1-1 Procurement Chain Management A Strategic Implementation Process

1-2 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.

1-3 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)

1-4 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).

1-5 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.

1-6 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, , by over 3,000%

1-7 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.

1-8 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. A procurement or a supply example

1-9 Buying Cereals from Wal-Mart Tenneco Packaging Paper Manufacturer Timber Company P&G or other Manufacturer Corn manufacturer Wal- Mart Plastic Producer Customer

1-10 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.

1-11 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.

1-12 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.

1-13 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.

1-14 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.

While we agree on the importance of procurement, how does it translate into a corporate strategy?

2-16 Achieving strategic Fit – Matching multiple strategies

2-17 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.

2-18 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.

2-19 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.

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. 2-20

2-21 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.

2-22 Sub-strategies of competitive strategy are used to decide Product development strategy: Portfolio of new products the company develops Marketing and sales strategy: Market segmentation and product position, price, and promotion. procurement strategy: – Nature of material procurement, transportation of materials, manufacture of products, service, distribution of product

Competitive Strategy and procurement Strategy – The relationship Competitive strategy New Product Development Marketing & Sales OperationsDistributionService procurement Strategy Supplier Strategy Operations Strategy Logistics Strategy

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. 2-24

2-25 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.

2-26 Achieving Strategic Fit Achieved – The steps involved Step 1: Understanding the customer and procurement uncertainty Step 2: Understanding the procurement capabilities Step 3: Achieve strategic fit

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. 2-27

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. 2-28

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. 2-29

2-30 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

2-31 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?

2-32 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.

2-33 A comparison of cost and responsiveness HighLow High Responsiveness Cost

Efficient and Responsive procurement chains – A Comparison EfficientResponsive Primary goalSupply demand at the lowest cost Respond quickly to demand Product design strategyMin. product costModularity to allow postponement Pricing strategyLower marginsHigher margins Mfg strategyHigh utilizationCapacity flexibility Inventory strategyMinimize inventoryBuffer inventory Lead time strategyReduce but not at expense of greater cost Aggressively reduce even if costs are significant Supplier selection strategyCost and low qualitySpeed, flexibility, quality Transportation strategyGreater 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. 2-35

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? 2-36

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: 2-37

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. 2-38

2-39 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

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.