MScBA Master’s Thesis
Supplier Performance Assessment Model for a Consumer Goods Manufacturer
By
R. De la Cueva Soler
Supervisor: Eva Karasek Co-Assesor: Taco van der Vaart
University of Groningen
Specialization Operations and Supply Chains, Faculty of Management and Organization
2006
Executive Summary
The driver of this research is the need of a consumer goods manufacturer for the development and implementation of a supplier assessment model. This firm is under great pressure from competitors and its financial situation is rather poor. Therefore, the overall goal of the company is to recover market share and improve its financial situation through sustainable profitability. In order to identify in an objective way which suppliers are affecting the company’s performance (and, consequently, its share of market and financial situation), the operations management staff has tried to develop an evaluation model for a long time already. However, time constrains have hampered the project. Currently, suppliers are only evaluated in terms of quality by the quality assurance department.
The company’s top management was interested in the project and willing to provide all the necessary information. However, once the research had started, the legal department at the corporate office decided to stop the project due to confidentiality issues. Despite this situation, it was decided to conduct the research with the available information and company knowledge.
No confidential information is included in the thesis at all, such as cost structures, supplier’s names, new products and projects, etc. Consequently, the research has no practical application as such, but can be used as a guide for the development of company-specific supplier performance assessment models.
The main research objective is the development of a company-specific supplier assessment model that enables the company to identify performance gaps and improve its performance.
Additionally, the model must aid in the implementation of procurement strategies that support the company’s goal of improving its financial situation. These two goal statements are expressed in the main question of the research. Five sub-questions were formulated in order to better support the answer to the main question and provide a guide of the different stages of the research. The first set of performance criteria is established based on the company’s long term objectives, strategies and products. Then, the supply base of the company is reviewed to determine the performance criteria that best fit in the current sourcing situation of the company.
By means of the portfolio approach proposed by Kraljic in 1983, the firm’s supplies/suppliers are differentiated for the development of the performance assessment model. At this stage of the research it was decided to focus the performance assessment model on the supplies/suppliers of the imports division. Later on, literature is reviewed to identify criteria that fit the company and round-up the set of criteria previously derived.
A survey was designed to question experts regarding the set of performance criteria in order to achieve the goals of the company. Two kinds of experts participated in the survey: with and without experience at the company. Based on the responses, the definitive set of performance criteria was established and grouped into five clusters. The weights for each cluster and performance criterion were established based on the survey results as well, whilst trying to keep the model as simple as possible. Furthermore, the way in which some criteria can be measured was also mentioned. The definitive performance criteria clusters and its corresponding weights are shown below.
1. Quality and Development 30%
2. Delivery 25%
3. Responsiveness 20%
4. Cost 15%
5. Service 10%
At the last stage of the research, the model suitability and feasibility are addressed. An important pre-condition for the use of the model is a reorganization of the purchasing function structure. Currently, the scope of the function is quite narrow and its strategies and goals are not aligned with other functional strategies and do not support the overall business strategy.
Therefore, an organizational structure is proposed in which the operations and purchasing
functions are merged into one: supply chain. This structure would result in a greater integration
of goals and strategies. Consequently, better coordination of activities and formation of cross-
functional teams would be enabled, necessary conditions for the correct implementation and
use of the supplier assessment model. An additional benefit of this restructuring is that, although the headcount remains the same, the cost of the organization in terms of employee compensation would be lower.
At the end of this thesis, several recommendations for further improvements or research are presented next to the already mentioned organizational structure:
1. The development of a supplier assessment model for the local products division.
2. The frequent review and update of the criteria included in the model in order to adapt it to the changing needs of the company.
3. Communicating frequently the performance status within the company and to the suppliers being evaluated.
4. Not using the model simply to reward or penalize supplier but to help them identify their performance gaps and improve their performance.
5. The model can be used as a guide to determine which suppliers should be substituted and with which more business could be done.
6. Implementation and use of a tool to identify the improvement priorities based on the
results of the supplier performance evaluation.
Index
I Introduction ... 5
2 Research design ... 6
2.1 Problem statement... 6
2.2.1 Research Questions ... 6
2.2 Research structure ... 7
3 Performance assessment criteria ... 9
3.1 Company background ... 9
3.2 Goals, strategies and status of the business and functional areas. ... 9
3.2.1 Sales and Marketing, the commercial areas ... 9
3.2.2 Operations ... 10
3.2.3 Procurement... 11
3.3 Products and Markets ... 12
3.3.1 Imported products ... 13
3.3.2 Local products ... 14
3.3.3 Markets ... 16
3.4 Consequences for the procurement function and performance criteria ... 18
3.5 Purchasing performance measurement ... 20
3.5.1 Importance of measuring the performance of purchasing ... 20
3.5.2 Performance criteria for the purchasing function... 20
3.5.3 Performance criteria for the company’s suppliers ... 22
3.6 Identification of priorities – supplies/supplier portfolio analysis ... 24
3.6.1 The Kraljic portfolio approach ... 24
3.6.2 Classification of supplies/suppliers ... 26
3.6.3 Performance criteria for the strategic and leverage suppliers ... 29
4 Performance Assessment Criteria Survey with Experts ... 32
4.1 The design of the survey... 32
4.1.1 The objective(s) of the survey ... 32
4.1.2 Survey conditions and available data ... 33
4.1.3 Survey participants – the sample ... 33
4.1.4 Questionnaire design ... 34
4.2 The survey results and its analysis ... 35
4.2.1 Demographic statistics ... 36
4.2.2 Descriptive statistics... 37
5 The Performance Assessment Model... 42
5.1 Selection of the criteria for the firm ... 42
5.2 Performance criteria clusters and weights ... 44
5.2.1 Literature review ... 44
5.2.2 Determination of clusters and its corresponding weights... 46
5.2.3 Determination of weights for each criterion ... 47
6 Conclusions and recommendations... 50
6.1 Model suitability and feasibility... 50
6.2 The appropriate location and structure of the procurement function... 51
6.2.1 Current location and structure of the function and issues ... 52
6.2.2 Location and organizational structure proposal ... 53
6.3 Recommendations for further improvements or research ... 57
Bibliography and References... 59
Appendixes ... Error! Bookmark not defined.
I Introduction
In the last years, there has been an increasing interest in the management of supply chains. An important part of supply chain management is on the supply side. Purchasing and supply management is the well-accepted term for the function that is involved in the management of companies interface with the supply markets. Especially in the last years, the interest of researchers and business professionals on the role of the purchasing function is greater than ever due to the benefits its correct deployment has for all types of companies. Already in 1983, Peter Kraljic suggested to adopt a strategic view for the purchasing function, transforming it into supply management. In his article, Kraljic recommends managers to recognize the weakness of the purchasing function ways to overcome it by establishing supply strategies.
The role the purchasing function can have within a company can vary to a great extent. At one end of the range, it can be considered as merely an operational area, without any strategic value for the company. At the opposite extreme, the function is viewed as extremely strategic and a provider of competitive advantage for the company. The tendency in the last years has been toward this last side of the range. For example, Malcolm Saunders includes the following statement in his book (taken from a booklet of the Department of Enterprise of the UK by the author):
“Purchasing and supply can no longer be treated as second-order function. The way forward lies with integrated materials management, pulling together suppliers, production and distribution. In the years ahead, those who have not got their purchasing and supply operations right will not be competitive.” (Saunders, 1997, pp. 1)
Several authors mention in their work the importance of aligning the strategies of each function of a company with its business strategy and goals. Whilst the business strategy must establish the direction the firm will follow, the strategies of each functional area must be designed in such a manner that these support it. At the same time, the functional strategies should support each other and any interrelation problems should be identified and solved. Traditionally, only the marketing and finance functions were regarded as strategic in general terms. However, the strategic importance of other functions has been addressed. Lately, operations management has been included in the formulation of the business strategy and regarded as a possible source of competitive advantage for companies. A similar thing is happening with the purchasing function. More and more companies have started to restructure its organization to exploit the benefits of the correct deployment of the function.
This new scope for the function has brought new responsibilities and tasks for it. In his book, Van Weele (2005) describes the several activities the function is responsible for under this new scope. One of these activities is the monitoring and evaluation of supplier performance.
Although this activity is considered as operational by the author, the performance of the suppliers of a company is regarded as strategic. Saunders (1997) states in his book that the capabilities to compete in terms of quality, time, flexibility and price and being, at the same time, successful financially, must be nurtured and shaped by a clear strategic vision. Much of these capabilities are provided by the suppliers. The author concludes that strategic purchasing and supply management needs to control and influence performance.
This thesis describes the formulation of a supplier performance assessment model for a
manufacturer of packed consumer goods. For some time already, the company’s operations
management staff has tried to develop and implement such a model. However, due to the
current conditions of the business, resources are scarce and no time has been available to start
with the project. This situation was known to the researcher, since he worked for five years at
the company before starting his master’s studies. The project was proposed to the top
management of the company and they decided to participate on it. However, a few weeks later
the legal department of the corporate office decided to stop the company’s participation due to
confidentiality issues. It was decided to continue with the research with the available information
and company knowledge. Consequently, this research will not have a practical application as
such, but can be used as a guide for the development of company-specific supplier
performance assessment models.
2 Research design
This part of the thesis will address the design of the research and the methodology followed.
Fist, the identified problem (driver of the research) will be described and the research questions will be outlined. The research has been divided into three main stages: company analysis, survey on performance criteria and model formulation. These will be described in the second part of the chapter.
2.1 Problem statement
The company for which the research will be performed is a major manufacturer of packed consumer goods focused on the aesthetic and general care of the body. Its main products are cosmetics, lotions, shampoos, styling gels, and shaving creams. Due to several years of poor commercial and financial performance, the company is losing market share to its competitors.
New management has arrived to the company, trying to implement novel ideas and to improve, firstly, the financial performance of the company. For some time, the operations management has tried to implement a supplier performance evaluation that enables the identification of supplier performance gaps and set the steps for supplier development, since there is a need to maintain/improve the quality of the products while keeping costs as low as possible. The rationale behind this is that supplier performance has a direct impact on the operations of the company and the resulting goods of its processes. As Saunders (1997) states, many suppliers add more value to the final products in their operations than is added at the final stage of the company apparently manufacturing these. Currently, the performance of suppliers is not being measured except for the quality aspects of their deliveries. Such aspects are evaluated by the quality assurance department, which performs delivery inspections and quality audits. As a result, the firm’s management cannot determine in an objective way which suppliers are affecting its performance.
2.2.1 Research Questions
As it has been mentioned, the aim of this research is to develop a supplier assessment model that enables the company to identify performance gaps and improve the service level provided by suppliers. First, the main question of the research is defined along with the supporting sub- questions. These will serve as guides for the development of an answer to the main question.
Main question(s)
How does a company-specific supplier assessment model should look like, in order to identify performance gaps and improve its performance? How can this model aid in the implementation of procurement strategies that support the company’s objective of improving its financial situation?
Sub-questions
1. - Based on the company’s long-term objectives, strategies, products, etc., which performance criteria are important and, consequently, should be included in the model?
The model not only has to fit the current situation of the company, but also consider its long term strategies, objectives and developments. These aspects will be reviewed to determine what characteristics of the suppliers’ performance the company should consider as important.
This way, the aspects of supplier performance that will be important for future success can be derived. In this part of the study, the methodology to be followed will be desk research, based on the researcher’s knowledge of the company and its situation (primary data).
2. - Which performance criteria should be included in the assessment model based on the supply base of the company?
In order to develop a model that best fits the conditions and needs of the company, its sourcing
situation must be understood. By doing so, a set of performance of criteria that fit the current
condition of the organization can be derived. Such diagnosis will be performed by describing the
supply base to form supply groups. These groups will be then classified by means of the Kraljic
Matrix or the Kamann Cube, depending on which model suits better the characteristics of the
supply base. The methodology used to answer this question will be desk research, based on the researcher’s knowledge of the company and its situation (primary data).
3. - Which performance criteria can be derived from literature that fit the company and round-up the group of indicators?
In order to develop a complete assessment model, performance criteria must not only be derived from the company’s situation and long-term expectations. Significant criteria might not be considered without reviewing the relevant available literature on supplier evaluation. This way, the set of performance criteria to evaluate will be rounded up. Desk research using secondary data will be the methodology followed to answer this question.
4. - What weights should be given to the performance criteria?
A comprehensive pool of supplier performance criteria will result from answering the three previous research sub-questions. Depending on the goals, nature, characteristics, situation, etc., of a company, some performance categories are viewed as more important than others. By assigning different weights to each performance category and, in turn, to each indicator, these differences in importance can be expressed. Such valuation is rather subjective and company specific, but examples of similar companies can be addressed despite its narrow contribution.
Surveys will be performed to identify the importance assigned to the performance criteria by the company personnel. Therefore, the methodology used will be field research using data sources.
5. - Does the model suits the company and is it feasible to implement under the current conditions?
Answers to the four previous research sub-questions will result in the supplier performance assessment model. Such model is intended to be suitable and feasible within the company, so that it can be implemented. Therefore, these aspects will be addressed by the research as concluding remarks.
2.2 Research structure
The research is divided in three main stages: the company analysis and its needs in terms of supplier performance, the survey on performance criteria and the formulation of the model. In this section of the chapter, each of these stages will be described. This structure suffered modifications when the company decided to not participate in the research and share information of its supplier base. The description presented below is the adapted one.
1
ststage – Company analysis
First of all, books and articles on purchasing and supply chain will be scanned and read in order to have a strong theoretical foundation. The first step of the research will be the description of the current situation of the company. Its goals, strategies, products and the markets it serves will be analyzed in order to determine which performance criteria are important to consider for the formulation of the assessment model. The result of this analysis will be the first set of performance criteria. However, this set of criteria is not likely to be valid for all types of suppliers. Consequently, the supply base will be categorized by means of the Kraljic matrix (portfolio analysis) in order to distinguish the different types of suppliers the company has.
Based on this classification, the previously derived performance criteria will be modified to fit the profile required for the evaluation of the most strategic suppliers. As a result, the list of performance criteria will be modified. This list will be then rounded up by including criteria considered as important on the available literature on the subject.
2
ndstage – Survey on performance criteria
A survey was designed to determine the importance each derived performance criterion has for
the stakeholders in the sourcing process. Due to the refusal of the company to participate in the
research, a different survey will be designed, but with the same objective. The survey will be
conducted with experts, with and without experience at the company under study. A couple of
company employees have accepted to participate as well, without revealing any information that
can be considered as confidential. The outcome of this stage of the research will be the results
of the survey and its statistical analysis.
3rd stage – Model formulation
Based on the results of the survey and its analysis, the model will be constructed in the last
stage of the research. First of all, performance criteria will be grouped into clusters or
performance dimensions. To establish this categorization, literature and case studies will be
reviewed. Once these are defined, weights will be assigned to each cluster according to the
importance respondents perceive each of the performance criteria has. Then the weights for the
performance criterion within each cluster will be determined considering the results of the
survey. Since the company decided not to participate in the study, the way of measuring each
criterion cannot be defined, as the participation of stakeholders is required. However,
suggestions on how to measure some of these criteria will be made. As concluding remarks of
the research, the suitability and feasibility of the model within the company will be mentioned,
along with some recommendations for further improvement and research. The outcome of this
last stage will be the supplier assessment model.
3 Performance assessment criteria
3.1 Company background
The company being analyzed is a manufacturer of consumer packed goods, focused on personal care products. It was founded almost 100 years ago and since then it has been one of the leaders in the market. The top management views it nowadays as world known and mass- market leader in the USA. Their vision is that based on quality products at affordable prices, the company provides glamour, excitement and innovation to its end customers. The company’s products are sold in more than 160 countries, under a globally recognized brand. According to the top management, such brand recognition aligned with product quality and strong marketing performance has enabled it to build up one of the strongest brands in the world.
Within the country that this thesis is focused on, the company was established almost 50 years ago. The company entered this market by establishing a manufacturing facility in it. Since then, the production has taken place in the same facility although during some periods it was outsourced. Today, the products of one division are imported from abroad and the rest are manufactured locally, within its facility or with subcontractors. The volume granted to the latter is, however, small. The company serves the end customers through the most important self- service retail stores. These are the main customers of the company, amassing almost 80% of the total sales. The rest is split up among other intermediaries such as wholesalers or drugstores. During the last decade, the company has suffered from strong competition in the market, not only from rival companies in the same distribution channels but also from direct sale organizations. As a result, total market share has been reduced. This, along with poor financial performance due to wrong management decisions and lack of innovation, has placed the company in a very undesirable position. As a result, the company board has taken some tough decisions involving downsizing and restructuring.
3.2 Goals, strategies and status of the business and functional areas.
The overall goal of the organization is to recover market share and improve its financial situation through sustainable profitability. It can be stated that the business strategy is to exploit the recognition of the brand by delivering top quality and innovative goods at affordable prices in a cost effective way. This is something that its most important competitors already do, but in a more efficient and effective fashion. Whilst Marketing, working along with other areas of the organization, has to focus on ways to increase the company sales, the Operations and Procurement departments have to optimize the use of resources to deliver the marketing promises in a cost effective way. Obviously, this shall be achieved without reducing the service level provided to its external and internal customers. The ultimate target is to make the company profitable once again. From this overall strategy, strategies for each functional department have been developed. In most cases, these are not defined explicitly but can be inferred from the objectives and tactics established.
3.2.1 Sales and Marketing, the commercial areas
In the case of Sales, the target is to increase sales mainly by improving the relationship with its key customers and achieving shelf excellence. These targets shall be met by reviewing the business terms with key customers, establishing functional teams to work with these, base replenishment on sell-out figures instead of sell-in volumes, reduction of stock at the point of sales, improving the control on returns and discounts, training personnel and marketing support.
In the case of marketing, the overall target is to increase market share in a profitable fashion. Its
strategy is based on the exploitation of the brand, using it as an umbrella for all goods. Such
strategy could be stated as using the brand awareness along with improved value,
differentiation, innovation, and resource allocation as means to achieve profitability. The
allocation of resources shall be focused primarily on the top performing product franchises. The
main issue is that the company competes against other multimillion companies with strong
brand portfolios. These colossal manufacturers have strategic presence in every market and
invest heavily on these due to its strong financial power. Moreover, the company products
considered as mass volume goods are the ones with the worst performance and lowest
contribution. By focusing resources, fragmentation of these among low potential goods and
franchises is avoided. Other tactics will be the rationalization of variants for each product family,
development of accurate consumer strategies, focus on efficiency at the point-of-sale and improve relationship with customers to leverage power.
3.2.2 Operations
The concept of manufacturing strategy gained attention since the publication of Wickham Skinner’s paper about this missing link within corporate strategy. Traditionally, Operations was viewed as concerned with day-to-day creation and delivery of goods. How could the area involved in such activities be strategic? It is not these activities, but the way in which an organization’s operations resources are managed is more and more seen as key for its long- term strategic success (Slack and Lewis, 2002). Saunders (1997) argues that manufacturing activities in Europe and America were seen as the cause of problems in business, when compared to the success of the Japanese manufacturers and their competitive edge. In the last years, more attention has been centered on the operations function since companies have realized its importance to achieve competitive advantage.
Within the company studied, the operations function is seen as one with strategic potential but still in a limited way. At the corporate level, this function is seen as a potential source of competitive advantage and the designation of a Chief Operation Officer shows it. However, this strategic vision of operations has not reached the international business units to the full length.
Professors Hayes, Wheelwright and Chase, (1984 and 1991, cited by Saunders, 1997, and Slack & Lewis, 2002), developed what they called the “Four Stage Model”, which can be used to understand the evolution of the role of the operations function / strategy.
Stage 1 – “Internal Neutrality” the lowest level of contribution of the function. The aim shall be to minimize the negative potential of the function, since the rest of the organization views it as holding it back from competing successfully. The function must address at this stage the worst problems and try to improve its performance or avoid larger mistakes.
Stage 2 – “External Neutrality”, when the company improves its performance trying to become as good as its competitors. The function attempts to implement the best practices and performance norms of the industry. As a result, the function does not grant any competitive advantage but it is not the source of competitive handicap either.
Stage 3 – “Internally Supportive”, when the operations function aims to achieve a clear link with the business strategy. Here, the operational capabilities of the organization are not seen as the best in the industry, but are paired up with the best competitors. The organization recognizes the strategic role of the function to support the business strategy. The function aims at this stage to become the best performer in the industry.
Stage 4 – “Externally Supportive”, when the organization views the operations function as a source of competitive advantage, since it can develop unique capabilities. Therefore, the function becomes central for the development of the business strategy. Operations is regarded as an innovative and proactive function that might even be driving the strategy of the company.
By means of the framework described above, the role of the operations function within the company can be identified. At a corporate level, the operations function is clearly seen as a strategic one that supports the business strategy. The position of COO has been created and works close to other officers and vice-presidents to support the business strategy of the organization. Consequently, it can be considered that the function is currently located somewhere between the second and third stages. Its capabilities and performance are not the best in the industry, but are achieving parity with the best competitors.
Focusing on the business unit studied, the operations function was seen, till recently, as holding
the operations back, placing it at the first stage of the model. Due to a large amount of general
management turnovers and differing strategies, the function lacked a clear vision of the
business strategy. Moreover, other areas perceived it as an underperforming area and that its
activities should be outsourced. Thanks to the structural changes at the corporate level, the
operations area earned better recognition. This was also enabled by the proactive approach of
the operations management at the business unit studied. The goods that were outsourced then
started to be produced in house once again, improving the service level and cost. Since then,
the area has attempted to implement the industry’s best practices in all its departments and
change the perception other functions had of it. The strategy of the operations function is to
manufacture and deliver quality products by implementing the industry’s best practices in a cost effective way. The main targets are to improve the current service level, decrease the amount of tied-up capital, and reduce the operating costs while maintaining or improving quality. Based on all the above mentioned, the operations function at the business unit level can be placed at the second stage of the “four stage model”.
3.2.3 Procurement
As with operations strategy, the term of procurement strategy appeared late in the business environment. For many years, such function was deemed as operational, involved with day-to- day activities. With the introduction of corporate and strategic planning during the 1970’s, the perception of the purchasing role started to shift. Although differing in its scope, the terms purchasing and procurement are used interchangeably quite frequently. The first refers primarily to those activities associated with the actual buying of materials. The latter, is the term that emerged as a result of the development of the strategic approach in purchasing and supply management. In procurement, the activities associated with the buying process are viewed as strategic and process-oriented (Stock and Lambert, 2001). As mentioned before, the groundwork for the establishment of the strategic role of purchasing took place. Several researchers addressed the need to include purchasing in corporate planning. At this stage, purchasing was viewed as an important function since sourcing markets offer both opportunities and threats to organizations. In the 1980s, important developments in strategic purchasing and supply management took place, stressing the concept of competitive advantage. The purchasing function was viewed as a potential source for competitive advantage for the organizations. During this decade, the idea of raising purchasing function to the same level as other business functions was introduced. In the 1990’s, the perception of the strategic role of purchasing was developed further, when a number of frameworks were developed to make the link between business strategy and the contribution of strategic purchasing (Saunders, 1997). In the study of Robert Monczka (1992, cited by Saunders, 1997), the concept of strategic sourcing management is introduced and is defined as “the integration of all decisions that affect the design and flow of purchased items into and through a corporate entity to finished products aimed at specific customers”. Moreover, the strategic role of purchasing is to perform such sourcing activities in a way that supports the overall objectives of the organization. As this function is a boundary-spanning one, it can make important contributions to the strategic performance of the organization (Stock and Lambert, 2001).
At the business unit under study, before the existence of purchasing as an independent function, the purchasing activities were managed by the operations function. A decade ago, the purchasing department was limited to one individual. The service provided by the department was rather limited to the search of potential suppliers and negotiation with these. All purchase orders were placed by personnel from other departments and no close follow up of the supplier base performance took place, except those evaluations performed by the Quality department.
The potential of the area under this structure was quite limited, due to the scarce knowledge and skills of the personnel in relation to the new vision where the management of supply affairs is seen as strategic. It can be stated that the purchasing culture was “old fashioned”. Good examples of this were the strong pressures placed on suppliers to reduce price or trying to achieve good price discounts by performing forward buying. Later on, the new operations management envisioned the potential of the purchasing area. New personnel were brought into the department and the structure extended from one individual to two, a manager and a purchaser. The aim was to improve the performance of the supply base by implementing the industry’s best practices such as those regarding supplier assessment and improvement.
Furthermore, some months later the packing engineering department began reporting to the purchasing manager instead of the operations manager. The idea behind this was to improve the coordination of strategies, goals and activities between these two departments to improve the performance of the supplier base in terms of cost, dependability and quality. Later on, under a new general manager, it was decided that the purchasing function should be a stand alone one, not depending on operations. Consequently, the procurement area was established reaching the top management levels.
At the same time, the strategic role of purchasing and supply management was viewed as
necessary by the top management at a corporate level. As a result, it was decided that the
position of Procurement Vice-president should be created. This impacted the culture of the
company, since a new perspective regarding sourcing was going to be implemented. The vision of the renovated Purchasing function, renamed as Procurement, is to establish a competitive supplier base that ensures quality inputs and access to innovation through suppliers at the lowest total cost. This new vision implied important structural changes that affected all the business units of the organization. New regional positions have been included in the structure of the Procurement area. The position of Regional Procurement Director for the Latin America (including the Caribbean) region was granted to the Procurement manager of the business unit studied. The resulting changes in the way the purchasing activities were performed found resistance in the personnel of the other areas. Moreover, the necessary actions to overcome this resistance were not taken and rather the change was imposed. As time went by and thanks to the efforts of the heads of the functional areas of the organization, the personnel started to understand the potential benefits of the procurement function. However this excitement diminished as time went by, since no visible important results were achieved by the function.
Moreover, some rumors of unethical activities started to surround the department. The general perception of the function was that it only searched for potential supplier and performed negotiations with these. Moreover, the time it took to process a requirement for a new supply seemed to be excessive. In the end, the Procurement Director had to leave and the position has not been occupied since then. It is clear that the Procurement area lacks vision and strategy, despite the efforts of the top management to exploit its strategic potential.
A similar model to the one of Hayes and Wheelwright, but related to purchasing function, was developed by Robert Beck and Brian Long (1988, cited by Saunders, 1997). It considers four stages:
Stage 1 – “Passive”, lacking of strategic direction and reacts to the requirements placed by other areas. The function is focused on routine operations and the selection of suppliers is based mainly on price and availability.
Stage 2 – “Independent”, adopting novel techniques, but with a different strategic direction from that of the business. Cost reduction and efficiency approaches are implemented and the top management views opportunities to improve profitability.
Stage 3 – “Supportive”, practices and techniques are adopted, strengthening the competitive position of the organization. Suppliers are seen as resources and the selection process is performed carefully. The sourcing performance is monitored and analyzed.
Stage 4 – “Integrative”, the strategy of the function is aligned with those of the other functions and support the business strategy, implementing a cross-functional approach. However, the authors still see the function as not ready to become a driver of competitive advantage. They argue that to achieve this, first the function must develop its own capabilities.
Based on the framework of Beck and Long, and the information provided of the current status of the function within the company, the stage at which it is currently situated can be identified. In the case of the function at the corporate level, it can be considered as being at the fourth stage.
The strategy of the function is aligned with that of the other areas and supports the corporate strategy. In the case of the business unit, the situation is not the same. As it has been mentioned, the strategic importance of the function has been identified by the top management, both at the corporate and business unit level. However, the lack of clarity of strategies and objectives obstruct its alignment with the strategies of other functions and the business strategy.
Therefore, it can be stated that the function is located at the second stage, “Independent”.
3.3 Products and Markets
In order to determine the performance criteria that shall be important for the purchasing function, the company’s products and the markets at which these are offered must be analyzed.
The nature and characteristics of the products will be described first. As it has been mentioned already, the products of the company are separated into two major divisions: imports and local.
The objective of this part of the research is to identify the product aspects that shall be
considered as important when defining the required supplier performance criteria. The market in
which the company competes is also an important feature in this chapter, since every type of
market leads to specific purchasing and selling behaviors. When deciding on his tactics, the
buyer should take into account the demand side and the supply side of the markets (Van
Weele, 2005).
3.3.1 Imported products
The first division groups all those finished items that are imported into the country and require to be “nationalized”. By this it is meant that imported products must show all the data in the native language of the product where it will be sold. As a result, these products have to be labeled or repacked. Due to the large amount of different sizes and shapes of labels, the process has to be performed manually. Only until the labeling process is performed, the products can be considered as finished goods ready for sale. The characteristics of the processing of these goods are quite straightforward; few components are required (imported goods and local labels), the assembly operation is simple, it is a labor-intensive process and low value is added.
The potential for innovation is limited at the business unit stage. The reason for buying these goods from the main business unit of the corporation is to obtain the lowest total cost. The largest percentage of sales is present in the headquarters business unit, almost 80%. As a result, the pulverized “international” market benefits from the cost efficiencies achieved by centralizing manufacturing volumes at the main business unit. One of the issues for the rest of the business units is that ordering has to be performed on sales forecasts, based on historical data rather than on current sales, due to the long delivery time. Moreover, the manufacturing environment
1at the main business unit for this type of products is make-to-stock, with delivery taking place from the end products store according to customer orders. This is the result of the long lead times required to produce the goods, which are manufactured in batches planned based on forecasts as well. Once the order is placed it takes almost two weeks to be delivered, due to the long distance to be traveled plus the time consumed at customs. Therefore, the type of process followed at both business units is push logistics. In push logistics, the order is pushed in the direction of added value, without need of customer influence or a definite customer order (Schönsleben, 2004). Research and development for these goods is performed in a global manner, at the main business unit. Few opportunities are granted to other business units to develop local goods.
At the business unit studied, this division represents 48% of the total gross sales in value but only a 25% in units sold. It is evident that the profit margin of the products of this division is much bigger than those in the local manufacturing division. This is caused by the difference in the use of the products of each division. The imports division groups products mainly related to the aesthetic care of the body, whilst the local division groups products that are more related to the general care of the body exterior. Examples of products of the imports division are cosmetics such as lipsticks or eye shadows, shaving razors and skin care products for men such as peeling creams and after-shave lotions. The first represent the biggest slice of the product portfolio since there is a large amount of shades for each product family. Demand per shade is low when compared to that of the other imported goods or the local ones. The imports are marketed as premium in the retail channel, offering top quality at affordable prices. The company is one of the market leaders for this type of products commercialized through traditional distribution channels, without considering the direct-sales firms. More information about the market is provided later on in this part of the chapter.
The portfolio of products to be commercialized is reviewed on a regular basis by the marketing function. Product introduction and withdrawal is reviewed on a frequent basis by the marketing and sales functions, based on market studies and point-of-sale data. In turn, the sales forecast is prepared based on sell-in figures rather than sell-out volumes
2, including feedback from marketing and sales regarding trends and special events. Based on this forecast, the production planners run the MRP process every two weeks and review the resulting order proposals. After being reviewed and modified (if necessary), orders are released. Orders for local materials, labels or cartons, are printed, authorized and sent via fax to the suppliers. The orders for finished goods are printed for authorization purposes and transmitted electronically to the headquarters. Along with the purchase order, a twelve-month rolling forecast is sent for production planning purposes. The receipt of the order and its quantities are confirmed by the headquarters, providing an estimated date of shipment. The invoices and required paperwork,
1 Production or manufacturing environment refers to a method in the planning and control of development, procurement and productions that is linked to a specific stock level (Schönsleben, 2004).
2 Sell-in refers to the actual sales of the company to its customers, whilst sell-out refers to the sales to consumers at the point-of-sale. The forecasts can’t be prepared from sell-out figures since not all of the customers collect and provide such data.
such as certificates of origin and bills of lading, are prepared and forwarded when the products are shipped. The traffic personnel, part of the operations area, receive the documents and monitor the importing of the goods, which is performed by a customs broker. Products are received and inspected to match physical quantities against the order(s) placed. Any differences are reviewed by the production planners with the headquarters personnel. Delivery data is updated in the system and the order documents, such as the invoice and receipt tickets, are delivered to the accounts payable department. The participation of the purchasing function in the process is limited to the authorization of the purchase orders. Some exceptions take place, however. Cases in which a new product requires a packaging component different from those already sourced occur and purchasing works with packing engineering to evaluate and select the supplier of the new component. This situation is rare, since the components required for new products vary in size or shape from the existing ones and can be sourced by current suppliers.
Purchasing should be involved in the purchasing process of imported goods at many stages, not limiting itself to the authorization of purchase orders. First, the function should participate in the review of the product portfolio along with marketing and sales, in order to challenge any introduction or withdrawal initiatives. Also, purchasing should contribute in the sales forecast elaboration, challenging any adjustment proposals made by marketing and sales, as well as providing feedback. Most importantly, however, the function must be responsible for the purchase process at all times. In his book, Van Weele (2005) states that at the operational level, purchasing is responsible for all activities related to the ordering and expediting function. One of the findings of a survey performed by the magazine Purchasing (2003, cited by Van Weele 2005) is that more than 81% of purchasing professionals state that they are responsible for maintaining inventory levels. Moreover, Van Weele mentions the purchasing positions that can be found in most large companies, one of these being materials planners. Such materials planners are responsible for the planning and ordering of materials, as well as monitoring and controlling suppliers on quality and delivery performance. Following this approach, the review of imports requirements as well as the release and transmission of purchase orders should be performed by the purchasing personnel instead of the production planners. Production planners should be focused instead on reviewing the manufacturing capacity, developing plans and schedules, and monitoring the processing of manufacturing orders. This way, the function would take the control of the purchasing process and become fully responsible for the availability of imported products for sale. The objectives of the function for this division shall be the consistent availability of imports to meet demand at the lowest possible total cost. As a result, the function should analyze the inventory turnover of finished goods, both at the point-of-sale and within the organization, to enable a quick response to market demand. Inventory level and purchasing volume policies would have to be established in order to maintain high service levels at a minimum cost, avoiding unnecessary tied-up capital. Moreover, the function would have to work closely with the headquarters in order improve the speed and reliability of deliveries. This might involve a review of the ordering and forecasting processes, in addition to implementing a performance measurement process.
3.3.2 Local products
The difference between the products of this division and those of the imports division seams clear. Local products are manufactured in the country where the business unit is located, the other are produced in another country. As a result, the processes to obtain a finished good of this division are more complicated. Moreover, the amount of materials required to produce these is larger by far. The chemical substances and powders required for the process are named “raw materials”
3, and these make out almost 90% of the bill of materials. The rest of the materials are the package components, such as plastic or aluminum bottles, labels, caps, etc.
Examples of local products are shampoos, deodorants, body creams, hair sculpting gels and sunscreens. The manufacturing processes are capital intensive, since expensive semi-
3 Raw materials are defined as those that are in natural state and not treated or prepared for use (Longman Dictionary of Contemporary English, 2005). This differs completely from the nature of the materials named as “raw materials” in the organization. Such components have already been treated or prepared for use at other tiers of the supply chain. This use of the term is aligned with the definition provided by Schönsleben (2004): “A raw material is, for the company, a purchased item or an original material that is converted via the manufacturing process”.
automated equipment is used. The amount of labor involved in the process is quite low, performing activities of set-up and monitoring primarily. High value is added at this stage of the supply chain and the potential for innovation is high. The manufacturing environment for these goods division is make-to-stock as well. However, the logistics process that is followed is push- pull logistics. Research and development for these goods is performed both at a regional and local level. Development of local and regional new products is permitted by the main business unit. However, lack of coordination due to the culture and attitude of personnel is still an issue constraining the exploitation of regional opportunities and development of capabilities.
These products represent 52% of the total gross sales of the business unit in value and 75% in units sold. The profit margin for these goods is lower than that of the imported products. The main issue with the products of this division is that the amount of units sold is low compared to those sold by competitors. This type of products is targeted for mass consumption, where large volumes of units need to be sold to reach a healthy profit margin. This volume issue makes negotiations with suppliers even harder, since larger batches than needed have to be ordered to get a good price. Moreover, such products are not traded by the company in all regions, especially not in the country of the main business unit. There is a high potential, however, within the region the business unit studied is part of. In this region, products are similar and opportunities to standardize these exist. On the other hand, the consolidated volume would still be low to improve drastically the cost of materials.
The purchasing process for this product division is more complex than that for the imports division. As it has already been mentioned, a large number of materials are required. The bill of materials for a specific product can include almost thirty components, not considering the packaging materials. However, different versions within a product family have a large amount of common materials, enabling the achievement of some economies of scale. The product portfolio for this division is also reviewed by marketing and sales, without the involvement of purchasing. Again, the sales forecast is prepared based on sell-in data and feedback from the commercial areas. Production planners run the MRP process for these products on a weekly basis and review the resulting order proposals for materials, as well as open orders. Any necessary modifications to quantities or delivery dates are made. Then orders are printed and forwarded for authorization to a purchasing engineer and the production manager. Once authorized, orders are sent via fax to the suppliers. Once the materials or components are manufactured or picked from stock, suppliers deliver these to the company. Supplies are then inspected by the warehouse clerk to match physical quantities against the order(s) placed. The production planners review any differences with the headquarters personnel. On the other hand, supplies are also inspected by quality assurance to check their compliance with the established specifications. If the products are approved, delivery data is updated in the system and the order documents, such as the invoice and receipt tickets, are delivered to the accounts payable department. Otherwise, supplies are rejected and both the production planner and the supplier are informed about it. In the case of new product development, where new materials and components are required, purchasing is involved at the early stage of the process. The role of the function here is primarily to evaluate and select suppliers based on specifications. In the case of current supplies, purchasing is involved in the review of volumes and prices on an annual basis. The function does not measure and evaluate the supplier performance on a broad basis. Exceptions take place, when extremely poor service levels take place and drastic measures must take place. On a day-to-day basis, the participation of purchasing is limited to the authorization of purchase orders or exception receipts of supplies that do not comply with the set specifications. This last situation takes place when the receipt of materials is urgent due to unexpected sales or delivery delays.
Again, the participation of the function in the purchasing process should increase. Van Weele (2005) states in his book that the purchasing function must become responsible for the purchasing process. Such process is composed of 6 stages: definition of specifications, supplier selection, purchasing contract, ordering, expediting and follow-up/evaluation. The author states that other functional areas participate in the process and are co-responsible for its outcome.
However, the professional buyers should act as facilitators for the entire supply cycle. Such role
includes being involved in new product development, evaluation and selection of suppliers,
preparing contracts, establishing ordering routines, taking care of order handling, expediting,
and evaluating supplier performance. Furthermore, Saunders (1997) mentions that purchasing
is also responsible for the establishment of sourcing strategies designed to achieve control of
performance with regard to quality, delivery, cost and service. In these strategies early supplier involvement, supplier development, supplier assessment, supplier certification and the measurement of performance are important, as well as inventory policies and transportation strategies. Following these lines of thought, the function at the firm must become responsible of all materials sourcing activities. Such activities include running the MRP process (in coordination with the production planners responsible for the availability of finished goods);
reviewing, modifying, releasing and forwarding orders; monitoring the status of open orders and delivery troubleshooting; evaluating supplier performance; supplier development; developing and implementing certification programs; developing and implementing sourcing strategies;
performing value and outsourcing analysis; etc. On the other hand, the purchasing function must also be involved in the forecasting process, providing feedback and challenging initiatives from the commercial areas. Further involvement in the new product development process is also required, enabling the introduction of innovation through the supplier base. Based on all the above mentioned, the objectives for the function, for this product division, are to ensure the availability of quality supplies and enabling innovation at a minimum cost. Here, the function should be able to establish and improve a supplier base that supports the company targets, namely, quality and innovation, at an affordable cost. To accomplish this, purchasing must develop sourcing strategies for the different types of materials (based on a portfolio analysis) and establish inventory and ordering policies in order to enable the availability of materials at an optimum cost. Establishing programs such as supplier certification and supplier development are also key activities to obtain the required service level and quality from vendors.
3.3.3 Markets
In the work of Van Weele (2005), attention is given to the type of supply markets and its influence in purchasing. The author states that the patterns of relationships between supplier and buyer are determined mainly by the external structure, the underlying pattern of goods and services deliveries. Such structure consists of a number of links, companies that are connected via markets. The market is the total of supply and demand, and several types of market structure are distinguished by economic theory for each side. These structures in their pure form rarely exist, but can be used to identify the situation of a company within a certain market (Van Weele, 2005). The market analysis performed considers the organization in the supply side and its customers, obviously, on the demand side. An analysis of the market where the organization has the role of the buyer is included in another chapter of this thesis.
Besanko et al. (2004) and Van Weele (2005) state that for the supply side, four different structures can be distinguished, namely, pure competition, monopolistic competition, oligopoly and monopoly. The main characteristic of pure competition is that neither the supplier nor the buyer can influence the price of the product. There are many suppliers of homogeneous goods and consumers look for the best price, as they are well informed. Markets for cocoa, iron or aluminum are examples of this type of structure. Monopolistic competition is characterized by a large amount of suppliers and high degree of differentiation, where each supplier aims to stand out and create a monopoly situation for himself. The notion of differentiation implies that consumers make choices among competing products, taking into account not only its price but other factors as well. Examples are the market for detergents, cigarettes and other durable consumer goods. In an oligopoly, the amount of suppliers and product differentiation is limited.
Winning a share of the market is tough, since important entry barriers are present. When suppliers are few in amount but there is product differentiation, this market is referred to as heterogeneous oligopoly. If the amount of suppliers increases, then the preferred term is monopolistic differentiation. Finally, a monopoly is that situation in which only one supplier exists for a given product and substitutes are too hard to find or situations in which a single supplier holds more than 60% of market share and competition comes from small firms. As a result, the supplier has the ability to act without constrains, controlling the pricing and quality of the product.
In the supply side of the market in which the company is involved, the amount of suppliers is
limited. Moreover, few competitors hold the major part of the market. However, suppliers make
great efforts to differentiate their products from that of the competition. In the case of the
imported goods, the company leads the market. Only three companies hold, together, more
than 50% of market share. However, pressure from its main competitor is building-up due to
strong marketing initiatives and continuous new product introductions and innovations. The
company has made large efforts to increase consumption and market share by introducing new products as well. For the local products, the company does not lead the market. Market share is quite limited, despite the perception customers have of the quality of its goods. In this case, the market participation is distributed over a larger amount of suppliers. However, three companies hold more than 50% of the market as well. For these products, innovations and new product introduction are not as often as with the imported products. Generally, customers look for products that offer the best value for price combination. As a result, margins are regularly low and large sales volumes are needed to achieve profitability. On the other hand, competition has increased since some companies that marketed other type of consumer goods have decided to enter the market. Finally, it is important to mention that the companies the organization competes against are the almost the same for both product divisions. Based on the descriptions of possible market structures available on literature, characteristics of both monopolistic competition and oligopoly are present in the company’s market. However, due to the importance of product differentiation in the market, it is concluded that the structure is that of monopolistic competition.
For the demand side, Van Weele (2005) distinguishes three types of market structure: pure competition, oligopsony and monopsony. The description given before for pure competition also applies here. In the case of oligopsony, it is the oligopoly situation in reverse. Few buyers are present in the market while the amount of suppliers is large. Buyers are aware of each other’s behavior and occupy a position of power in the supply chain. Examples are the automobile and the retail industries. Finally, monopsony is that situation where there is a single buyer for the product versus a large amount of suppliers. However, this type of situation is rare. Examples are the railways or public utilities such as gas or water supply.
The company’s customers are primarily retailers, representing almost 80% of the total sales and few of them hold the gross majority of this percentage. The four top customers are the most important retailers in the country and hold almost 70% of the retail market. Strong competition between these takes place, placing large pressures on suppliers in terms of service level, quality, cost, and product differentiation. In some cases, retailers demand exclusivity on promotions or even products. Such retailers hold the position of power in the supply chain. As a consequence, it can be concluded that the structure of the demand side of the market is that of an oligopsony.
Taking into consideration the possible situations for both the supply side and market side of markets, Van Weele (2005) presents a matrix where the position of power is considered. Such position depends on the amount of suppliers and buyers on the market, resulting in either dominant, equal or subordinate. The resulting matrix is shown in table 3.1. Based on the conclusions reached above, the company’s market should be located in between the fifth and eighth quadrants, bilateral oligopoly and demand-side oligopoly respectively. However, the position of power is on the demand side, due to the strength of retailers. Therefore, the company’s market tends more towards the lower quadrant, demand-side oligopoly. This is true for the two product divisions of the company.
Market characteristics have a strong influence on the objectives, strategies and policies of the purchasing function of a company. In the case of the company analyzed, there is a strong competition among companies to increase market share. End customers look for innovative and quality goods at affordable prices. To maintain or increase its market share, the company must be able to offer such combination in the most efficient and effective way. Therefore, purchasing must establish a supply base capable to source quality and innovative materials at the minimum total cost possible. This last feature is very important to improve the profitability of the company.
The organization capable of providing attractive differentiation at the overall lowest cost will undoubtedly increase market share. On the other hand, retail companies are also demanding differentiation from their suppliers. The objective of this differentiation requirement is to earn the preference of end customers over their competitors. Such strategy might imply special discounts, promotions, store activities or exclusive products. Furthermore, retailers are increasing their pressure on suppliers to reduce inventories at the point-of-sale and improving the service level. As a result, material availability is a key issue to ensure the service level required by the top customers, especially in the case of those products with erratic demand.
Failing to comply with the required levels might result in penalizations or more radical measures,
such as the reduction of shelf space or product delisting. Also, purchasing must become a
source of innovation that enables the company to differentiate its products from those of the competition.
Amount of Buyers Amount of
Suppliers
One Few Many
One Bilateral monopoly
Limited supply-side monopoly
Supply-side monopoly
Few Limited demand-side monopoly
Bilateral oligopoly
Supply-side oligopoly
Many Demand-side
monopoly
Demand-side oligopoly
Polypolistic competition
Table 3.1 - Market Structure Matrix, adapted from Van Weele (2005).
