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Operations and Supply Chain Management

Kraljic’s Supply Matrix

S19: SOURCING MANAGEMENT

Prof. Vivek Roy

Indian Institute of Management Kashipur

Kraljic’s supply matrix

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Kraljic’s Supply Matrix

• Top right quadrant: The Bullwhip Effect
• Strategic items where supply risk and impact on profit are
high
• Highest impact on customer experience
• Forward buying: retailers responding to a temporary price cut by
• Price is a large portion of the system cost stocking up
• Typically have a single supplier
• Focus on long-term partnerships with suppliers
• Bullwhip effect: phenomenon of variability magnification as we move
• Bottom right quadrant from the customer to the producer in the supply chain
• Items with high impact on profit
• A slight change in consumer sales ripples backward as magnified oscillations
• Low supply risk (leverage items) upstream, like the result of a flick of a bullwhip handle
• Many suppliers
• Small percentage of cost savings will have a large impact on
bottom line
• Focus on cost reduction by competition between suppliers

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Increasing Variability of Orders Up the Supply Kraljic’s Supply Matrix

Chain • Firm’s supply strategy should depend on two
dimensions
• profit impact
• Volume purchased/ percentage of total purchased cost/ impact on
product quality or business growth

• supply risk
• Availability/number of suppliers/competitive demand/ make-or-
buy opportunities/ storage risks/ substitution opportunities

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What is Sourcing?

Sourcing is the business function responsible

for all activities and processes required to
purchase goods and services from suppliers

• select suppliers
• negotiate contracts
• manage process of acquisition

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Related Terms

• Purchasing
• process of buying goods and services
• supplier selection, buying, negotiating contracts

• Strategic Sourcing
• seeks competitive advantage with sourcing
opportunities
• builds supplier relationships

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Strategic Sourcing Strategic Sourcing Continued

• Strategic sourcing: the development and management of supplier
relationships to acquire goods and services in a way that aids in
achieving the immediate needs of the business
• In the past, sourcing was another name for purchasing
• As a result of globalization, sourcing implies a more complex process
suitable for products that are strategically important
• Specificity: refers to how common the item is and, in a relative sense, how many
substitutes might be available
• Commonly available products can be purchased using a relatively simple process
• Request for proposal (RFP): used for purchasing items that are more complex or
expensive and where there may be a number of potential vendors
• Vendor-managed inventory: when a customer actually allows the supplier to
manage an item or group of items for them

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Sourcing Decisions: The Make-or-Buy

Sourcing Design Matrix
Decision
• Outsourcing - buying materials and components from suppliers instead of making them in-
house. The trend has moved toward outsourcing.
• Backward integration refers to acquiring sources of supply
• Forward integration refers to acquiring customer’s operations.

The Make or Buy decision is a strategic decision.

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Sourcing Decisions: The Make-or-Buy Sourcing Decisions: The Make-or-Buy Decision- Cont.
Decision- Cont.
Reasons for Buying or Outsourcing Reasons for Making

• Cost advantage: Especially for components that are non-vital to the • Protect proprietary technology
organization’s operations. • No competent supplier
• Better quality control
• Insufficient capacity: A firm may be at or near capacity. • Use existing idle capacity
• Control of logistics- lead-time transportation, and
• Lack of expertise: Firm may not have the necessary technology and warehousing cost
expertise. • Lower cost

• Quality: Suppliers have better technology, process, skilled labor, and the
advantage of economy of scale. Many times companies use a
combination of both make & buy

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Sourcing Decisions: The Make-or-Buy Decision- Cont. Roles of Supply Base

The Make-or-Buy Break-Even Analysis
Supplier Base - Suppliers that a firm uses to acquire its materials, services,
supplies, and equipment.

Firms emphasize long-term strategic supplier alliances consolidating volume

into one or fewer suppliers, resulting in a smaller supply base.

Preferred suppliers provide:

• Early supplier involvement- Information on the latest trends in
materials, processes, or designs
• Information on the supply market
• Capacity for meeting unexpected demand
• Cost efficiency due to economies of scale

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Supplier Selection How Many Suppliers to Use

The process of selecting suppliers, is complex and should be Single-sourcing- a risky proposition. Although trends favor
based on multiple criteria: fewer sources, avoid single source.

• Product and process • Order System and cycle Reasons Favoring a Single Supplier Reasons Favoring More than One
technologies time Supplier
• Willingness to share • Capacity • To establish a good relationship
technologies and • Communication • Less quality variability • Need capacity
information capability • Lower cost • Spread risk of supply interruption
• Quality • Location • Transportation economies • Create competition
• Cost • Service • Proprietary product or process • Information
• Reliability • Volume too small to split • Dealing with special kinds of
business

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Sourcing Process Sourcing Design Matrix

• Supplier Selection
• Existing vs. New Suppliers
• Request for Quotation (RFQ), Request for
Proposal (RFP), Request for Bid (RFB)

• Negotiate Contracts

• Manage Process of Acquisition

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Electronic Auctions Advantages of E-Auctions

Buyers can use Electronic Auctions (E-Auctions) to
select suppliers and determine aspects of the • simplified comparison of supply sources
purchase contract
• decreased error rate
Look at:
• market transparency
• Advantages and Disadvantages
• increased buying reach
• Types of E-Auctions
• reduction in ordering cycle time
• Criteria for Use
• Three Stages of the E-Auction Process

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Disadvantages of E-Auctions Types of E-Auctions

• Open Auction
• unrealistic low bidders seek to renegotiate • suppliers can select items to place offers on
after contract is awarded (may eliminate • suppliers can see competitive offers
better suppliers) • suppliers can keep submitting offers until close

• auction may include nonparticipants • Sealed Bid Auction

seeking to gather market intelligence
• may interrupt an existing good supplier
relationship
• sellers submit one blind bid
• Reverse Auction
• one buyer and many sellers
• most common type
• sellers place decreasing bids

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E-Auction Criteria Three Stages of E-Auction Process

1. Preparation
• E-Auctions should have: • set product requirements
• identify and prequalify suppliers
• specifications for goods or services well
defined • specify auction rules
• test and train participants on technology
• sufficient number of qualified suppliers
2. The Auction Event
• clear understanding of market standards
• communication between suppliers and seller
• clear rules for running the E-Auction
3. Follow-up

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Sourcing Process Continued Bidding or Negotiation?

Sourcing function determines how to award
It is important for supplier management to be
contracts
directed through the sourcing function
• combine requests from different users for same • Competitive Bidding
materials to lower costs
• awards business to the most qualified bidder
• seek input from other functions of organization • most efficient for purchasing standard items
• understand material requirements to meet • Negotiation
performance standards
• communication process between two parties that
• “Maverick buying” attempts to reach a mutual agreement
• best when working with suppliers on factors
beyond the purchase

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Bidding or Negotiation? Cost vs. Price

• Cost
• sum of all costs incurred to produce the product

Total Cost = Fixed Costs + Variable Costs

• Fixed Costs
• do not vary with # units produced
• taxes, insurance, overhead

• Variable Costs
• vary directly with # units produced
• materials, labor

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Cost vs. Price Continued Cost vs. Price Example

• Price
Variable Cost

• the amount at which the item is sold in the marketplace Materials $5,000

Labor $2,000

• Fair Price +
• lowest price that can be paid while ensuring a continuous
Fixed Cost
supply of quality goods
Facility Overhead $3,500

• Total Cost of Ownership (TCO) Total Cost (not TCO) $10,500

• purchase price plus all other costs associated with acquiring the +
item
Profit $1,000

Selling Price $11,500

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The Role of Purchasing in an Organization The Purchasing Process

The primary goals of purchasing are:
1. Ensure uninterrupted flows of raw materials at the lowest total cost,
2. Improve quality of the finished goods produced, and
3. Optimize customer satisfaction (internal and external – who are internal
customers?)
Purchasing contributes to these objectives by:
• Actively seeking better materials and reliable suppliers,
• Work closely with strategic suppliers to improve quality materials, and
• Involving suppliers and purchasing personnel in new product design and
development efforts.
Manual Purchasing-Older system, prone to duplication of effort and error
Step 1-Material Requisition/Purchase Requisition- stating product, quantity, and delivery due date
are clearly.
Step 2- The Request for Quotation (RFQ) or Request for Proposal (RFQ)- Buyer identifies suppliers
& issues a request for quotation/proposal(RFQ/P).
Step 3- The Purchase Order (PO)- The purchase order is the buyer’s offer & becomes a binding
contract when accepted by supplier.
Step 4- Expediting- The proactive checking to make sure that an order will be completed on time.

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The Purchasing Process- Cont. The Purchasing Process- Cont.

Electronic Procurement (e-Procurement)

Advantages for the e-Procurement System
• Time savings
Step 1- Material user inputs a materials requisition- relevant information such as quantity and date
needed. • Cost savings
• Accuracy
Step 2- Materials requisition submitted to buyer- at purchasing department (hardcopy or electronically). • Real time
Step 3- Buyer assigns qualified suppliers to bid- Product description, closing date, & conditions are • Mobility
given. • Trackability
Step 4- Buyer reviews closed bids & selects a supplier
• Management
• Benefits to the suppliers
Companies utilize EDI (Electronic Data Interchange, extranets, etc)

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Purchasing: Centralized vs. Decentralized Purchasing: Centralized vs.

Decentralized
Purchasing Organization dependent on Advantages- Centralization Advantages- Decentralization
many factors, such as market conditions • Concentrated volume- • Closer knowledge of
& types of materials required. leveraging purchase volume requirements
• Avoid duplication
• Local sourcing
• Centralized Purchasing- purchasing • Specialization
department located at the firm’s • Lower transportation costs • Less bureaucracy
corporate office makes all the purchasing • No competition within
decisions. units
• Common supply base
• Decentralized Purchasing- individual,
local purchasing departments, such as A hybrid purchasing organization- both decentralized at the
plant level, make their own purchasing corporate level and centralized at the business unit level may be
decisions.
warranted.

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International Purchasing/Global
Sourcing Measuring Sourcing-Purchasing Performance
Global Sourcing-
• Opportunity to improve quality, cost, and delivery
performance
• It may be your only option!
• Requires additional skills and knowledge to deal with
international suppliers, logistics, communication, political
environment, and other issues.

• Import broker or sales agent- performs service for a fee.

• Import merchant- buys and takes title to the goods.
• Trading company- imports & carries wide variety of goods.

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Measuring Sourcing-Purchasing
Inventory Turnover Calculation Performance
Inventory Turnover and Weeks-of-Supply are two
common performance measures of the sourcing
function

• Inventory Turnover
• measures how quickly inventory moves

Inventory Turnover = Cost of Goods Sold

Average Inventory Value

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Inventory Turnover Example Measuring Sourcing Performance

Continued
Jenco Inc. produces dolls. Annual cost of goods sold
is $8,000,000 and average inventory is $2,000,000.
What is the annual inventory turnover? • Weeks-of-Supply
• provides the length of time demand can be met
Inventory Turnover = with on-hand inventory
Cost of Goods Sold
= Average Inventory Value Average On-Hand Inventory
Weeks of Supply =
$8,000,000 Average Weekly Usage
$2,000,000

= 4 inventory turns/year

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Kraljic’s Supply Matrix

Weeks of Supply Example • Top left quadrant:
• High supply risk but low profit impact items.
Jenco Inc. has an annual cost of goods sold of • Bottleneck components
$8,000,000 and average inventory is $2,000,000. • Do not contribute a large portion of the product cost
How many weeks of supply are on-hand? • Suppliers have power position
• Ensure continuous supply, even possibly at a premium cost
Weeks of Supply = • Focus on long-term contracts or by carrying stock (or
Average On-Hand Inventory both)
• Bottom left quadrant:
= Average Weekly Usage
• Non-critical items
2,000,000 • Simplify and automate the procurement process as much
as possible
$8,000,000/52
• Use a decentralized procurement policy with no formal
requisition and approval process
= 13 weeks of supply

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Product Typology and Sourcing Functional Products

• Functional products: the staples that people buy in a wide range of
retail outlets, such as grocery stores and gas stations
• Functional Products • Product life cycle of more than two years
• Contribution margin of 5 to 20 percent
• Innovative Products • Only 10 to 20 product variations
• An average forecast error of only 10 percent
• Lead time for make-to-order products of from six months to one year

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Innovative Products Fisher’s Functional vs. Innovative Products

Functional Products Innovative Products

• Innovation can enable a company to achieve higher profit margins

• Newness of the innovative products makes demand Product clockspeed Slow Fast

Demand Characteristics Predictable Unpredictable

• for them unpredictable
• Typically have a life cycle of just a few months Profit Margin Low High
• Imitators quickly erode the competitive advantage that innovative products Product Variety Low High
enjoy
• Companies are forced to introduce a steady stream of newer innovations Average forecast error at the
time production is committed
Low High

• The short life cycles and the great variety typical of these products
further increase unpredictability Average stockout rate Low High

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Supply Chain Strategy Procurement Strategy for the Two Types

• Functional Products • Functional Products

• Focus should be on minimizing total landed cost
• Diapers, soup, milk, tiers
• unit cost
• Appropriate supply chain strategy for functional products is • transportation cost
push • inventory holding cost
• Focus: efficiency, cost reduction, and supply chain planning. • handling cost
• duties and taxation
• Innovative products • cost of financing
• Fashion items, cosmetics, or high tech products • Sourcing from low-cost countries, e.g., mainland China and
• Appropriate supply chain strategy is pull Taiwan is appropriate
• Focus: high profit margins, fast clockspeed, and • Innovative Products
unpredictable demand, responsiveness, maximizing service • Focus should be on reducing lead times and on supply
level, order fulfillment flexibility.
• Sourcing close to the market area
• Short lead time may be achieved using air shipments

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HP’s Portfolio Strategy

Sourcing Strategy for Components • Exponential growth in demand for Flash memory
resulted in high demand uncertainty
• Fisher’s framework focuses on finished goods and demand side • Uncertain price and supply
• Kraljic’s framework focuses on supply side • Significant financial and supply risk.
• Combine Fisher’s and Kraljic’s frameworks to derive sourcing strategy • Commitment to purchase large amount of inventory
• huge financial risk through obsolescence cost.
• Not have enough supply to meet demand
• both supply risk and financial risk
• purchasing from the spot market during shortage periods yield to
premium payments
• HP’s solution: the portfolio strategy
• Combined fixed commitment, option contracts, and spot
purchasing

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Qualitative Approach to Sourcing Strategy Supply Chain Uncertainty Framework

Uncertainty
Supply

A qualitative approach for evaluating component sourcing strategy

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Four Types of Supply Chain Strategies Outsourcing

1. Efficient supply chains: utilize strategies aimed at creating the
highest cost efficiency
2. Risk-hedging supply chains: utilize strategies aimed at pooling and
sharing resources in a supply chain to share risk
3. Responsive supply chains: utilize strategies aimed at being
responsive and flexible
4. Agile supply chains: utilize strategies aimed at being responsive and
flexible to customer needs
• Outsourcing: moving some of a firm’s internal activities and decision
responsibility to outside providers
• Allows a company to create a competitive advantage while reducing
cost
• An entire function may be outsourced, or some elements of an
activity may be outsourced, with the rest kept in-house

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Reasons to Outsource and the Resulting

Logistics Outsourcing
Benefits
• Logistics: the management functions that support the complete cycle of
material flow
• Purchase and internal control of materials
• Planning and control of WIP
• Purchasing, shipping, and distribution of finished product
• Emphasis on lean inventory means there is less room for delivery errors
• Logistics companies have complex computer tracking technology that
reduces the risk in transportation and allows the logistics company to add
more value to the firm
• Third-party logistics providers track freight to tell customers exactly where
its drivers are and when deliveries will be made

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A Framework for Structuring Supplier

Summary
Relationships
• Sourcing is a term that captures the strategic nature of purchasing in
today's global and Internet-connected marketplace
• The bullwhip effect is when changes in demand are magnified as they
move from the customer to the manufacturer
• Supply chains can be categorized based on demand and supply uncertainty
characteristics
• Four types of supply chains are identified: (1) efficient, (2) risk-hedging, (3)
responsive, and (4) agile
• Costs can generally be categorized into three areas
• (1) acquisition costs, (2) ownership costs, and (3) post-ownership costs
• Inventory turn and weeks of supply are the most common measures to
evaluate supply chain efficiency

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Thank You

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