Unit
Unit11
Introduction
Introduction
Unit
Unit22
Framework
Framework
for
forSupply
Supply
Strategy
Strategy
Unit
Unit33
ships&&
Contracts
Contracts
Unit
Unit44
Routine
Routine
Items
Items
Unit
Unit55
Leverage
Leverage
Items
Items
Unit
Unit66
Bottleneck
Bottleneck
Items
Items
Unit
Unit77
Critical
CriticalItems
Items
Unit
Unit88
CommodiCommodities
ties
Learning Objectives
Describe five options for purchasing commodities traded on

commodity exchanges.
List the main issues relevant to purchasing commodities

out of the commodity exchanges.
ITC
M4:U8:1
Market prices for commodities may vary significantly
TFC Commodity Charts - Lumber (CME) - Monthly Price Chart

ITC
M4:U8:8.1-1
Factors which can influence supply

and/or demand of commodities include:
Floods, drought, plant disease..
Wars & strikes
Changes in Government policy & regulations
Cartel agreements
Changes in consumer tastes
Availability of new substitutes
Activities of speculators
ITC
M4:U8:8.1-2
Purchasing commodities
PRICE is the main uncertainty!
MAIN OPTIONS FOR BUYERS:

1 Spot purchasing
Commodity exchanges give

reference prices, but involve
more paper trading than
physical delivery
You will normally buy from a
trader/dealer or producer
2 Speculating: will prices
go up
or down?
3 Hedging by Buying forward
4 Hedging in more complex situations
5 Call options
ITC
M4:U8:8.2-1
Option 1 - Spot purchasing...

Quantities are purchased only as & when needed
Little stock is held
In some cases it may be possible to regularly adjust the
prices of your finished products to reflect commodity market
prices - if not, you will bear the risk
12
3
9
6
ITC
M4:U8:8.2-2
Spot purchasing...
The example of Clunk Industries Ltd.
Spot: $100
T1
ITC
Spot: $?
T2
Clunkonite price used

for your contract
You purchase
clunkonite at
Spot T2: $?
Spot T2: $X
T3
Clients risk
M4:U8:8.2-3
Option 2 - Speculating...
Can be very risky and is not recommended unless
you have a very good understanding of the market
ITC
M4:U8:8.2-4
Speculating...
Spot: $100
T1
Spot: $?
T2

for your contract
Spot T2: $?
T3
Your risk &

clients risk
You purchase
clunkonite at
Spot T1: $100
ITC

for your contract
You purchase
clunkonite at
Spot T1: $100
Spot T2: $X
Your risk
M4:U8:8.2-5
Option 3 - Hedging through forward buying...

Use forward contracts which fix the price (based on the
futures price on the commodity exchange) for a given
quantity to be delivered to you at some point in the future
Forward buying eliminates your price risk
The main difference (basis) between the spot price and the
futures price is due to the carry cost (of holding stock) and
variations in supply & demand.
Futures prices are based on certain standard grades,
quantities and delivery months set by the commodity
exchange
ITC
M4:U8:8.2-6
Forward buying...
Spot: $100
T1
Futures: $110
Spot: $?
T2
T3

for your contract
Futures T2: $110

You place forward contract to
buy clunkonite at
No risk to you or
to your client
Futures T2: $110

ITC
M4:U8:8.2-7
Option 4 - Hedging (in more complex situations)

Hedging is a way of minimising your price risk by
simultaneously entering into two opposite contracts in two
different markets (e.g., in the cash market and in the futures
market).
ITC
M4:U8:8.2-8
More hedging...
by Clunk Industries Ltd.
Futures: $110
T1

for your contract
Spot T3: $?
T2
Canc
e
l out
Futures: $115
Spot: $?
T3
Clients risk
your
risk

buy clunkonite at
Futures T2: $110

sell clunkonite at
ITC
Futures T3: $115
Cancel out
your risk
You purchase
clunkonite at
Spot T3: $Y
M4:U8:8.2-9
Option 5 - Call options

Another form of hedging. A call option gives you
the right - but not the obligation - to purchase an
amount of a commodity at a fixed price at a
specified time in the future
ITC
M4:U8:8.2-10
When to use which strategy

Guidance on the usage of different commodity purchasing strategies
Strategy
Buy only for
immediate
requirements
Speculation
Effect
Pay the market price (and accept
that the market will change).
If successful, you pay less than

the average market price if
unsuccessful, you pay more.
When appropriate
When you have a low expertise in the market.
When the price of finished goods can vary to take
full account of variations in the price of the
commodity.
When there is certainty of future requirements.
When the buyer has a high level of market
expertise.
Avoid this option wherever possible.
Fixes the price of a future

purchase.
When future requirements are certain.
Hedging
Mostly cancels out the effect of

price moves in the market.
When you will be paid based on the price of the

commodity at a date different to that when you
need to buy it.
Call options
Fixes the price for a future

purchase, but there is no
obligation to make the purchase.
When you need a fixed price for the commodity

for use in a quotation or bid.
Buying forward
(futures
contract)
ITC
When you prefer to know the price in advance

rather than take the risk of the market price at
the time of purchase.
M4:U8:8.2-11
Other things to consider

Buying from the producer...
You may spot buy or use term contract
You may try for a fixed price, but may
have to renegotiate if prices change much
Build in pricing schemes if appropriate (e.g.,
minimum & maximum thresholds)
or from the local market

No commodity exchange mechanisms, so you will
have to spot buy or speculate
ITC
M4:U8:8.3-1

m4 Strategy Procurement

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ITC

Coverage: The Total Supply

This Module will help you to:

By the end of this Unit, you should be able to:

Module 4 - Developing Supply Strategy

A Framework for Supply Strategy

Supplier Relationships and Contract Types

Supply Strategy for Routine Items

Supply Strategy for Leverage Items

Supply Strategy for Bottleneck Items

Supply Strategy for Critical Items

Supply Strategy for Commodities

Having a supply strategy

The Supply Positioning Model

Prioritise your time and effort

The Supply Positioning Model:

4 types of purchase items

80% of items = 20% of value

20% of items = 80% of value

Summary of typical quadrant characteristics

Standard or nonstandard purchase

Often nonstandard, but

The Supply Positioning Model - some examples

Moving Around the Supply Positioning Model

Your overriding objective...

Identify different items that can

Review the specifications and go

Work with suppliers to develop

Identify new sources through

Moving towards the leverage quadrant

Bottleneck item: Ways to increase expenditure and/or reduce risk

Critical item: Ways to increase expenditure and/or reduce risk

Select the best overall deal at the time of purchase

Repeated spot purchases

Are also called framework agreements,

Call-off and fixed contracts

Fixed or calloff contract?

Why or why not?

A successful partnership is characterised by:

Partnerships are appropriate for critical and

Comparison between arms-length relationships and partnerships

Collaboration is the main reason

Focus on negotiating the price down

Focus on understanding and reducing costs

Low level of trust

High level of trust

Minimum information sharing to hide

Much information sharing to promote optimal

No investment in the relationship

Investments made to improve the efficiency

Disputes resolved by reference to

Disputes resolved by discussion

Strong personal relationships

Little effort required to manage supplier

Involves significant effort to manage the

How to develop a partnership:

Determining if a partnership is working:

Partnerships sometimes fail because:

Partnership and your organisation

How do you benefit?

What would make you ready/prevent you from doing this?

A joint venture is a separate unit formed and owned by

Internal provision means making rather than buying