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Procurement Chain Management

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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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Buying Cereals from Wal-Mart


Timber Company Paper Manufacturer Tenneco Packaging

P&G or other Manufacturer

Wal- Mart

Customer

Corn manufacturer

Plastic Producer

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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 customers 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 Nikes strategy: R and D on one hand and marketing, sales, and distribution on the other. Example 2: CISCO CISCOs 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

Service

procurement Strategy

Supplier Strategy

Operations Strategy

Logistics Strategy

See the Dell example Matching competitive and procurement strategies


Suppose Dells 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 Dells competitive strategy.

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The Dells 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.

Dells 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 Primary goal Supply demand at the lowest cost Min. product cost Responsive Respond quickly to demand

Product design strategy

Modularity to allow postponement Higher margins Capacity flexibility Buffer inventory Aggressively reduce even if costs are significant

Pricing strategy Mfg strategy Inventory strategy Lead time strategy

Lower margins High utilization Minimize inventory Reduce but not at expense of greater cost

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 Dells 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.