Procurement & Supplier Development.

SCHOOL OF ENGINEERING

P01 – Planning to buy

E354 : PROCUREMENT AND SUPPLIER

DEVELOPMENT

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Engineering, Republic Polytechnic, Singapore.

Planning to buy Marsiling Cross Docking Centre (MCDC) serves as a transit centre that sorts and merges incoming shipments from different warehouses and delivers them to various destinations.

Currently, the receiving process is rather slow and error prone. The staff has to enter the shipment info when goods are received and shipped out. Upon project meetings with the supply chain department, it was suggested that using automated identification technology such as barcode reader may help to improve on the current process. Your manager, Mike suggested that you may buy up to 3 sets of PDA with built-in barcode reader for a trial run. There are no pre-existing suppliers for the product but you have some catalogs obtained from the web. The followings are some important performance features that Mike has specifically mentioned to you:

Assist Mike in constructing a suitable specification so that you can use it to request quotations from potential suppliers. How do you forecast for the project purchase in FY2010?

School of Engineering

P01

Planning to buy

E354 – Procurement and Supplier

Development


Purchasing activities in an organisationArea of Responsibility Activities

Purchasing/buying Create contracts, manage key purchasing processes

Purchasing research Benchmarking, identify supply chain trends

Inventory control Manage inventories, expedite material delivery

Transportation Manage/select inbound/outbound transportation

Environmental and investment

recovery/disposal

Comply with legal and regulatory requirements;

Manage disposal of surplus materials/equipment

Forecasting and planning Plan/forecast short/medium/long term requirements

Outsourcing and

subcontracting

Evaluate suppliers and negotiate contracts; Support

transition from internal to external supply & vice-versa

Nonproduction

/nontraditional purchases

Manage cost effective delivery of office supplies,

security services, advertising, insurance

Supply chain management Implement and manage key supplier relationships;

Develop strategies to use supply network


Type of purchasesConsumer products – Goods purchased

by individuals and households for personal

consumption

Resale Products – Purchased by

organisation in order to resell at a profit

(e.g. retail)

Services

E.g. Warehousing/Distribution,

Transportation

E.g.

http://www.dhl.com/publish/g0/en/services/l

og_services.high.html

Consumables/Maintenance, Repair and

Operating Items – essential for running a

business:

•Maintenance/Repair Items – Lubricants,

paints

•Operating supplies – Office supplies,

packaging materials

Industrial Products – Purchased by organisation for use in manufacture of other

products to make profits or other objectives. They can an be divided into:

Capital equipment items. E.g. machinery, tools and instruments

Production materials (3 categories):

Raw materials and commodities: minerals, petroleum, dairy goods, fruits

Semi-finished goods and processed materials: rods, tubing, wires, chemicals, leather,

sugar, paper

Component parts and assemblies: car engines, bearings, gauges, wheels, radio

http://www.dhl.com/publish/g0/en/services/log_services.high.html




http://www.northernbrewer.com/pics/fullsize/ GasTubing.jpg

http://z.about.com/d/pediatrics/1/0/5/6/06175.jpg


Differences in purchasing of goods and

services

Services can be defined as all the economic activities that are intangibleand imply an interaction to be realised between service provider andconsumer.

Comparison of services and goods

Services Goods

An activity or process A physical object

Intangible Tangible

Service is produced and consumed

simultaneously

Separation of production and

consumption

Customer participate in production Customer may or may not

participate in production

Heterogeneous Homogenous

Perishable – cannot be stored for

future use

Can be stored for future use or sale


Typical Procure-To-Pay (P2P) Process


Step1: Forecast and Plan Requirement

The purchasing cycle begins with the identification of a need (arequirement).

In most cases, procurement personnel would have an annual/bi-annualplanning process whereby they would review the spending pattern forthe organisation and prepare a forecast of what will be purchased.

A project need may take the form of a component , raw materials or afinished item. It may also be a service such as a need to for foodservice to provide lunches at the company cafeteria.

Not all needs can be forecasted ahead of time. Needs that comes upsuddenly, which is not planned for and there is no pre-existing supplierto provide the product or service required can be handled through spotbuy.


Step 2: Needs Clarification/Requisitioning

The most common method of informing purchasing of materials needsis through a purchase requisition.

Sometimes a service is required. In this case, the user would completea statement of work (SOW) which specifies the work that is to becompleted, when it is needed and what type of service provider isrequired.

For very small companies that have not automated their purchasing orinventory management processes, materials needs can becommunicated through travelling purchase requisition. This is a formthat consists of a printed card or a barcode with information about theitem to be purchased from.

Within requisitioning process, it is important to include a description ofwhat is to be sourced. There are variety of methods of communicatingthe user’s requirement.


Method of Description

Description of market grade/Industry standard – This is the best choicefor standard items, where the requirements are well understood andthere is common agreement between supply chain partners aboutwhat certain terms means.

Description by brand – Used when a product/service is proprietary orwhen there is a perceived advantage to using a particular supplier’sproducts or services.


Method of Description – More detailed

Description by specification – Specification can cover characteristicssuch as materials used, the manufacturing or service steps required andeven physical dimensions of the product.

Description by performance characteristics – Focuses attention on theoutcomes the customer wants, not on precise configuration of theproduct or service.

Description by prototypes/samples – Prototypes can provide criticalinformation on the look and feel of a product or service. E.g. Aprototype information system that a company may share with potentialsoftware vendors. It may include sample output screens and reports.


Step 3:

Supplier Identification and Selection (1)

Once the need and description of need are identified, you would need todecide if the need is fulfilled by a supplier that has an existing contractualrelationship with the company or the need is fulfilled by a new supplierthat is not currently qualified to provide products and services to the firm.

For some items, the firms may maintain a list of preferred suppliers thatreceive the first opportunity for new business. A preferred supplier hasdemonstrated its performance capabilities through previous purchasecontracts and receive preference during the supplier selection process.

Identifying potential suppliers is different from reaching a contract oragreement with suppliers. Competitive bidding and negotiation are twomethods commonly used when selecting a supplier.

Competitive bidding involves request for bids from suppliers which thebuyer is interested to do business. This process is initiated when thepurchasing manager sends a request for quotation (RFQ) to the supplier.The objective is to award the business to the most qualified bidders.



After bids has been received or negotiation has taken place, thesourcing team would select a supplier and move on to authorize thepurchase through purchase approval process.

If the purchase contract requires negotiation between the buyer andseller (rather than competitive bidding), purchasing sends a request forproposal (RFP) to a supplier. In many firms, both RFQs and RFPs aresynonymous.

The potential evaluation of suppliers begins after determining that apurchase needs exists. The source evaluation requires the developmentof a list of potential suppliers. Buyers use different performance criteriawhen evaluating potential suppliers.

Note: When an internal customers purchase directly from nonqualified suppliers and try to bypass purchasing in the process, this known as maverick spending.



Procurement Value Quotations/Open tender

For small value purchase (where Estimated

Procurement Value (EPV) <= $3,000)

At least 2 quotes are required.

(Depending on company

practices: 3 quotes may be

required).

For EPV > $3,000 but <= $70,000 Invitation to quote (ITQ)

For EPV > $70,000 Invitation to tender (ITT)

E.g. of procurement guideline


Step 4: Approval, Contract, and Purchase

Order Preparation

After the supplier is selected or a requisition for a standard item isreceived, purchasing grant an approval to purchase a product orservice. This is accomplished through several different approaches,depending on the type of system in place.

The drafting of a purchase order (PO) takes place after supplierselection is complete. The purchase order details critical informationabout the purchase: quantity, material specification, qualityrequirements, price, delivery date, method of delivery, ship-to address,purchase order number, order due date.

For an item or group of items ordered repetitively, from a supplier,purchasing may issue a blanket purchase order – an open ordereffective for 1 year, covering repeated purchase of an item or family ofitems.


Step 5: Receipt and Inspection

This phase of purchasing cycle involves the physical transmittal ofpurchase requirements. Purchasing and material planning mustminimize the time required to release and receive material (E.g. use ofEDI). Better relationship with supplier can support a JIT orderingsystem. The receiving process can also be made efficient as possible byusing barcode technology to receive and place supplier deliveries ininventory.

Receiving

Process


Step 6: Invoice Settlement and Payment

Once the item or service is delivered, the buying firm will issue anauthorization for payment to the supplier. Payment is then paid throughthe organization’s accounts payable department. This is increasingbeing accomplished through electronic means e.g. using electronicfunds transfer (EFT).

Example of streamlining the receiving, invoicing and payment process:

www.vendors.gov.sg

http://www.vendors.gov.sg/








Problem Statement - Specification


Problem Statement – Specification (Con’t)

Additional requirement:

(see:

Going further Question)


Problem Statement – Procurement forecast


Problem Statement - Conclusion

There are various activities in the organisation in which purchasingassume responsibilities.

Organization buy many different goods and services. The type ofpurchases can be classified into consumer product, industrial product,resale products, consumables/Maintenance, Repair and OperatingItems and services.

It is important to understand the difference between goods andservices.

A typical procure-to-pay process can be classified into six steps: forecastand plan requirement, Need clarification/requisition, SupplierIdentification/selection, Approval and PO generation, Receipt andInspection, Invoice settlement and Payment.


Learning Objectives

Discuss the differences between type of purchases and explain thedifferences between goods and services

Explain the steps in the Supply Process

Determine the needs and construct a specification for the purchase anda procurement forecast


P02 – Source strategically


DEVELOPMENT






Source Strategically Mapple Logistics is embarking on an upgrade project to improve the existing laptops in the company. This is to streamline the existing support and software applications in the company and also provide a higher level of staff satisfaction. There are several decisive factors to consider for the new procurement such as cost, quality, technology, vendor support and brand. There are also several alternatives in the market which are pre-qualified by the IT department. They are all major suppliers of commercial and personal computers and they are known as SXX1, SXX2 and SXX3 respectively. As a buyer for the procurement division, which is the best supplier to choose for your purchase based on the multiple sources that you have? What other sourcing strategy you can use to reduce the supply base?


P02 Source Strategically


Development

Initial Supplier

Qualification

Agree Measurement

Criteria

Obtain relevant

Information

Make Selection


Strategic Supplier Selection Process Step 1: Initial Supplier Qualification

Supplier qualification is the first step towards supplier selection. Thegoal is to identify suppliers who meet the requisite product and processstandards and are capable of supporting the buyer’s long-termobjectives. Because organisations are resource constrained,qualification helps to reduce the pool of potential suppliers to a moremanageable number for detailed evaluation and selection. Supplierqualification is concerned with the supplier’s capabilities as a whole. Itis therefore a ‘sorting’ rather than a ‘ranking’ exercise.

Step 2: Agree Measurement Criteria

The strategic selection process continues with identifying relevant andappropriate selection criteria. The most significant trend withinselection criteria has been the move away from price and towards atotal cost approach.


Strategic Supplier Selection Process

(con’t)

21 Supplier

Selection

criteria out of

the 5 main

competitive

priorities

Price is visible because it is the

bottom line of any supplier bid or

quote

However, price rarely reflects the

total cost of doing business


Strategic Supplier Selection Process

(con’t)

Step 3: Obtain Relevant Information

The third stage in the process is obtaining the information used tocompare suppliers across criteria. It is important that the information iscomparable across suppliers so that, for example, information onquality from supplier A can be compared to information on quality fromsupplier B. Information should also be timely and accurate.

Step 4: Make Selection

A range of models can be used. Multi-criteria decision-making models such as (AHP) can be used for more complex selection esp. high-value goods.

For low value product, comparison of information would do.

Initial Supplier

Qualification

Agree Measurement

Criteria

Obtain relevant

Information

Make Selection


Selection Criteria - Cost Unit Price: The unit price is simply the price of one unit and will be

clearly specified on a supplier’s response to an RFQ. It is easy to comparethe unit price across various supplier firms because the data are objectiveand comparable.

Pricing Terms: Pricing terms include quantity discounts, promotions andpayment terms. Quantity discounts can be an important factor in thetiming of purchases, but important that any discounts are consideredagainst the cost of holding additional inventory, depreciation of thatinventory and reduced flexibility. Payment terms refer to the length oftime before payment is due. Longer payment terms have a positive effecton working capital and therefore are an important factor when comparingsuppliers. Buyer firms may also seek discounts for quick or early payment.

Exchange rates: Exchange rates will vary according to the location ofeach supplier. Buyers operating global supply chains will find thatfluctuating exchange rates can have an enormous impact on profits.


Selection Criteria - Quality Apart from price and delivery, quality is probably the most common

criterion used in the supplier selection decision and in somecircumstances is given primary importance.

How do you measure supplier quality before delivery? E.g. the use ofquality system certification such as ISO 9000 certification. By followinga series of guidelines produced by the International StandardsOrganization, companies can apply for ISO 9000 certification thatofficially reports conformance to quality standards. However there arealso criticisms of over-reliance on quality certification:

The cost of registration and maintenance

The perceived lack of relevance especially within small and service-basedorganisation

Lack of flexibility in the process may stifle management innovation/creativity

Furthermore, buyer firms may also visit supplier plants to ascertain thegeneral attitude of management and workers to quality.


Selection Criteria - Delivery

On-time delivery considers the variability of a supplier’s deliverycompared to the time agreed by the buyer. Buyers aim to selectsuppliers with low variability to help reduce the need for highquantities of safety stock.

Minimum lot size simply refers to the minimum order quantity thebuyer firm can place with the supplier. Suppliers maintain minimumorder quantities because they can gain economies of scale bymanufacturing long runs of the same product.

The location of the supplier, lead-time and inbound delivery costsmust all be considered against any savings a low cost manufacturer mayoffer. In an era of agile manufacturing and mass customisation, shippingdelays from distant supplier locations can significantly stymie efforts topull components through the supply chain. Even in low-variety massproduction environments, distant suppliers can delay responses tovariations in demand and create the need for expensive expediting.


Selection Criteria - Flexibility

Flexibility is the ability of the supplier to manage variation from thebuyer firm without significant trade-offs with other competitivepriorities.

Volume flexibility refers to the ability and willingness of the supplierfirm to change order volumes without significant penalties. Volumeflexibility is important when firms face progressively uncertainenvironments, global competition and technological acceleration.Flexible suppliers are of particular benefit where demand is uncertainby reducing the need to hold high levels of safety stock.

Mix flexibility refers to the ability and willingness of the supplier tochange the mix of ordered products without significant penalties.Increased product variety can increase customer perceived value byoffering greater choice with little or no trade-off with price or time. Mixflexibility within suppliers is especially important within agile or masscustomisation environments.


Other Selection Criteria

Environmental measures are growing in importance as new legislationand consumer pressures hold end manufacturers (or OEMs)increasingly responsible for the impact of their products across theproduct life cycle. Studies have shown that firms that proactivelyengage with environmental issues can reduce costs and increasecustomer value.

Innovation capabilities are becoming an important consideration forsupplier selection. Involving suppliers in product development allowsthe Buyer to focus on core capabilities and tap into suppliers’ expertise,resulting in reduced time-to-market, better product design and quality,and a lower product cost. From an innovation perspective, the Buyerneeds to ensure a technological and cultural ‘fit’ between the twoorganisations. The Buyer may consider the rate of innovation (thenumber of new products or patents) and the type of innovation(continuous versus discontinuous).


Potential Suppliers Sources

Company records

Catalogs (online and printed)

Trade Journals and Trade Shows

Advertisements

Supplier and commodity directories

The Internet

Sales representatives

Colleagues, networking, professional contacts

Visits to suppliers

http://www.supplychainasia.com/magazine

http://nl.sitestat.com/elsevier/elsevier-com/s?ScienceDirect&ns_type=clickout&ns_url=http://www.sciencedirect.com/science/journal/14784092


Online Survey

Setting up survey question using

survey monkey


Supplier Selection – Weighted Scoring

Weighted Scoring system:

A simplistic approach to a decision problem

Assign weights to each of the criteria that are to be considered

Rank each decision alternative on a scale from 1 (worst) to 10 (best)

Multiply weights by the rankings for each criterion and sum them up

The alternative with the highest score would be the most preferred

SXX2 has a higher weighted score and thus would be the selected

supplier using the weighted scoring method.


Supplier Selection - AHP

-The Selection Hierarchy

Selection Of Suppliers

Supplier SXX1

Technology

Supplier SXX2

Goal

Selection criteria

Alternatives

QualityVendor

SupportCost Brand

Supplier SXX3


Supplier Selection – AHP (Using Expert Choice)

- Pair-wise Comparison for Criteria

Perform pair-wise comparison of criteria with respect to the goal

Pair-wise comparison

Sort by priority after pair-wise comparison



- Pair-wise Comparison for Alternatives

Perform pair-wise comparison of alternatives for each of the criteria.



- Synthesize the result

What is your decision?

The inconsistency measure is to identify possible errors injudgments as well as actual inconsistencies in thejudgments themselves. It measures the logicalinconsistency of your judgments.

In general, the inconsistency ratio should be less than 0.1or so to be considered reasonably consistent.


Dynamic Sensitivity Analysis It is used to investigate the sensitivity of the alternatives to changes in the

criteria.

When performing a sensitivity analysis you may vary the priorities of thecriteria and observe how the priorities of the alternatives would change. Bychanging the relative importance of criteria, the change of final selectiondecision can be observed.


Sourcing ConfigurationsSingle Sourcing Multiple Sourcing

Delegated

Sourcing

Parallel

Sourcing

Sourcing Configurations


Sourcing ConfigurationsSingle Sourcing

Occurs due to

- deliberate choice of buyer,

- explicit request by final customer

- Only one source of supply

Multiple Sourcing

- Use to maintain competition in a supply market

- A range of suppliers to choose from

- Buyers using this structure will tend to focus onpurchase price rather than total cost. This approachmaintains continuity of supply in the short term,whilst enabling the buyer to achieve pricereductions.

Delegated Sourcing

- The customer delegates authority to a key supplier who becomes first tier supplier that works with all other supplier.

Advantage:

- Buyer able to reduce day to day transaction cost

- Buyer tends to transfer capabilities and technologies that enables supplier to produce required sub-assembly

Disadvantage:

Supplier can become too powerful

Parallel Sourcing

- Parallel sourcing allows the buying firm to to workon a single or sole-sourced basis with eachcomponent supplier within a product group whilemaintaining a multiple sourced relationship acrossproduct groups.

-While each supplier supplies into a separateproduct group (sole sourced), the buyer hasalternative sources of supply if necessary (multiplesourced). Furthermore, the buyer can compare theprice, delivery and quality of goods across differentsuppliers but for similar components.

Sourcing Configurations


Problem Statement

Sourcing configuration provide the means for implementing supplystrategy. They must be aligned to the requirements of the organisation.

The selection of supplier goes through the stages of initial supplierqualification, agree measurement criteria, obtain relevant information,and make selection.

As we see, weighted scoring (simple) and AHP (more detailed andconsistent) can be used for supplier selection.


Learning Objectives

Identify the stages of strategic supplier selection and some of

the primary criteria used to select suppliers

Utilize suitable supplier selection technique

Describe key sourcing configurations


P03 – Look Beyond The Price


DEVELOPMENT






Look Beyond The Price Mark is a procurement engineer in a hard disk manufacturing company named Disk- Smart.

Read/Write Heads is a key component of the hard disk drive. Currently Disk-Smart is purchasing Read/Write Heads from two suppliers, RWH-Super and RWH-Excel. Mark has been tasked by his General Manager to evaluate the two suppliers so that one of them will become a strategic partner with the company. Mark is asked to look beyond the purchase price of the read/write heads as both suppliers offer almost the same price and pricing terms. Quality is an important factor that Mark should take into account when selecting a strategic partner. The following table contains information of quality related activities, which will contribute additional cost to the company. (See Table 1) Table 1

Type of cost Read/Write Heads Supplier: RWH-Super ($)

Read/Write Heads Supplier: RWH-Excel ($)

Warranty 52500 157500

Returned Materials (from Disk-Smart’s customers) 52500 140000

Review and Reliability 8750 8750

Scrap and Rework 70000 210000

Product Audit 24500 35000

Acceptance Testing 17500 52500

Quality Control 8750 8750

Total 234500 612500

Standard Direct Labor cost 100000 300000

Sales (Year 2009) 980000 2940000

What will be the criteria and initiatives that Mark should adopt, to select his preferred strategic supplier? What are the steps he can take to improve the supplier quality? Advise him.


P03Look Beyond the Price


Development


Definition of Quality

There is no universally accepted definition of quality, the following are common

elements found in all definitions of quality:

Quality involves meeting or exceeding customer expectations (American

Society for Quality)

Quality is defined as fitness for use (Joseph Juran, 1904-2008)

Quality- Conformity to requirement not goodness (Philip Crosby, 1926-2001)

Quality applies to products, services, people, processes and environments

Quality is an ever-changing state. What is quality today may not be good enough

tomorrow.

The concept of quality should also extend to the suppliers


The Cost of Quality COQ Definition: The cost of conformance (COC) plus the cost of non-

conformance (CONC) or the cost of doing things wrong

Cost of Conformance (COC)

Prevention costs : cost of any action taken to investigate, prevent or reducedefects and failures

E.g. quality control/engineering, including design/specification reviewand reliability engineering, training, systems improvement

Appraisal costs :cost of assessing the quality achieved

E.g. product audit cost, laboratory acceptance testing

Cost of Non-Conformance (CONC)

Internal failure: Costs arising within the manufacturing organization beforetransfer of ownership to customers

E.g. scrap, rework and repair, troubleshooting

External failure: Costs arising after transfer of ownership to customers

E.g. Complaints, returned materials for repair, warranty costs


Total Quality Cost Index

(Labor Cost Base Index)

Supplier RWH-Excel has a lower Total Quality Cost Index compare to Supplier RWH-Super

Quality costs themselves provide little information, since they may vary due to suchfactors as production volume or seasonality. Thus, index numbers can more effectivelyanalyze quality cost data. To establish significance of quality costs, we use ratios toshow relationships between total costs, costs of prevention , appraisal and failure.Total Quality Cost Index (labor base) = Total quality costs/ direct labor costsClassify into 4 main types of Costs as defined by COQ

Calculate Total Quality Cost Index

Step 1

Step 2

Step 3

Types of Cost RWH-Super RWH-Excel Types of cost

Warranty 52500 157500 External Failure

Returned materials 52500 140000 External Failure

Review and Reliability 8750 8750 Prevention

Scrap and Rework 70000 210000 Internal Failure

Product Audit 24500 35000 Appraisal

Acceptance Testing 17500 52500 Appraisal

Quality control 8750 8750 Prevention

Total 234500 612500

Types of Cost RWH-Super RWH-Excel External Failure 105000 297500

Prevention 17500 17500Appraisal 42000 87500

Internal Failure 70000 210000

Types of Cost RWH-Super RWH-Excel

External Failure 1.05 0.99

Prevention 0.18 0.06

Appraisal 0.42 0.29

Internal Failure 0.70 0.70

Total 2.35 2.04


Type of cost Read/Write Heads Supplier: RWH-Super($)

Read/Write HeadsSupplier: RWH-Excel($)

Warranty 52500 157500Returned Materials (fromDisk-Smart’s customers) 52500 140000Review and Reliability 8750 8750Scrap and Rework 70000 210000Product Audit 24500 35000Acceptance Testing 17500 52500Quality Control 8750 8750Total 234500 612500Standard Direct Labor cost 100000 300000Sales (Year 2009) 980000 2940000

Total Quality Sales Index

(Sales dollar base index)

Total Quality Sales Index=Total quality costs/ Sales

Supplier RWH-Excel has a lower Total Quality Sales Index compare to Supplier RWH-Super

Types of Cost RWH-Super RWH-Excel

External Failure 0.11 0.10

Prevention 0.02 0.01

Appraisal 0.04 0.03

Internal Failure 0.07 0.07

Total (based on Sales) 0.239 0.208


Total Quality Sales Index

(Comparison of 4 quarters in a year) Example: Compute a sales dollar base index for NX Inc. to analyze the following

quality cost information and prepare a memo to the management.

Comparing Qtr 4 to Qtr 1, the overall index fell by 8%. Internal failure reduced from$468.20 from 1st quarter to $166.40 in 4th quarter and External failure also reducedfrom $280.80 to $128.60. Management should maintain or increase the level ofprevention and appraisal in an effort to reduce quality costs, especially failure costs.

Total quality Sales index(Sales dollar base)= Total Quality Costs/Total Sales


Supplier Certification (What is it?)

Usually before a new supplier is given an order, and often before a supplier isallowed to quote, the purchaser conducts quality capability or qualityassurance survey on supplier’s premises. The purpose is to ensure that thesupplier is capable of meeting the specifications and quality standardsrequired.

The survey will not only examine the supplier’s equipment, facilities andpersonnel but also the systems in place to monitor and improve quality. Alsoexamined are supplier’s effort to seek cooperation and compliance in qualitystandards from its suppliers and the supplier’s commitment to ongoing qualityimprovement. Hence to summarize, it is:

Part of a larger strategy of Supplier Quality Management

Process of managing the relationship between your organization and itssuppliers to coordinate as one in creating value for all stakeholders

A minimum requirement to be considered to work


Quality Certification: ISO 9000 The short form of the International Organization for Standardization is ISO.

ISO is a network of the national standards institutes of countries worldwide

ISO 9001:2008 is the latest version to standardize quality requirements recognized internationally.

It sets broad requirements for the assurance of quality and formanagement’s involvement.

Organization certified to under ISO 9000 standards are assured to havequality equal to their peers.

ISO9001’s requirements are generic in nature, and are applicable to organizations in any industry or economic sector

ISO 9000 is based on 8 Quality Management Principles.


ISO 9000 (8 Quality Management Principles)

1. Customer focus

– understanding customer’s needs, striving to exceed their expectations.

2. Leadership

– establishing direction, unity of purpose, and a supportive work

environment.

3. Involvement of people

– ensuring that all employees at all levels are able to fully use their abilities

for the organization’s benefit.

4. Process approach

– recognizing that all work is done through processes, and managing them

accordingly.


ISO 9000 (8 Quality Management Principles)

5. Systems approach to management

– expanding on the previous principle in that achieving any objective requires a

system of interrelated processes.

6. Continual improvement

– as a permanent organizational objective, recognizing and acting on the fact that no

process is so good that further improvement is impossible.

7. Factual approach to decision making

– acknowledging that sound decisions must be based on analysis of factual data and

information.

8. Mutually beneficial supplier relationships

– taking advantage of the synergy that can be found in such relationships.


Other Quality Certifications (Industry Specific Examples)

Airline Industry: Boeing Preferred Supplier Certification, AS9100, ISO13485

• Suppliers are evaluated on:

Advanced Quality System Implementation

Business Processes

Performance

• Level of Certification:

Gold (E.g. Lockheed Martin Corporation, Harris Corporation)

Silver (E.g. 3M Company, Mitsubishi Heavy Industries Ltd)

Bronze (E.g. West Coast Aerospace Inc)

Retail/ Food Industry: Starbuck Preferred Supplier Program, HACCP

• Coffee sourcing guidelines

• Performance criteria : Quality, Environment, social conditions, sustainability measures

• Financial Incentives

• 3rd Party Verification


Why Supplier Certification?

Ways to determine which suppliers meet the company’s needs

Aware of what suppliers can and cannot do before everyone invests time andmoney

May not have to do some processes, such as inspection

Consistent methods for managing suppliers

Develop supplier capabilities

Build stronger and open relationships

Better communication and sharing of information

Better serve the customers

Meet corporate improvement objectives through collaboration


A Supplier Development Program : QS9000

A supplier development program developed by a Chrysler/Ford/GM supplier

requirement task force.

The task force was impaneled to develop standard reference manuals, reporting

formats, and technical terminology.

The goal of QS 9000 is to enhance quality systems for suppliers while

eliminating redundant requirements and reducing costs.

In order to promote use and acceptance among automotive suppliers

worldwide, QS-9000 was recently rewritten as ISO/TS 16949 .

On 14 December 2006, all QS 9000 certifications were terminated. QS9000 is

considered superseded by ISO/TS 16949.

ISO/TS 16949:2002 was prepared by International Automotive Task Force

(IATF) and Japan Automobile Manufacturers Association Inc (JAMA),with

support from ISO/TC 176, Quality Management and Quality Assurance.


QS9000 and ISO9000 ISO/TS16949

= ISO 9001:2000 requirement

+ Automotive Requirement

+ Customer Specific Requirement

QS 9000 is fundamentally different from ISO 9000.

QS 9000 is a sector-specific standard developed by the automobile and truck

manufacturers for their suppliers.

QS 9000 is specifically designed to help automakers prove they have

standardized processes for dealing with their customers.

There is much more guidance given to suppliers in the QS 9000 standard.


Why Supplier Development?

The quality of purchased supplies is critical to the quality of acompany’s product and/or services.

Traditional approach to customer-supplier dealings has been based onthe assumption that they are adversaries in which the customer andsuppliers have differing objectives, and are engaged in a win-losecontest.

In this situation, the customer’s best protection was thought to be theestablishment of a number of sources of supply for each bought-outitem and regular switches from one supplier to another through theuse of price-driven contracts.

The end-result is a large supplier base and limited co-operationbetween the parties.

Supplier development requires a fundamental shift in the customer-supplier relationship. It requires a company to treat its suppliers aslong-term business partners.This is a strategic decision.


Barriers to Supplier Development

Poor communication and feedback

Performance feedback to suppliers

On-going communications with suppliers

Precise materials specification data

Supplier complacency

Fail to have adequate quantitative and proactive measures of how well they

are satisfying their customers needs and expectations. Measures are mainly

reactive and centered on internal and external failure data.

Misguided supplier improvement objectives

Companies are often unsure what they want from their supplier

improvement initiatives.

Many have vendor audit programmes but no clear supplier development

objectives.


Barriers to Supplier Development

Credibility of the customer as viewed by their suppliers

Suppliers need to be convinced that a customer is serious about continuous

quality improvement, and this is conditioned by the customer’s behavior and

attitudes.

Misconceptions regarding purchasing power

General view is that a purchaser’s influence on its suppliers varies with its

purchasing power.

Companies with considerable purchasing power may well improve the

quality of purchased items but will not necessarily achieve lasting benefits of

motivate their suppliers to internalize the benefits of a process of

continuous quality improvement to satisfy all their customers.


Supplier Development Process (Dos’)

Look at ways of reducing the size of the supplier base. By reducing incoming

material, component and sub-assembly variability, outgoing product and

service quality will improve.

Ensure, that in support of the supplier development process and its various

stages, your staff and those in the customer organization use the appropriate

engineering quality tools, such as FMEA, QFD, DOE.

Involve suppliers in new product development

Encourage suppliers to dispatch only conforming product, thereby

eliminating the need to carry out duplicate testing and inspection on

incoming goods

Award long-term contracts to key suppliers who have demonstrated

commitment and improvements in order to show tangible evidence of a

long-term relationship


Supplier Development Process (Dos’)

Consider implementing an assessment and rating scheme to select and

measure the performance of suppliers. Poor selection will lead to increased

costs as other suppliers are sought to compensate for the deficiencies of the

one chosen without due care

Develop procedures, objectives and strategies for communicating with the

supply base

Treat suppliers as partners, thereby establishing trust, co-operation and

dependence

Ensure that staff dealing with suppliers act in a consistent and courteous

manner

Respond positively to suppliers requests for information


Supplier Development Process (Don’ts)

Treat suppliers as adversaries

Keep suppliers short of information

Buy goods on price alone. Ensure other criteria such as quality and delivery

performance, R and D potential, competitive manufacturing and engineering

excellence are also taken into account

Constantly switch suppliers

Accept non-conforming goods

Talk quality but act product schedule and price per piece

Forget that the initial samples procedures is a key factor in receiving

conforming supplies


Supplier Development Process

Points to take note

The objectives of supplier development

Developing a strategy and plan to accomplish these objectives

Deciding which vendors to involve in the improvement plans

Ensure that the philosophy of the organization supports teamwork


Supplier Quality Improvement Process

Target selected suppliers Overview meeting with supplier

Supplier self -survey

Supplier Initiates improvement

activities

Trial audit by Disk-Smart

Supplier audit by Disk-Smart

Disk-Smart’s production and

engineering Team inputs

Monitor continuous

improvement

Receive

Certification?

Step 1: Meet and Plan

Step 2: Supplier Self-Survey on quality management and measurement,

safety, training and facilities

Step 3: Strategy Planning

Step 4: Trial Audit

Step 5: The Formal Audit

Step 6: Recommendation

Review yes

No


Problem statement

o In order to select the preferred supplier with good quality, Mark should look atthe issue in terms of supplier’s cost of quality, the available suppliercertification program and how he can develop the supplier further throughsupplier development program.

o First, the Cost Of Quality (COQ) gives a value indicating the Cost OfConformance and Cost Of Non-Conformance. This can be obtained using ratiosand the results indicates a better supplier in terms of COQ.

o Quality certification such as ISO 9001 is a standardized quality requirementsrecognized internationally and it is based on 8 principles.

o As the quality of purchased supplies is critical to the quality of a company’sproduct and/or services, supplier development requires a fundamental shiftin the customer-supplier relationship. It requires a company to treat itssuppliers as long-term business partners. This is a strategic decision.

o Hence throughout the supplier development process, he would need to beaware of the Do’s and Don’ts and other important points.


Learning Objectives

Definition of Quality

The concept of Cost of Quality (COQ)

Supplier Certification

ISO 9000

Industry/firm specific examples

Supplier Development

ISO/TS 16949

Barriers to supplier development

Dos’ and don’ts

Supplier Quality improvement process


P04 – Worldwide Supply Risk


DEVELOPMENT






Worldwide Supply Risk

DIH Computers is the leading technology solution provider of high performance business server, which is headquartered in Singapore. As Singapore is well-known for her strict quality control, assemblies are done here for high-value product and the servers are build-to-order. The servers are consumed both locally and overseas. DIH Computers has to source components from overseas market as local manufacturers of the required components are non-existent. However, purchasing internationally results in additional transaction costs and also exposes the purchase to currency risks and vulnerability along the supply line. On the other hand, this has enabled the company to gain access to new technology much easier and it also helped the company to reduce cost. Recently, a SCM security consultant was engaged to perform a preliminary security risk assessment of the storage area at the warehouse for the server. Help him to identify possible security threat factors and suggest the factors which are the most risky and requires immediate attention from the management. How do you also improve on the current sourcing strategy?

(Proposed storage area #1: Storage of servers)

(Proposed storage area #2: Storage of components)

Management Feedback Cost

1. The cost of each server and component can be as high as $20,000 and $980 respectively

2. Each order can be up to 10 servers or 100 components

3. Each CCTV camera cost about $375

Historical happening - Cargo

1. Goods (Servers and components) are stolen quite often within days or weeks.

2. It was discovered that internal staff or visitors to the warehouse committed the theft. Unauthorized personnel are quite unlikely to commit theft.

3. It is possible that servers are damaged by deliberate sabotage by internal staff or visitors but not unauthorized personnel.

4. Damage is quite unlikely to happen to components. Components are mostly due to manufacturing defects.

Historical happening - Information

1. Staff experience virus attack with system downtime at least once a year

2. The potential financial lost due to virus attack with system downtime is $100,000

3. There was a one-time occurrence of unauthorized access to the information system. Important data was stolen and information wipe out. Important work cannot be carried out for weeks as a result.

4. It has never happen before that staff can logon to the system without password or authentication. If it happens, the consequence is moderate.

Historical happening - Asset

1. It is possible that the camera may be damaged but not the storage area

2. There was an occurrence whereby 10 servers costing $30,000 were stolen

3. If happen to storage area, the financial impact is <$50,000

Current Sourcing Strategy in different assembly plants

(Servers)

(Processors)

Note: 1. DIH Computers also has an assembly plant in

Hangzhou. It has a different set of supplier qualification criteria, bidding process and procurement process. Assembly department and Customer Service department keep track of their own inventory separately.


P04 Worldwide Supply Risk


Development


Role of International Purchasing Offices An organization progresses (usually reactively) from domestic buying to

international purchasing because it confronts a situation for which no suitable

domestic supplier exists, or because competitors are gaining an advantage

due to international purchasing. Firms may also find themselves driven toward

international purchasing because of triggering events in the supply market.

Such events could be a supply disruption, rapidly changing currency

exchange rates, a declining domestic supply base, inflation within the

home market, or the sudden emergence of worldwide competitors. The

following exhibit describes the role of International Purchasing Offices (IPO).


Decentralized Purchasing with Centralized

International Purchasing

The structure contains elements of centralized and decentralized decision making.

Decentralized purchasing at the divisional or business-unit level supports domestic buying, while a centralized international purchasing office supports the international requirements of the different business units.


Common Cost, International transactional

cost and managing currency risk Common costs (Cost common to

domestic and international purchasing)

Unit purchase price quoted by a supplier

(including effect of quantity discount,

MOQ, effect of price due to expedited

shipments),

Tooling charges

Charges of transportation from supplier

International transactional costs

(Additional cost not part of domestic

purchasing)

Packaging requirements higher due to

longer distances travelled and increased

handling of shipments.

Items entering country are subjected to

tariff, customs duty, customs broker fee.

International shipment also requires

insurance protection. Other include port

and handling fees.

(Detail: Refer to next slide)

To reduce uncertainties due to currency

fluctuations, there are varieties of

measures:

Purchase in the same currencies

e.g. US dollars to eliminate currency

fluctuations.

Currency Hedging – Buyer and

sellers trade futures exchange

contracts. It can also use forward

contract.

Track currency movement.

Currency Adjustment contract

clause. Both parties agree that

payment occurs as long as exchange

rates do not fluctuate outside an

agreed upon range or band.


Total Cost of International PurchasingBase Price

– Any quantity

breaks, minimum

purchases,

surcharges.

– Price if rush

shipment is required

Tooling

– Does the purchaser

owns the tools?

Packaging

– A hidden cost (may

be expensive for long

distance and multiple

handling)

– Seek consultation

to minimize cost for

international

purchasing

Escalation

– How long the

quoted price is firm

(e.g. Determine what

causes the price to

increase)

Transportation

– Consider

consolidation of

shipment

– Use multinational

carriers or freight

brokers to manage

shipment and cost if

required

Customs Duty

– Duties paid anytime

a shipment crosses

international line

– May fall into more

than 1 classification

Insurance Premium

– Not typically

included in ocean

shipment price (e.g.

marine insurance)

Payment Terms

– Foreign supplier

may be up to 60 days

but for local may be

on delivery

Additional

Fees/Commission

– Ask supplier,

customs broker or

transportation

personnel who would

pay.

– Who would pay for

storage if needed?

Port and Terminal

Handling fees

– For unloading

cargoes, admin

service of port

personnel and use of

port

Customs Broker

Fees

– A flat charge per

transaction

Taxes

– Any additional

taxes to be paid?

Communication

Costs

– Phone, email,

faxes, telex, mail,

travel charges

Payment and

Currency Fees

– Bank transfers,

hedging and forwards

contract

Inventory Carrying

Cost

– Cost includes

interest rates forgone

for investing fund ,

insurance, storage,

obsolescence.


Progressing from International Purchasing

to Global Sourcing



to Global Sourcing (con’t)

At some point, many companies determine that moving beyond basic

international purchasing might yield new and untapped benefits. An

internationalization of the sourcing process takes place as firms

evolve or progress first from domestic purchasing to international

purchasing, and then to the global coordination and integration of

common items, processes, designs, technologies, and suppliers across

worldwide locations.

Level II represents basic international purchasing that is usually reactive

and uncoordinated between buying locations or units.

Strategies in Level III begin to recognize that a properly executed

worldwide sourcing strategy can result in major improvements. However,

strategies at this level are not well coordinated across worldwide buying

locations, operating centers, functional groups, or business units.

Level IV, which represents the integration and coordination of sourcing

strategies across worldwide buying locations, represents a sophisticated

level of strategy development.



to Global Sourcing (con’t) Operating at level IV requires worldwide information systems, personnel with

sophisticated knowledge and skills, extensive coordination and communication

mechanisms, an organizational structure that promotes central coordination of

global activities, and leadership that endorses a global approach to sourcing.

While worldwide integration occurs in Level IV, which is not the case with Level

III, the integration is primarily cross-locational rather than cross-functional.

Organizations that operate at Level V have achieved the cross-locational

integration that firms operating at Level IV have achieved. The primary

distinction is that Level V, participants integrate and coordinate common items,

processes, designs, technologies, and suppliers across worldwide purchasing

centers and with other functional groups, particularly engineering.

This integration occurs during new-product development as well as during the

sourcing of items or services to fulfill continuous demand or after-market

requirements. Only those firms that have worldwide design, development,

production, logistics, and procurement capabilities can progress to this level.

While many firms expect to advance toward Level V, the reality is that many

will lack the understanding or the willingness to achieve this level of

sophistication.


Global Sourcing success factors


International Purchasing benefits

3.49


Global Sourcing Benefits

4.69


Post 9/11 and the effect on global sourcing

and supply line The future of import procurement will

contain a necessary component of

cargo security.

US customs: Implementation of

International Trade Data System

(ITDS). This is an intra-agency initiative

to standardize and streamline

international trade data process within

the US government. After 9/11, due to

increasing need for security, the

government and business, demands

that confidential business

information remains confidential.

Customs Automation helps in trade

facilitation. As Customs services in

countries throughout the world begin to

mirror the Advance Manifest

requirements in US, the exporting

country’s export declaration may serve

as the importing country’s declaration.

RFID could be used for clearance.

Hence the global procurement industry

need to remain abreast of the evolving

RFID technology that may hold the key

to transforming the way a company

runs its supply chain operations.

As we see, the future of procurement

for importing would be filled with fewer

duties, less paper but more standards,

rules, regulations and bureaucracy.


Security risk assessments

A suitable methodology is to use ISO 28001:2007 (Security

Management systems for the supply chain). It includes the best

practices for implementing supply chain security, assessment and plans.

The methodology used in security risk assessments rely on a thorough

and accurate understanding of the 5 crucial elements:

Assets – Anything of value to the organisation

Threat – Any possible intentional actions or series of actions with a

damaging potential to any of the stakeholders, the facilities,

operations, the supply chain, society, economy or business continuity

and integrity

Vulnerability – Intrinsic properties of something that create

susceptibility to a source of risk that can lead to a consequence.

Consequence – Outcome of an event affecting objectives

Likelihood – Chance of something happening


Identification of Assets

Assets

People

Property

Information

Intangibles

Structure

Equipment

DataNetwork

Market

Share

Credibility

Reputation


Identification of Threat

External Treat Source Internal Threat Source

Organised Crime (e.g. Theft) Employees

Terrorism Vendors

Criminal opportunists Authorised personnel with grievances

Competitors Operational activities within a facilitywhich may pose a threat to the security of the infrastructure or operations

Activists (e.g. Strikes)

Businesses and people in neighbourhood

Activities adjacent to a facility

Professional Espionage/Spying

Natural Disaster (e.g. Tsunamis, Typhoons, Cyclones, Earthquakes)

Pandemic (e.g. H1N1, bird flu)

Qualitative Threat Rating Matrix


Vulnerability Supply chain vulnerabilities refers to those due to uncertain economic

cycles, customer demand and disasters. E.g.

Land Rover reduce their workforce by over 1000 when their key

supplier went insolvent.

Dole was affected by its Hurricane Mitch hitting their banana plantations

in Central America in 1998.

11 Sep 2001 suspended air traffic, leading Ford Motor company to close

5 plants for several days.

16 Apr 2010 - Iceland volcanic eruption. Virtually all of Europe's major

airports remain closed as a huge plume of volcanic ash drifts south and

east across the continent from Iceland.

Many things can disrupt supply chains. Hence it is important to have

supply chain resilience.


Generic Vulnerability Matrix


Consequence

Consequence – outcome of an event affecting objectives

What kind of consequences?

Human cost

Financial Cost

Environmental Cost

Corporate Image cost

Physical and psychological cost to employees,

customers, suppliers and other stakeholders

Equipment and property replacement, downtime,

overtime pay, stock devaluation, lost

sales/business, lawsuits, regulatory fines/penalties

Physical harm to the environment

Reputation, standing in community, negative press,

loss of customers


Security Risk Consequence


Security Risk Likelihood

Likelihood – chance of something happening (How likely? – rare, occasionally,frequently, constantly?)


Risk rating matrix


Threat factors that requires attention

Threat factors that requires

Attention

Note:

1. Per order cost of server = $20,000 * 10 = $200,000

(Moderate consequence. If up to 10x order = $2,000,000

still moderate consequence)

2. Per order cost of component = $980 * 100 = $98,000

(Moderate consequence)

3. Goods (Servers and components) are stolen quite often

within days or weeks.

Almost certain


Companies with ISO 28000 certification YCH - The benefits of ISO 28000: 2007 certification will enable better

monitoring of freight flow, to combat smuggling and to respond to the

threat of piracy and terrorist attacks as well as to create a safe and

secure international supply chain regime.

CWT - The certificate represented a significant milestone in CWT’s

chemical logistics business that enables the Group to offer a high quality

supply chain solutions to its customers across the regions without

compromising with the safety requirements.

DB Schenker - Implementing ISO 28000 at this time will help strengthen

supply chain security, thereby safeguarding the interests of the company

and boosting the confidence of its customers.

TNT - Customers, especially in the hi-tech sector, value the emphasis

they put on security. The certification process propelled them to draw up

a framework to work through wider security issues - both upstream and

downstream the supply chain - in a systematic way.


Future Global Sourcing Trends

Global sourcing is a continuous journey of development and

improvement. Foremost in this journey is the need to develop or obtain

human resources that have the skills and willingness to evaluate the

supply network from a worldwide perspective. Other developments will

include the need to agree on global performance measures, establish

integrated systems between worldwide units and with suppliers, and

continued development and refinement of a Level V global process.

Greater integration between marketing, engineering, and sourcing

groups should occur as firms evolve toward higher globalization levels.

We also expect a trend toward doing business with suppliers that have

global capabilities. In addition, the focus of global sourcing will shift from

part (i.e., component) sourcing to subsystems, systems, and services.

Cost-reduction pressures will also result in pressure to source in

emerging supply markets, such as China and Eastern Europe. The

ability to manage these changes will begin to separate leading from

average firms.


Problem Statement A company progress from domestic buying to international purchasing because it

confronts a situation for which no suitable domestic supplier exists, competitors

are gaining an advantage due to international purchasing or because of

triggering events in the supply market. A specialized form of international trade

that has increased over the last 25 years is countertrade.

Certain costs are common (not necessary mean equal) to both domestic

purchasing and international purchasing. But for international purchasing, there

are transactional costs that are not part of domestic purchasing.

A company engaging in international purchasing can progress to global sourcing

through global coordination and integration of common items, processes,

designs, technologies, and suppliers across worldwide locations.

Post 9/11 affects global sourcing in several aspects such as Cargo security (C-

TPAT, CSI and FAST), the necessity to keep Confidential business information

confidential, Customs automation and RFID technology for clearance. Singapore

has a voluntary certification programme called Secured Trade Partnership (STP)

administered by Singapore Customs.

A suitable methodology is to use ISO 28001:2007 (Security Management

systems for the supply chain). It includes the best practices for implementing

supply chain security, assessment and plans.


Learning Objectives

Differentiate between international and global sourcing and

discuss the reasons for global purchasing

Explain Post 9/11 and the effect of global sourcing and supply

line

Evaluate the suitability for global sourcing


P05 – What Is The Price?


DEVELOPMENT






What Is The Price?

SMT Ltd, a supplier for Printed Circuit Board Assembly (PCBA), has just finished

a discussion with a potential buyer, Victronics International. Victronics has

considered using a fixed-price plus incentive fee contract with SMT so that it

allows cost-savings sharing with the supplier. The sharing of cost saving between

the buyer and supplier is 80:20. The total dollar volume of PCBA purchased by

Victronics has a traceable cost of $2,400,000. The total quantity of PCBA to be

purchased is 60,000 units based on the forecast for this year.

SMT Management wants to have a profit margin of 15% on sales by setting a

target price. Based on the profit margin and cost of PCBA, what is the target

price SMT should set?

If the actual cost is $3,000,000, how would this affect the target profit of SMT?

As a business executive of SMT, help your manager to assess the right pricing

and the impact to the profit. Also, explain to your manager other possible pricing

methods and the considerations in using different types of purchasing contract.


P05

What Is The Price?


Development


Pricing Decisions and how it can be set

Pricing

Decisions

Political, legal,

and image issues

Competitors Costs

Customer

demand

Costs Market

Forces

Prices are

determined by the

market, subject

to costs that must be

covered in the long

run.

Prices are based on

costs, subject to

reactions of

customers and

competitors.

What

affect

pricing

decisions

?

How are

prices

set?


Supplier Pricing Models

Supplier Pricing Models

Cost-plus

Total Cost

Product Cost

Variable Cost

Market-driven

Competition-based

Demand-based

Target Costing

With maximum

Price

Without Maximum

Price


Cost-plus pricing based on Total Costs Cost Structure Example (100,000 units)

Per Unit TotalCost Cost

Variable Costs (per unit):Direct materials $ 3.00 $ 300,000Direct labor 10.00 1,000,000Factory overhead 1.50 150,000Selling and administrative 1.50 150,000

Total variable costs $16.00 $1,600,000Fixed Costs:

Factory overhead 0.50 50,000Selling and administrative 0.20 20,000

Total fixed costs 0.70 70,000Total costs $16.70 $1,670,000

Desired selling price

Manufacturing

Cost

Selling Expenses

Administrative

Expenses

Desired Profit

Markup Percentage:

Desired profit $160,000

Total costs $1,670,000

Total cost per unit $16.70Markup ($16.70 x 9.6%) 1.60Selling price $18.30

= = 9.6%

If the company’s desired profit is

$160,000.


Cost-plus pricing based on Product CostPer Unit Total

Cost Cost

Variable Costs:

Direct materials $ 3.00 $ 300,000

Direct labor 10.00 1,000,000

Factory overhead 1.50 150,000

Selling and administrative 1.50 150,000

Total variable costs $16.00 $1,600,000

Fixed Costs:

Factory overhead 0.50 50,000

Selling and administrative 0.20 20,000

Total fixed costs 0.70 70,000

Total costs $16.70 $1,670,000

Product Unit Cost = $15 per unit

Manufacturing

Cost

Product Cost

Markup

Administrative

Expense

+

Selling Expense

+

Desired Profit

Desired selling price

Using the product

cost concept only

the manufacturing

costs are included in

the amount to which

the markup is

applied.

Total Manufacturing Cost = $1,500,000


Cost-plus pricing based on Product Cost

Manufacturing cost per unit $15.00Markup ($15 x 22%) $3.30Selling price per unit $18.30

Markup

percentage

$160,000 + $170,000

$1,500,000

=

If the company’s desired profit is

$160,000

Administrative Expense + Selling

Expense = $150,000 + $20,000

= $170,000

= 22%

Markup

percentage

Desired profit +

Total manufacturing costs=

Total selling and

administrative

expenses


Cost-plus pricing based on Variable Cost

Variable cost per unit $16.00Markup ($16 x 14.4%) $ 2.30Selling price $18.30

The variable cost concept uses

total of the variable

manufacturing costs and the

variable selling and

administrative expenses as the

amount to apply a markup.

Product Cost

Markup

Variable

Manufacturing

Cost

+

Variable

Administrative

and Selling

Expenses

Total Fixed

Costs +

Desired

Profit

Markup

percentage

Desired profit +

Total variable costs=

Total fixed costs

Markup

percentage

$160,000 + $50,000 + $20,000

$1,600,000

=

= 14.4%


Demand-based pricing

Identify and analyze important characteristics of existing or potential customers Can use the pricing process to better understand customers and better

identify additional marketing opportunities

Costs of production and the nature of competition may be ignored

Promotional pricing

• Price is used to attract the customers’ attention or support other promotionalefforts.

Segmentation pricing

• Divide the market into logical groups and pricing to appeal to each group, examplesof groupings might be location, time of the year, income levels, tourists

Volume pricing

• Use volume discounts to increase sales revenue

Product-bundle pricing

• Combine several products and offer the entire set at a special price. This can beused to sell slow moving merchandise


Competition-based pricing

Determine what you are selling, recognizing substitutes, identifying existingfirms in your relevant market, and analyzing how other firms in the marketcompete.

Characteristics of the market are being recognized and incorporated into thepricing decision

Production costs are not explicitly included

Market pricing

Price at the same level as the competition

Market-penetration pricing

Set price at a level required to penetrate the markets, price below thecompetition to gain market entry. The easiest way to generate buyer attentionis discount price.

Market-share pricing

Establish a price necessary to obtain a predetermined market share. Thisprocedure is used after market penetration has been achieved.

Compare selling price

with competitors

Above the Market

Below the Market

At the Market


Target Costing Target costing is a method that combines market-based pricing with a cost

reduction emphasis. Under target costing, a future selling price is anticipated,using the demand-based methods or competition-based methods. It is widelyused by company in the development stages of new products.

Target cost per unit = Target price – Target profit per unit

Present Future

Actual Cost Target Cost

Profit

Desired

Profit

Required cost

reduction

Expected Market Price

Present Market Price


Target Costing

Target sales price $21.00Variable costs:

Manufacturing $13.00Selling and administrative 1.10

Unit variable cost 14.10Fixed costs:

Manufacturing $ 3.00Selling and administrative 1.90

Unit fixed costs 4.90Target profit $ 2.00 Target cost per unit = $21 - $2 = $19 Profit margin on sales = 2/21 = 9.52%

E.g. If in the contract, the share ratio of buyer/seller is 60/40 or 60:40It means the supplier would bear 40% of any cost overrun


Type of contracts – Fixed-Price ContractType of contracts Description Buyer

RiskSupplierRisk

Firm fixed price

Most basic. Price does not change regardless of fluctuations inoverall economic conditions, industry competition, level of supply,market prices or environmental changes.

Low High

Fixed price with escalation

If the supply is to be over a period of time, there is a possibility thatcost may increase. Then the party may choose to negotiate anescalation clause. The escalation clauses allow either increases ordecreases in the base price depending on the circumstances.

Fixed price with determination

Where parties cannot accurately predict labor or material costs andquantities to be used prior to the execution of the purchaseagreement (e.g. unproven technology). Initial price based on bestguess estimates of labor and materials, then renegotiated once aspecific level or volume of production is reached.

Fixed price with incentives

Initial target price based on best-guess estimates of labor andmaterials, then cost-savings due to supplier initiatives are shared ata predetermined rate for a designated time period.

Fixed-price contracts are the simplest and easiest for purchasing to manage because there is no need

for extensive auditing or additional input from purchasing. It is the most basic type of contract.


Type of contracts – Cost-Based ContractType of contracts

Description Buyer Risk

SupplierRisk

Cost plus incentive fee

Base price based on allowable supplier costs, and any cost savings areshared between the buyer and supplier based on a predeterminedrate for a designated time period.

Cost sharing Actual allowable costs are shared between parties on apredetermined percentage basis and may include cost productivityimprovement goals.

Time andmaterials contract

Supplier is paid for all labor and materials according to a specifiedlabor, overhead, profit and material rate.

Cost plus fixed fee

Supplier receive reimbursement for all allowable costs up to apredetermined amount, plus a fixed fee, which is a percentage of thetargeted cost of the good or service. High Low

Cost-based contracts are appropriate for situations in which there is a risk that a large contingency fee

might be included using a fixed price contract. It is generally applicable when the goods and services

procured are expensive, complex, and important to the purchasing party or when there is a high degree

of uncertainty regarding labor and material costs.


Desirability of using Contracts under

different conditions

Environmental Condition

Fixed-price Contract Incentive Contract Cost-based contract

High componentmarket uncertainty

Low High

Long-term agreements

Low High

High degree of trust between buyer and seller

Low High

High process/technology uncertainty

Low High

Supplier ability to affect costs

Low High

High dollar value purchase

Low High

Desirability of use


Element of a contract - Introduction A contract typically consists of an introduction of parties that will be engaged in

the contract. It may begin with:

THIS AGREEMENT IS MADE this ________day of ________2010 at __________

BETWEEN

1. ICH Ltd, a company registered in Singapore having its registered office at 199,Tuas West (the “Buyer”) AND

2. LKH Ltd, a company registered in Singapore having its registered office at 200,Loyang Ave (the “Supplier”)

Following the introduction, there are several numbered sections (called “clauses”)that describe the different sets of conditions that the parties agree to follow intheir conduct of their business relationship.

The clauses in the first part of the contract may also refer to a series of “schedules”that provide specific details behind the clauses. These schedules may provideadditional information on the method of manufacture, the statement of work, howto calculate specific measures, health and safety requirements, pricing schedules,and other important details.


Element of a contract - Clauses

Definition: Define all of the important terms contained within the contract andis important so everyone understands exactly what each term means.

Scope of Agreement: Defines what is in and out of scope

Purchase Orders: Outline the relationship between the Agreement and anyother purchase orders issued by the company to the supplier.

Supply and Delivery: Specifies the terms for supply and delivery of the productand service

Specifications, Quality, Health, Safety Environment: Describes the method ofmanufacture and quality requirements.

Payment: Specify terms such as “current price”, “prior price” and other criteriathat determine how or if prices will be adjusted over the course of thecontract.

Liability: Specifies who is responsible if there are injuries or damage, over thecourse of the contract, and any damages to be paid. This may also includeinsurance requirements.


Element of a contract - Clauses Force Majeure: Course of events that occurs if there are unforeseen events

such as earthquake or hurricanes that prevent a supplier from fulfilling itsobligations to the buyer.

Effective Date and Termination: States when the contract becomes effective,when it terminates and any agreements relating to conditions when thecontract can be extended beyond the termination date.

Intellectual Property (IP): Specifies who owns any IP that comes out of theagreement and who owns what IP going into the agreement.

Confidentiality: Ensures all information, technology and so on shared betweenthe parties remain confidential and is not shared with other customers orsuppliers.

Governing Law: Stipulates the court of law where any disputes will be settled.The clause may also stipulate the use of arbitration or other forms of conflictresolution.

Signatures: Buyer and Seller


Verification of contractVerifying the following information will help ensure that the contract is appropriate

The contract identifies clearly what is being bought and the cost.

The contract specifies how the purchased item is going to be shipped anddelivered.

The contract covers the question of how the items are to be installed (if installationis to be a part of the contract).

The contract includes an acceptance provision detailing exactly how and when thepurchaser will accept the products.

The contract addresses the appropriate warranties.

The contract spells out remedies including liquidated damages and clausesspecifying the consequences for late performance.

It is common among these clauses to include a force majeure clause that identifiesthe conditions under which performance is excused. Common items included in aforce majeure clause are war, embargo, and changes in the law.


Problem Statement

Target profit = Target price - target cost

0.15X = X – 2,400,000/60,000

0.85X = 40

Target price X is $47.059

Share ratio of 80:20 means the supplier would get 20% cost saving or bear 20% of any cost overrun

Cost exceeded by

$3,000,000 - $2,400,000 = $600,000

Seller incentive would be reduced by

-$600,000 * 0.20 = -$120,000

Target profit = $(2,400,000/0.85) * 0.15 = $423,529.41

Since the seller has to pay $120,000 the target profit would become

$423,529.41 - $120,000

= $303,529.41

Hence the seller has to obtain revenue= actual cost + profit

= $3,000,000 + $303,529.41

= $3,303,529.41

However, since the maximum price is $3,200,000

Profit = $3,200,000 – 3,000,000

= $200,000 ( This is the maximum profit the supplier will get due to the setting of ceiling price in the contract)


Problem Statement

Customer demand, competitors, costs, political, legal and image issues affectthe pricing decision. The price is based on cost and determined by the market.

The supplier pricing model can be classified into cost-plus, market driven andtarget costing. Based on the problem statement, the supplier wanted to set atarget price and therefore target costing can be used.

There are also various contracts such as fixed-price or cost-based. The one tobe adopted is fixed-price plus incentive fee contract and therefore theincentive due to cost saving or additional cost due to cost overrun must befactored in determining the profit of the supplier.

A purchasing contract consists of an introduction, clauses and schedules. Mostcommonly used contracts are developed from earlier contracts that aresubsequently modified to fit the situation at hand.


Learning Objectives

Evaluate the relations of cost to price and determine how suppliers

establish RIGHT price- The Pricing Models

Describe different types of contracts that exist and the considerations

when selecting contract types

Explain the elements of a purchase contract


P06 – What is the total purchase cost?


DEVELOPMENT






What is the total purchase cost? Kuan Cheong, the procurement manager for Deliver’em! Logistics is evaluating the purchase of one TMS systems for his distribution and transportation operations in Singapore. In the past, the company only makes use of excel spreadsheets for planning the trucking activities and it is no longer feasible. He has tabulated the cost elements based for one of the purchase options based on the supplier quote. Determine the total cost of this contract over five years period and suggest how you would approach the supplier about reducing the total cost of ownership (TCO) for the system over the lifecycle of this contract. What other equipment acquisition method could you suggest to him? The organization’s cost of capital was 12.33 percent. Cost Elements/Measures:

Cost elements Cost Measures

Purchase Price:

Equipment (Server) Supplier quote: $25,000 per System

Operating Systems Server License

Supplier quote: $630 per System

TMS Application Supplier quote: $160,000 per System

Run-time License Supplier quote: $5,000 per user for 99 concurrent users

Acquisition Cost:

Sourcing 1 Full-Time-Staff required for 4 months. He earns $65,000 per annum

Administration 1 P0 @ $50 and 5 invoices @ $40 each

Usage Costs:

Implementation Service $800 per man day for 1 week (System setup, install, network, test)

Software Support (Bugs-fix, Patches, application support)

Supplier quote: $1,838 per month per System

Maintenance Support (Database backup/cleanup, upgrades, configuration)

Supplier quote :$11,388 per month per System

Opportunity Cost Downtime 26 hours per System per year @ $45 per hour

End of Life:

Salvage Value (per server) $5000


P06What is the total purchase cost?


Development


Capital Equipment Classification

Capital equipment is defined as one of the subclasses of the fixed assetcategory and includes industrial and office machinery and tools, transportationequipment, furniture and fixtures and others. As such, these items are properlychargeable to a capital account rather than to expense. Some capitalequipment can be placed in more than one classification. Thus, a computersystem might be either installation or accessory equipment according to itsprimary application.

Types of Capital equipment

Buildings (Permanent

construction on site to house or

enclose equipment)

Installation equipment (machinery,

plants)

Accessory Equipment

(use to facilitate production of

goods and services)

Operating equipment

(Goggles, special footwear, brushes,

brooms)

Tools and Instrument

(associated with production of goods and services such as

word processors, surgical instruments,

cash registers)

Furnishing and fittings

(Carpet, flooring, furniture and

benches)


Consumables

Consumables – all supplies classified as indirect and do not form part of asaleable product and that may be sub-classified into production, such asdetergent, maintenance such as lubricating oil or office such as stationery.

Consumables

Operating supplies

E.g. stationery, office supplies, machine oil, fasteners,

insecticides, fuel, small tools and packaging materials.

MRO items

E.g. electrical supplies, caretaking requirements, lubricants, paint,

plumbing accessories and a wide range of repair parts or spares for

plant and equipment.


Capital Equipment Categorization for

purchase – Control

Acquisitions of capital equipment may be transformational (fundamentallychange the working of the whole organization) or incremental (effect usuallyconfined to user, department or function).

Category Description Approval Level

A Strategic new equipment (fundamentally changeworking methods throughout company)

Usually require approval by board or CEO.B Operational new equipment (confined to a particular

function, department, project, operation)

C Replacement equipment (replace obsolete, fullydepreciated equipment)

Discretion of senior managers – subject to budget approval

D Vehicle and transportation (motorcars, lorries)

E Administrative equipment (office machinery, fixtures)

F Miscellaneous (cannot be classified as A-E and notexceeding a prescribed value)


Challenges of procuring Capital Equipment

Challenges

Bought less frequently than other purchases Difficult to

determine best time

to buy

Final cost of equipment more

difficult to determine (E.g. insurance, depreciation , obsolescence)

Consideration of

environmental impact and

disposal

Tax Consideration

May require a significant start-

up period

Technology forecasting –

when it would become

obsolete? Can it be modified?

Strategic Importance –Output from

equipment become prime driving

factor

Substantial amount of money to

be expended


Capital Expenditure and Characteristics Expenditure on capital equipment differs from that on materials and components

in many ways, including the following:

a the cost per item is usually greater

a the items bought are used up gradually to facilitate production rather than as a partof the end product

capital expenditure is financed long-term capital or appropriations of profit ratherthan from working capital or charges against profit

a tax considerations, such as capital allowances and investment grants, have animportant bearing on whether or not to purchase capital equipment and the timing

of such purchases

a government financial assistance towards the cost of capital equipment may beavailable, such as where a manufacturing organization is located in a developmentarea

the purchase of capital equipment is often post-ponable, at least in the short term

the decision to buy capital equipment often results in consequential decisionsrelating to sales, output and labor — in the latter case, consultations with theappropriate unions may be necessary.


Sourcing and Supply Issues

Design and R&D Consideration: Development and design issues must beaddressed when a customer requires new equipment currently not availableon the market. There are two standard issues in any new equipment product:

Who will pay for development and design and how?

How will the risk of failure be shared between buyer and supplier?

Engineering service:

Presale Service: Such service is clearly a matter of sales promotion, and when nosubsequent sale results .The prospective buyer may ask for and receive a greatdeal of presale service and advice without a real intention of buying or knowingfull well that the firm providing the service will under no circumstances receivean order.

Postsale Service: Often equipment is sold with a production guarantee, anadditional reason for supervising both the installation and the operation of theequipment. The prime abuse of postsale services arises from those firms thatinsist on furnishing and charging for it whether or not the buyer feels a need forit.


Sourcing and Supply Issues (Con’t)

Importance of cost factors:

Is the equipment intended for replacement only or to provide additionalcapacity? What is the installed cost of the equipment? What will the start-upcost be? Will its installation create problems of plant layout? What will be themaintenance and repair costs, and who will provide repair parts and at whatcost?

Total Cost of ownership:

Life cycle costing (LCC) or total cost of ownership (TCO) is an appropriatedecision approach to capital investments. The philosophy behind LCC isrelatively simple: The total cost of a piece of equipment goes well beyond thepurchase price or even its installed cost. What is really of interest is the totalcost of performing the intended function over the lifetime of the task or thepiece of equipment. Thus, an initial low purchase price may mask a higheroperating cost, perhaps occasioned by higher maintenance and downtime costs,more skilled labor, greater material waste, more energy use, or higher wasteprocessing charges.


Sourcing and Supply Issues (Con’t)

Sourcing and Selection: Careful consideration is required in any capital assetpurchase. Selecting the right type of equipment-the proper installation andcommon interests in efficient operation, the availability of repair parts and ofrepair services throughout the entire life of the machine.

Legal Issues: E.g. Purchased machinery must comply fully with the safetyregulations of the state, province, or country in which it is operated, and thesesafety regulations vary greatly in different locations.

Disposition of obsolete or Replaced equipment: What to do with old orreplaced equipment is an interesting question. One procedure is to trade in theold machine on the new, with the supplier making an allowance and assumingthe burden of disposal.


Evaluation using Total Cost of Ownership

(TCO) Total cost of ownership requires a purchaser to identify and measure costs beyond

the standard unit price, transportation, and tooling when evaluating purchaseproposals or supplier performance. Formally, total cost of ownership is defined asthe present value of all costs associated with a product, service, or capitalequipment that are incurred over its expected life.

Typically these costs can be broken into four broad categories: Purchase Price. The amount paid to the supplier for the product, service, or capital

equipment

Acquisition Costs. All costs associated with bringing the product, service, or capitalequipment to the customer’s location. E.g. sourcing, administration, freight, and taxes.

Usage Costs. In the case of a product, all costs associated with converting thepurchased part/material into finished product and supporting it through its usable life. Inthe case of a service, all costs associated with the performance of the service that arenot included in the purchase price. In the case of capital equipment, all costs associatedwith operating the equipment through its life. E.g. inventory, conversion, scrap, warranty,installation, training, downtime, and opportunity costs.

End-of-Life costs. All costs incurred when a product, service, or capital equipmentreaches the end of its usable life, or net of amounts received from the sale of remainingproduct or the equipment (Salvage Value), as the case may be. E.g. are obsolescence,disposal, clean-up and project termination costs.


TCO Model

Based on this model, the procurement manager should explore the possibilities ofreducing service costs such as software support and maintenance support; theseappear to be the highest value, and contribute most to costs.

The company can also negotiate further on the support cost such combining thesoftware and maintenance support cost as one support item.

99 licenses


Financing Equipment Acquisition - Leasing

Many manufacturers of capital equipment lease as well as sell theirequipment. Leasing advocates point out that leasing involves payments for theuse of the assets rather than for the privilege of owning the asset. Short-termrentals are a special form of lease that make a lot of sense when limited use ofthe equipment is foreseen and the capital and/or maintenance cost of theequipment is significant. Often an operator can be obtained along with thepiece of equipment rented.

Type of lease

Finance leases

• The rental covers virtually all the costs of the asset therefore the value of the asset is equal to or greater than 90 per cent of the cost of the asset

• The leasing company claims written-down allowances whereas the customer can claim both tax relief and VAT on rentals

Operating leases

• The lease will not run for the full life of the asset and the lease will not be liable for its full value

• The lessor or the original manufacturer or supplier will assume the residual risk

• This type of lease is usual for equipment where there is a well- established second-hand market, such as cars or construction equipment


Factor affecting decision to Lease or Buy In practice, the decision to lease or buy is complicated, depending on

operating, legal and financial considerations.

Operating factors relate to the advantages of a trial period before purchase,the immediate availability of cost-saving equipment, the period for which theassets are required and the hedges provided against obsolescence andinflation.

Legal factors are important as the leasing agreements are one-sided in thatmost risks are transferred to the lessee. The lessee should therefore carefullyexamine the terms and conditions of the contract, especially with regard tosuch aspects as limitations on the use of the equipment and responsibilities forits insurance, maintenance and so on. Where possible, improved terms shouldbe negotiated.

Financial factors are usually crucial in deciding whether to lease or buy. Theseinclude:

the opportunity cost of capital — that is, what the purchase price of theequipment would earn if used for other purposes or invested elsewhere

the discounted cost of meeting the periodical rental payments over theperiod of the lease — note that ‘flat’ interest rates, calculated on the initialamount owing


Other approaches – Make use of 3rd party

hosting service with a dedicated server

If a 3rd party server hosting service is used to host the WMS application, the cost ofserver and server license can be excluded. Hence there is also no salvage value.

However, there would also be a usage fee that need to be paid to the data centre to host it.

Cost Excluded

Server

Cost not

included

No

Salvage

Value


Other approaches –Subscription-based

method

If it is a subscription based method, the cost could be further reduced. Thefollowing amount can be excluded = $ 782,524.18.

If actual subscription only amounts to 20% of the original total cost of ownership(Server, Operating Systems Server License, WMS application, Run-time license,Sourcing, Administration, Implementation service, Software Support, maintenancesupport , opportunity cost, salvage value over 5-year period)

= 20% of $ 1,277,524.18

= $225,504.84

Note:

1. Item not excluded

– Run-time License

2. Sourcing Cost may not be

excluded if the staff is required

For 4 months.


Lifetime cost of capital Equipment

Some elements of lifetime cost of capital equipment


Environmental aspect for purchasing

ISO14000 family of standards

ISO 14000 is an environmental standards and it focus on environmentalmanagement. Many purchasers of products regard certification to ISO14001 asan assurance of a supplier’s commitment to environmental performance andquality. In the long run, companies with EMS (Environmental managementsystem) offers lower cost & less problems to their customers

Example: Green supplier guidelines by Toshiba


ISO14001

ISO 14000


Example of Emerging standards


Problem Statement In general, capital equipment can be classified into several categories

namely, building, installed equipment, accessory equipment, operating

equipment, tools and instrument, furnishing and fittings.

Acquisition of capital equipment can be transformational or incremental

and different level of management are required to approve various

category of capital purchase. There are challenges as well as sourcing

and supply issues to dealt with in capital purchase.

Total cost of ownership (TCO) is an appropriate decision approach to

capital investments. Based on the TCO model develop for the next 5

years, the procurement manager should explore the possibilities of

reducing software support and maintenance support; these appear to be

the highest value, and contribute most to costs. The company can also

negotiate further on the support cost such combining the software and

maintenance support cost as one support item.


Problem statement

Other approaches includes:

Hosting the server using 3rd party hosting with dedicated server

Subscription-based method

Besides buying straight from the supplier, the buyer can also lease

capital equipment and there are also factors to consider in deciding

whether to lease or buy.

Green purchasing is about integrating environmental considerations into

purchasing decisions. Or simply buying product that is sourced and

manufactured in an environmentally friendly way. One notable standard

is ISO14000 family of standards.

Running a green purchasing program is essential for any organization

that aims to reduce its environmental impact. E.g. Toshiba, Toyota,

Honda, Fujitsu, etc


Learning Objectives

Evaluate the challenges of equipment buying

Identify possible sourcing and supply issues

Perform an economic evaluation

Assess other types of equipment acquisition methods – leasing

Discuss ISO14000 environmental standards


P07 – Matching Supply with Demand!


DEVELOPMENT






Matching Supply with Demand Medi-Tech was established in 2003 and specializes in providing storage and distribution logistics services for the Healthcare industry. Medi-Tech, as a third party logistics service provider, also provides inventory management as part of the value added services to its customers.

Jon, the Supply Chain Director of Medi-Tech, is asked to reduce the inventory costs of current inventory. All the buyers are currently trying to keep average stock level to be 1 month of supply for all the Stock Keeping Units (SKU). Attached below are the SKU list the company is holding and the historical demand.

SKU List.xls Historical Demand.xls

Jon needs to present his analysis and provide recommendations that will reduce the cost of inventory owned without affecting the customer service level. Can you help Jon?


P07 Matching Supply with Demand!


Development


Inventory Management

Inventory is one of the most expensive assets of many companies.

Inventory management is a required core competency of any

operation manager, material manager, buyer or planner.

There is a need to balance between inventory investment and

customer service.

Functions of inventory:

a. Decouple various steps in the supply chain processes

b. Buffer from demand fluctuation or supply uncertainty

c. Take advantage of the quantity discounts

d. Hedge against inflation


Types of Inventory

Raw Material : Purchased but not processed

Work-in-progress (WIP): Undergone manufacturing process

transformation but not completed

Maintenance/repair/Operating (MRO): Spare Parts for repair, service

and warranty purposes

Finished goods: Completed products awaiting order

Do you know which types of inventory are for “Independent”

demand and which types of inventory are for “dependent” demand

respectively?


Independent & Dependent Demand

Independent demand – the demand for items is independent of the demandfor any other item in inventory, e.g. MRO parts & Finished goods in thecontext of the company.

Dependent demand – the demand for item is dependent upon the demandfor some other item in the inventory, e.g. WIP & raw materials in thecontext of the company.

Categorize into “independent” and “dependent” demand items as theanalysis will be different.

Today’s problem: The SKUs are of independent demands

Note:

In the context of a car manufacturing company, the final product is new cars. The cars are

independent demand. The demand for wheels and tyres is dependent on the production of

cars. Hence wheels and tyres are dependent demand.

In the context of a tyre manufacturing company, the final product is tyres. The tyres are

independent demand. The demand for rubber is dependent on the production of tyres.

Hence rubber is a dependent demand.


ABC Analysis

Divide the inventory into three classes based on annual dollar

volume:

A items: Most important, ~20% of items, ~80% of annual dollar

volume.

B items: Moderately important, next ~15% of items, but ~15% of

annual dollar volume.

C items: Least important. ~65% of items, but only ~5% of annual

dollar volume.

It is also known as 80/20 rule to prioritize and focus on what are the

critically important parts for the business.


Item Part No. Unit Cost ($) Monthly Demand (pieces)Unit Cost ($) *

Monthly Demand % of dollar volume

Cumulative % of

dollar volumeItem % Type

SKU-740 1000 800 800000 30% 30% 3% A

SKU-547 1500 500 750000 28% 59% 7% A

SKU-678 800 650 520000 20% 79% 10% A

SKU-590 223 600 133800 5% 84% 13% B

SKU-621 765 120 91800 3% 87% 17% B

SKU-100 29 2900 84100 3% 90% 20% B

SKU-850 30 1200 36000 1% 92% 23% B

SKU-569 100 340 34000 1% 93% 27% B

SKU-730 60 500 30000 1% 94% 30% B

SKU-191 23 985 22655 1% 95% 33% B

SKU-280 19 847 16093 1% 96% 37% C

SKU-290 10 1198 11980 0% 96% 40% C

SKU-210 17 700 11900 0% 97% 43% C

SKU-330 23 500 11500 0% 97% 47% C

SKU-340 14 800 11200 0% 97% 50% C

SKU-635 350 30 10500 0% 98% 53% C

SKU-400 9 1000 9000 0% 98% 57% C

SKU-420 79 100 7900 0% 99% 60% C

SKU-380 5 1200 6000 0% 99% 63% C

SKU-450 3 1999 5997 0% 99% 67% C

SKU-480 40 100 4000 0% 99% 70% C

SKU-690 80 50 4000 0% 99% 73% C

SKU-230 15 200 3000 0% 99% 77% C

SKU-511 2 1500 3000 0% 99% 80% C

SKU-879 2 1500 3000 0% 100% 83% C

SKU-540 14 200 2800 0% 100% 87% C

SKU-188 21 100 2100 0% 100% 90% C

SKU-110 19 100 1900 0% 100% 93% C

SKU-150 21 90 1890 0% 100% 97% C

SKU-250 15 100 1500 0% 100% 100% C

ABC Analysis A items are identified


ABC Analysis Curve


Basic Model for Inventory AnalysisQ

uant

ity in

Sto

ck

Time

Safety Stock

Reorder Level

Target Stock level

OrderDelivery

Safety stock = Customer service factor × Standard deviation of demand × √ (Lead time + Review

Period);

Reorder level = Usage rate × (Lead time) + Safety stock;

Average stock level (ASL) = Safety Stock + Order quantity/2;

Target stock level (TSL) = Usage Rate × (Lead time + Review period) + Safety stock;

Maximum Stock level = TSL – Usage Rate × Lead time.

The reorder level is triggered by

the information from the system

that the stock is low taking into

the supply lead time. Safety stock

or minimum stock level is vital for

ensuring that there is warning of

low stocks.


Inventory Policies

The inventory analysis tool looks into five types of inventory policies:

(R,Q) policy which places a “fixed order quantity Q” on a pre-determined reviewperiod R;

(s,Q) policy which places a “fixed order quantity Q” whenever the inventory positiondrops to the reorder point, s, or lower;

(R,S) policy which replenishes the inventory up to target level S on a pre-determinedreview period R;

(s,S) policy which replenishes the inventory up to target level S once inventoryposition drops to the reorder point, s, or lower; the order quantity is variable and iscalculated by subtracting the on-hand quantity from the maximum inventory; and

(R,s,S) policy which replenishes the inventory up to target level S once inventoryposition drops to the reorder point, s, or lower on a pre-determined review period.This may be practiced when the inventory manager reviews several SKU togetherand place a joint order to the same supplier for volume or transportation discount.


Inventory Analysis Result for Today’s

Problem (assume no MOQ constraint)Focus on A items : SKU-740

Assumptions:

•The demand is normally distributed

•Assumption on the inventory policy: (R, Q) policy

•EOQ Applies i.e. EOQ = √(2 DS/IP)

•Ordering Cost per order (I) = $41

• Rate of carrying inventory = Annualized Holding Cost as percentage of unit price= 30%

Std Dev of demand - (Obtain from the historical demand of SKU-740

= STDEV (values of the 24 period) = 174.95

Safety Stock = Customer service factor × Standard deviation of demand × √ (Lead time + Review Period)

= 1.64485 x 174.9534 x SQRT(0.5+0.25) = 294.21

EOQ = √(2 DS/IP) = SQRT (2x800x12x41/(0.3x1000)) = SQRT(2624) = 51.22

Average Stock Level = Safety Stock + Order quantity/2

= 249.21 + 51.22/2 = 274.83

=NORMSINV (95%)


Inventory Analysis Result for Today’s

Problem (assume no MOQ constraint)Average Stock Level = 274 unit = 0.34 months of supply

(instead of 1 month rule of thumb used by buyers)

For (R, Q) inventory policy,

there is a saving of 0.66 months (Equivalent of

$1000*800*0.66 = $528K annual inventory dollar saving)

Note:

Number of months = Average Stock Level/monthly demand

= 274/800

=0.34

Note:

Savings = 1-0.34 = 0.66 months

Inventory saving = Unit cost x monthly demand x savings

=$1000 x 800 x 0.66

=$528K

Note that if continuous review policy is adopted, review period will be =0

Safety Stock = Customer service factor × Standard deviation of demand x SQRT(Lead Time)

= 1.64485 x 174.9534 x SQRT(0.5)

= 203.49


Quantity Discount Models

Reduced prices are often available when increased quantities are

purchased.

Trade-off is between reduced material cost and increased holding

cost

Total cost = Ordering cost + Holding cost + Material Cost

= DS/Q + QH/2 + PD

A

B

D: Annual Demand

S: Ordering cost per order

H: Holding cost per unit per year

Q: Quantity per order

P: Price or Material Cost per unit


Steps for Quantity Discount

1. Calculate Q for each discount using EOQ formula (let H = IP)

I: Annualized holding cost as percentage of unit price

P: Price per unit or material cost per unit

EOQ = √(2 DS/IP)

2. Adjust Q upward if quantity is too low for discount (eg Point B,

Q=1000 is selected)

3. Compute total cost for each discount, including material cost.

4. Select Q with the lowest total cost


Today’s Problem on Quantity Discount

Why the ordering cost per order is so high?

(Ordering cost consists of issuing PO, follow up,

receiving and invoicing)

Why the inventory holding cost is so high?

(Inventory Holding cost consists of product

devaluation, obsolete, scrap, damage, interest

cost due to money tied up, space cost)

Be clear on how to derive your assumption for D, S and I


With MOQ constraint (for SKU-547

based on (R, Q) policy)

Material cost reduction >> Inventory cost reduction

Choose the price and quantity that give the lowest total cost

Buy 5000 units at $1000 per unit for SKU-547


Conclusion

Effort could be extended to all “B” items SKU to find optimal

safety stock, and average stock level.

For SKU-740, potential inventory reduction expected

Explore all other inventory policies and parameters to achieve

best inventory reduction.

For SKU-547, obtain quantity discount benefit with an increased

in inventory, but significantly reduced material cost.

(material cost impact cost of goods sold more than inventory

holding cost)

Review Supply Chain parameters such as review period, fixed

order quantity, customer service level, delivery frequency, and lead

time to reduce inventory further.


Learning Objectives

Arrange the inventory items by performing ABC classification

Analyze the inventory needed to support required customer

service and least unit cost for a purchase quantity discount

Utilize the functions of inventory and basic inventory models to

explain the implication of minimum order quantity (MOQ)


P08 – Win-Win!


DEVELOPMENT






Win-Win! Mike is the Supply Chain Manager of a global Plasma TV manufacturer in Singapore. The company is contracting an ODM (Original Design Manufacturer) in Shanghai Free Trade Zone to provide him the main engine (without the color casing, stand & Accessories such as User guide, power cord, etc). Mike purchases power cords, user manuals, color casings and packaging materials from suppliers in Singapore and Malaysia. These materials are required to assemble the engine to the finished good (FG).

Mike is responsible for purchasing and materials management. He negotiates contracts with suppliers, schedules deliveries, and manages inventories. A major challenge presented by these responsibilities is carrying sufficient inventories to ensure that material is always available for assembly. However, holding inventory unnecessarily is expensive for the company. As the annual inventory carry cost is high, the company has decided to embark on an initiative to reduce inventory stocked in the company and reduce paper works. The plan for year 2010 is to negotiate for the transition to JIT Procurement with the suppliers for power cords, user manuals, accessories, color casing and packaging. Help Mike to come out with a proposal of the new initiatives. How should he negotiate with his suppliers so that it is a win-win initiative for both the company and the suppliers?

Distribution Model

ODM Factory (Shanghai FTZ) Republic Manufacturing Singapore Republic Distribution Center (Singapore)

Factory Outbound

Freight and Duties

RP Outbound

Freight

Suppliers

Supplier Global Markets

outbound

Freight

TV Engine

Power cord, user

manuals, accessories,

color casing Packaging

Assembly Finished

Goods

Finished

Goods


P08 Win-Win


Development

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Negotiation

Negotiation is defined as a process of formal communication, either

face-to-face or via electronic means, where two or more people come

together to seek mutual agreement about an issue or issues.

The negotiation process involves the management of time, information, and

power between individuals and organizations who are interdependent. Each

party has a need for the other yet recognizes that compromises or

concessions are often required to satisfy that need.

In order to prepare for a negotiation an understanding of the costs that go

into a price and the way suppliers present prices is essential.


Issues that may requires negotiationAgreement on a

supplier’s allowable

costs

Delivery schedules and

requirements

Expected product and

service quality levels

Expected product

and service quality

levels

Protection of proprietary

information/intellectual

property

Improvement requirements

in quality, delivery

performance, lead time, cost

Contract volumes Liability for damage Payment terms

Progress payment

schedules

Warranties Mode of transportation

Capacity

commitments

Material lead times Performance incentives

Contract length and

renewal

Technology support and

assistance

Special packaging

requirements

Resolution

mechanisms for

contract disputes

Resources related to

developing closer

relationships


Five-Phase Negotiation Process


Negotiation Strategy – Critical Elements Overall a negotiation strategy should consider three critical situational

elements: Time

“80/20” rule Deadline strategies: Conceal your deadline Declare an earlier deadline Find the other side’s deadline

Information “The heart of negotiations” – shapes strategy, reality Preparation is key - side with more info has edge BATNA is the most important

Power Whole process is about power, ego, leverage Balance between parties is a key factor

Note: BATNA = the Best Alternative To a Negotiated Agreement. BATNA = thevalue or point at which you will choose no agreement over a settlement.BATNA is similar to the “walk-away” value or point.


Strategy to be used: Principled Negotiation From Getting to Yes, key

elements: Focus on interests, not

positions: Interests = needs, desires,

concerns, fears that lead to“why”

Positions = specific demand Separate people from problem

People negotiate – areaffected by egos, feelings,anger

“Step into their shoes” todiscover their reasoning

Focus on objective criteria Facts, principles, standards

can be used to frame an offer Develop mutual-gains options

A settlement must be superiorto no agreement for bothparties

Propose options with gainsfor both parties

Positions versus Interests


Element of Principled NegotiationsSeparate people from problem Focus on interests not positions

Develop mutual-gains options Focus on objective criteria


BATNAWhat is and what is not?

A BATNA is a back-up plan, a boundary and empowerment for you. It gives you the

strength to walk away from an agreement that is not mutually beneficial. Remember,

mutual gain is an important mindset and goal in principled negotiation. A BATNA is

not a least acceptable option, a bottom line or punishment for your counterpart.

How to create a BATNA?

To create a BATNA, ask yourself, “If we both walk away, what could I do to

address my interests?” Then invent a range of alternatives; discuss alternatives

with a colleague or mentor. Also consider what your counterpart’s BATNA may

be.

For example, a BATNA for the salesperson may be to escalate the deadline to his

manager to shift other client priorities. It isn’t the best option; it may be the best

alternative. With your situation in mind, write your BATNA and a BATNA your

counterpart may choose.

BATNA is different from Bottom Line

A bottom line signifies the worst possible outcome that a negotiator might accept.

The bottom line is meant to act as the final barrier where a negotiation will not proceed

further. It is a means to defend oneself against the pressure and temptation that is

often exerted on a negotiator to conclude an agreement that is self defeating.


Traditional versus JIT purchasing


Objectives of JIT Purchasing JIT purchasing is a purchasing system in which material purchases are

contracted so that the receipt and usage of material to the maximumextent possible coincide. With JIT purchasing, it means that thematerials or components are received from supplier just in time to usethem (for production or sales). They are in fact delivered to the factoryfloor.

JIT is popular because carrying costs are actually much greater thanestimated because warehousing, handing, shrinkage and investmentcosts have not been correctly estimated into the total cost.

Objective of JIT Purchasing

To identify and eliminate wastage in the procurement process

To procure quality product at the right time at the right location

To reduce cost of quality, lead-times and inventories

To reduce procurement cost through elimination of waste

To procure materials on demand

To develop procurement flexibility

To improve quality and supplier performance

To add value in activities and eliminate non-value-adding activity


JIT Procurement reduce Waste at Hewlett-

Packard

Waste Reduction (%)

82%

50%

50%

30%

30%

20%

40%

0% 20% 40% 60% 80% 100%

Lead Time

Space

Scrap

Setup Time

Finished Goods

Inventory

Raw Material

Inventory

Work-in-Process

Inventory


JIT in Toyota Production System

http://www2.toyota.co.jp/en/vision/production_system/


Benefits of Perfecting JIT ProcurementReduction in inventory

Reduced inventory holding cost;

Reduced waste from manufacturing process;

Reduced obsolescence cost;

Reduced depreciation of handling and storage equipment;

Reduced administrative cost, etc.

Toyota:

Inventory turnover ratios have gone up to over 60 times per year, compared

to corresponding ratios of 5 to 8 reported by most US manufacturers

Better buyer-supplier relations

Long-term buyer-supplier partnership and continuous communication eliminates the need for frequent re-bidding.

Allow joint planning with minimal inspection by supplier and precise delivery schedules.


Benefits of Perfecting JIT Procurement

Reduced lead time and improved lead time reliability

Can be obtained through extensive communication between buy and

supplier regarding inventories, production schedules, change orders,

quality issues through EDI, Email or network.

Reduced paperwork

JIT procurement needs the purchase orders to be released for long term,

with a provision of frequent deliveries.

Paper work lead time + Manufacturing lead time + Transportation lead time +Receiving and inspection

Manufacturing lead time + Transportation lead time


Benefits of Perfecting JIT ProcurementReduced logistics cost

Logistics cost in buying activity varies from 5%-25% depends on volumeand distance in any company. JIT procurement requirements likeconsolidation of small shipments at a designated location, and long-termcontract with carrier companies can reduce total logistics cost.

Improved quality

JIT procurement strives to buy defect-free goods. Because of smallershipments of items, suppliers generally supply better quality as comparedto the larger shipments.

Reduced cost of telecommunication

JIT procurement benefits get multiplied if the supplier’s manufacturingfacilities are geographically near to the buyer’s plant, apart fromcoordination benefits and transportation cost advantages. Geographicproximity encourages greater interaction.

Reduction in prices

Buyer no longer sticks to price issues of individual components and parts,rather he works out the total cost of buying from the supplier. This helps inmaintaining quality and keeps the total cost of procurement to the minimum.


JIT Purchasing Supplier selection Criteria

JIT Purchasing

Supplier

selection criteria

Description

Delivery 1. Supplier must be able to meet frequent deliveries

2. Flexible enough to meet sudden minor surge in demand

Quality and

Reliability

1. Supplier need to deliver quality product at the right time

2. High quality standards e.g. ISO 9000 is desirable

Price 1. JIT purchasing is characterized by cost-based rather then price

based negotiation. Both buyer and supplier works out the cost

involved in the production of the component and determine a

fair margin for the supplier.

Lead-time 1.Purchasing small batches in JIT purchasing means frequent exchange of

orders and receipts between buyer and supplier. Information sharing plays a

critical role in this.

Location 1.Geographical concentration of supplier around the buyer

2. Proximity has the benefits of reducing costs and lead-time due

to transportation

Technological

capability

1. Supplier need to have technological infrastructure to meet the dynamic

market conditions


Critical Success Factors in Perfecting

JIT Procurement Quality

Buyers from the best companies are more interested in process control in the supplier’s plant than its delivered quality

Proximity of suppliers

This facilitates JIT procurement and enhance the following benefits:

Enhancement of small lot size deliveries

Frequency of communication and personal visits

Reduction in lead time, transportation and inventory carrying costs

Flexibility in ordering, to meet consumption needs on an hourly basis

Supplier relations

Make extensive use of EDI

Allow each other to access inventory data and production plans to have better control

Share information of present and future plans and their impact on each other’s business

Make full disclosure and discuss problems to reach mutually agreeable solutions


Critical Success Factors in Perfecting

JIT Procurement Accurate production forecasts and schedules

Reduce the buffer stocks which are used to take care of uncertainties

JIT procurement can’t tolerate fluctuation of supply

Supply chain management

Requires individual links in the supply chain to change their relationship intopartnership

Sharing of timely and sensitive inventory and shipment status data

Reliable transportation

Small lot size and standard containers

A supplier should be flexible in his manufacturing to produce small lots

Elimination of inventories

Suppliers can be asked to implement JIT manufacturing, total qualitymanagement program that can directly contribute towards inventoryreduction


EDI (Electronic Data Interchange)

Is a system that aids customer and supplier communication by linking

together supplier and customer information systems.

Customers are now helping suppliers to isolate bottlenecks in operations

and improve efficiency in other areas.

This is being replaced by e-commerce (B2B) using the Internet


Supplier Relations for JIT ProcurementSupplier requirements:

Financial aspect

Strict adherence to schedule

Flexibility in manufacturing

Trust in partnership

Benchmarking for continuous improvement

Supplier challenges:

The supplier bases must be sorted, there should be a narrow, manageable and reliable supplier base

Geographic dispersion

Incomplete communication and information sharing

Inconsistent supplier quality

Poor relationship between buyers and sellers


Perfecting JIT Procurement Implementation

Phase 1: Learning and investigation

Learning to identify areas of wastage, reducing inventories, eliminating waste by

exposing problems for solution;

It’s essential to start training the employees involved in JIT procurement

Phase 2: Pilot Programs

Begin with a few suppliers, a few part numbers with “A” class categories, a few

transporters and frequent deliveries directly to the assembly line

Any conflict not resolved immediately will be a barrier to implementation

Phase 3: implementation

The experience and success gained in the pilot project is extended to other key

suppliers, and then in stage with all suppliers.


Limitations of JIT Procurement

Most companies are very much accustomed to the traditional ways of

storing inventory and the other methods that go along with that. To

all of a sudden just change the whole process can be very difficult to

become accustomed to.

The success of JIT procurement is varied from company to company.

What works very well in some companies can be a total failure in

others.

Employees must be committed to the JIT process in order for it to

work efficiently. They must set the improvement of quality as their

ultimate goal.

With the shorter cycle times involved, there is more pressure and

stress on the workers to get the work done quicker.

The employees must have very flexible skills and be willing to learn

new ones at all times.


VMI JIT procurement is still a system in which the buyer orders from the seller. The next

step after JIT is VMI (vendor managed inventory), a process in which sellersmonitors their buyers' use patterns and makes the decision what to ship whenneeded

SLC:

Supplier

Logistics

Centre

Global

Plasma TV

manufacturer


Problem Statement Mike should negotiate for the transition to JIT Procurement with the

suppliers for power cords, user manuals, accessories, color casing andpackaging due to the proximity of the suppliers to the plant as they arelocated in Singapore or Malaysia. This can help to reduce lead-time andcost. In terms of delivery, the supplier are able to meet frequentdeliveries and flexible enough to meet sudden surge in demand.

However he has to take note that for JIT implementation, there are noshort cuts. Implementing JIT procurement requires a cultural changewithin the company, and a fundamental change in management thinking.JIT procurement is not a panacea for all the problems, need to take intoaccount the possible limitations during implementation

In negotiating for the new implementation with the supplier, he canexpress his interest by making use of principled negotiation strategy.Using such negotiation strategy, he should focus on interests and notpositions, separate people from positions, focus on objective criteriaand develop mutual gains options. Having a BATNA is important as it isa backup plan. It gives you the strength to walk away from anagreement that is not mutually beneficial.


Learning Objectives

Develop the framework for rational negotiations

Assess the benefits of JIT purchasing

Rationalize the possible issues with JIT purchasing

Examine the deployment of VMI for the part purchased.


P09 – Is it legally binding?


DEVELOPMENT






Is it legally binding? Rongping is the general manager of Cool-Buy, a large IT product and gadgets store at the centre of Bihar Circle. Each day, hundreds of customers visited the store. Recently, the store has also introduced a home delivery service, with orders being posted, e-mailed or faxed by customers to the store. The following problems had surfaced: a. Johnny, a customer, is insisting he is entitled to buy an iphone for $8.99, the

price indicated on the shelf. The iphone should have been priced at $899.99.

b. Connie responded to a home delivery advertisement by fax. Rongping faxed a confirmation slip, but the machine malfunctioned and the confirmation never arrived. Connie is now threatening to sue.

c. Wei Kang, another customer, has returned to the store with a “$20 off for

$100 spent” voucher. Wei Kang tells Rongping that he cut the voucher out of the newspaper which he bought on the way home from the shop, where he had spent $600 and he wanted to use it for his previous purchase.

Advise Rongping how she should handle the problems. You may think about the rules on the formation of contract (i.e. offer and acceptance, consideration, intention to create legal relations) as to whether they are satisfactory in the problems encountered.


P09 Is it legally binding?


Development

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Law and Economic Development

The root of Singapore law lies within English Law as it was a former British

colony. In recent years, the System legal system has become less a copy of

the English legal system. The drive towards an autochthonous (locally

developed) legal system continues as it is guided by the need for relevance

to and compatibility with Singapore’s need and local condition.

Singapore recognizes the importance of law in maintaining political and

social order as well as engendering conducive environments for economic

activity. Law is regarded as a fundamental economic value, which must be

carefully nurtured and to enhance Singapore’s aspiration to be a total global

business centre.

In criminal law, the primary purpose is to “punish” or deter potential criminals

from committing offences. The offender may suffer a jail term or a fine or

both. The general purpose of the civil law is to compensate the innocent

party for the damages or losses which he or she has suffered or incurred

arising from alleged wrongdoing of the other party.

The law of contract falls under the branch of civil law.

Supreme court – then and now

http://en.wikipedia.org/wiki/File:Singapore_old_Supreme_Court.jpg

http://en.wikipedia.org/wiki/File:Supreme_Court_Building,_Aug_06.JPG


Valid contract and its requirements A contract is a legally binding agreement. For an agreement to be

binding, it must satisfy certain requirements of a valid contract:

There must be a meeting of the minds between the parties as

manifested through offer and acceptance.

There must be a consideration and the intention to create legal

relations

Parties must have the capacity to contract

The parties must freely consent to the agreement

Basic terminology: void, voidable, unenforceable

A contract is void when the law treat it as never exist at all on account of

some serious flaw or mistake.

A contract is said to be voidable where law treats the contract as valid when

made but one of the parties to it has the right to avoid it but not the other party.

An unenforceable contract is one where there is a valid and legally binding

contract but it cannot be enforced e.g. because of provision of law/law

limitation.


Types of Contracts:

Unilateral or Bilateral, Simple or Special

A bilateral contract is one that the offeror makes a promise in return for a

promise on the part of the offeree.

A unilateral contract is one that the offeror makes a promise in return for

an act to be performed by the offeree.

Performance of the act constitutes both the acceptance of the offer as well

as consideration.

Simple contract: Most contracts that are entered into business for everyday

life are simple contracts, unless indicated otherwise.

Note: They can be oral, in writing or part oral, part in writing

Special contract: Formal contract by deed or under seal such as grant of

gift or purchase of land.


Offer and its nature

In order to have an agreement, which is the final requirement for a valid

contract, there must be an offer and an acceptance of the offer.

An offer is an expression of willingness to contract on specified terms, make

with the intention that it is to become binding as soon as it is accepted by the

person to whom it is addressed. It is a definite promise to be bounded

provided that certain specified terms are accepted.

The party making the offer is the “offeror” and the party to whom the offer is

made is the “offeree”.

Offer involves 3 elements

It contains the terms of the exchange

It is an indication of the willingness to be bounded

It confers the offeree the power to bind the offeror upon the acceptance of

the offer such that the offeror can no longer withdraw the offer

An offer may be made orally, in writing or by conduct.

Compare the differences between offer and invitation to treat (next slide)


Invitation to treat and its nature An invitation to treat is simply an expression of willingness to enter into

negotiations with the other party. Hence the party instead of making an offer,

invite others to make an offer. At this stage, there is no intention to be

bounded.

The following are some common instances of invitations to treat.

Advertisements in newspapers, magazines, TV, radio and Internet

Company prospectus – e.g. IPO

[Patridge v Crittenden (1968)].

Note certain cases where advertisement may amount to an offer:

[Carlill v Carbolic Smoke Ball (1893)](*Intention to be bounded)

Display of goods: Supermarket, Shop window display

[Fisher v Bell (1960)

Self service display: Pharmaceutical Society of Great Britain v Boots

Cash Chemist (1953)]

Auctions: Call for bids by the auctioneer

Invitation to Tenders, quote

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Offer Termination1. The offer may be revoked. The law permits an offer to be revoked anytime

before it is accepted. In order for it to be effective, however, revocation must

be communicated to the offeree. [Byrne v Van Tienhoven (1880)]

Note that revocation does not have to be communicated by the offeror himself.

Communication can be made by some other reliable source. [Dickinson v

Dodds (1876)]

There is no legal obligation on the part of the offeror to keep the offer open for

a specific period even if he had promised to do so. [Routledge v Grant

(1828)]

2. The offer may lapse. In some cases, an offer has no time limits, but the law

states that the offer should lapse after a reasonable period of time.

[Ramsgate Victoria Hotel v Montefiore (1866)]

3. The offer may be rejected. The offer may be rejected on the part of the offeree.

Once rejected, it cannot be subsequently insist on accepting it. A counteroffer

has two effects: it act as rejection of original offer and it stands as a new

offer capable of being accepted by the offeror. [Hyde v Wrench (1840)]

4. The failure of a condition, the offer is not capable of being accepted

5. Death of the offeror or offeree may in some cases terminate the offer


Acceptance and its nature

An acceptance to an offer brings a contract to existence, making both

parties legally bounded.

It is an unconditional agreement to all the terms of the offer

It must be made when the offer is still open

It may take place through written, spoken words or by conduct

Note: An offeree must agree to all the terms contained in the offer. Any

attempt on his part to introduce new terms would result in counter offer.

8


Communication Rule for Acceptance The general rule is that before any binding contract can come into existence,

the acceptance must be communicated to the offeror. [Felthouse v Bindley

(1862)]. A valid acceptance must be communicated and there must be

agreement to all essential terms in the contract. (i.e. must be on the same

terms as the offer). An agreement to agree in future is not a contract.

It can take place through direct oral, written communication or conduct.

E.g. of acceptance by conduct: [Brogden v Metropolitan Railway (1877)]

The general rule applies to all modes of instantaneous communications

including face-to-face negotiations and communications by telephone,

telex, fax and email. In such case, communication must actually be received

by the offeror not when it is sent. E.g. [Entores Ltd v Miles Far East

Corporation (1955)]. In [Brinkibon Ltd v Stahag Stahl (1983)], it was also held

that acceptance is made when and where it was received. Telex message sent

outside working hours would not be considered instantaneous.

Note: The position with regard to email as mode of instantaneous communication

is not conclusive.


Postal Rule for Acceptance

For postal rule (as opposed to general rule), acceptance takes place at the

time where the letter of acceptance is posted and is complete regardless

when the letter reaches the offeror or whether it reaches him at all.

The postal rule will apply subject to 2 conditions:

1. It is reasonable to do so. An offer made by post may generally be

accepted by post, but in some circumstances, it may be reasonable to

accept through post offers made in other ways.

2. The letter of acceptance must be properly stamped and addressed.

E.g. Acceptance was effective on posting: [Adams v Lindsell (1818)]

E.g. Acceptance was effective even if Letter of acceptance lost in post:

[Household Fire and Carriage Accident Insurance Co v Grant (1879)]


Special Situations on acceptance Silence – Silence cannot normally be a mode of acceptance. If the rule

were otherwise, that could lead to abuse. For instance, a business could

send goods to a person’s home and state in an accompanying document

that if it did not hear from that person in an hours time, it would take it that he

has accepted the goods. If such a thing were allowed, that would indeed be

an easy way to do business. [Felthouse v Bindley (1862)].

In certain circumstances, it can be construed as acceptance. E.g. both

the offeror and offeree may agree that the offeree would have a positive

obligation to communicate only if he wishes to reject the offer, which is rare

in practice. [Southern Ocean Shipbuilding Co Pte Ltd v Deutsche Bank

AG (1993)]

Ignorance of offer – The general rule is that a person cannot accept an

offer of which he has no knowledge (i.e. unaware of). [Gibbons v Proctor

(1891)]

An exception to the general rule applies where the offeror has waived the

right to receive communication. Thus in unilateral contracts, such as [Carlill

v Carbolic Smoke Ball Co (1893)], acceptance occurs when the offeree

performs the required act and does not have to inform the offeror.


Consideration and its requirements

Requirements:

Consideration must be requested by the promisor

The idea of exchange requires that the benefits conferred or detriment suffered

by the promisee must be requested by the promisor.

Consideration must not be past

An act done prior to and independent of a promise cannot be regarded as valid

consideration for the promise since it is not done in exchange for the promise.

~ If Y voluntarily washes X’s truck and thereafter, X promises to pay $30 to Y.

This promise is not enforceable.

Consideration must move from the promisee

A person can only enforce a promise if the consideration for the promise is

furnished by him. Note: Consideration does not have to move to the promissor.

~ If Y promises to pay X $30 if X washes W’s car, the consideration provided by

X is valid although it does not confer a direct benefits on Y.


Consideration and its requirements

Consideration must be sufficient

Sufficient refers to “legal validity” i.e. something having value in the eye of

the law – meaning where consideration is given in monetary terms or is

readily measured in economic terms. (Not necessary money)

~ If Y agrees to sell his car to X for $30,000 although it has a market value of

$60,000, X’s payment of $30,000 is sufficient consideration even though it

may not be a fair price for Y’s car. [Chappell & Co Ltd v Nestle Co Ltd

(1960)].

Example of insufficient consideration

~ Intangibles: love, affection, motives of sentimental nature

~ Moral obligations and motives: holding moral/good behavior at ransom

~ Vague or insubstantial consideration

~ Performance of existing contractual duty

~ Performance of existing public duty: policeman protecting citizens


Consideration The general rule is that a promise is only enforceable if it is supported by

consideration, that is, where the promise is given in exchange for something

of value. The legal value of consideration:

A promise to do something one has no prior legal duty to do (e.g. to pay for the

receipt of goods)

The performance of an action that one is otherwise not obligated to undertake

(e.g. to provide accounting service)

To refrain from action that one has a legal right to undertake (forbearance)

Example

~ Bilateral contract: in a contract for sale of goods, the seller promises to ship

specific goods to the buyer and the buyer promises to pay for the goods when

they are received these promises constitute consideration

~ Unilateral contract: Edward offer his neighbour: “ If you paint my fence, I will pay

you $300”. Jenny paints the fence. The act of painting is the consideration that

creates Edward’s contractual obligation to pay

~ Forbearance: Where a party has a claim against another, he may agree to refrain

from enforcing the claim for a promise given by the latter.


Legal relations and Legal Capacity An intention to create legal relations means the readiness of each party to

accept the legal consequences if he does not perform the contract.

Presumptions for domestic/social situation

No intent [Belfour v Belfour(1919)]

Business/Commercial presumes intent Intent

Legal Incapacity

Minor - In Singapore context, a minor is an individual under the age of 21.

UK, US and Malaysia is 18. Hence the general rule is that contracts

entered into by minor are not enforceable against him. That means an

adult party would not be able to sue a minor for a breach of contract and

obtain remedies for breach.

Mental incapacity – Mental retardation or intoxication

Privity

Only parties to a contract can incur rights and obligations under it. A third

party is a stranger to a contract. Third party have right if contract provide for

it and it confers benefit upon them.


Factors vitiating a contract Incapacity. Both parties must know what they are doing. This eliminates parties

who are impaired in any way. Incapacity includes intoxication, mentally unsound,

minority (not of legal age).

The subject of the matter is not legal and valid. The definition of a valid

contract is that the product or service contracted must be legal (by statute or

case law) and not against public policy (restraint of trade are not enforceable

unless reasonable).

Duress and undue influence. The law requires that a contract has to be

entered into by one’s free will and not being forced or under threat or victimized

(undue influence).

Misrepresentation. It refers to a term of contract that turns out to be false.

Mistake. Mistake has to be shared by both parties. If X makes a mistake in the

calculations and quote a lower price to Y and Y is unaware of the mistake, the

mistake is unilateral. Hence X will not be able to set the contract aside on the

grounds of that mistake. However if the unilateral mistake is a mistaken belief

held by one party, it may suffice provided the other party is aware of this.

Note: Silence or inactivity does not amount to an acceptance or a

misrepresentation.


Contract Cancellation and breach of

contract Contract cancellation

A contract should be considered a binding obligation, however if

cancellation is a possibility, the basis and terms of cancellation

should be agreed on in advance and made part of the terms and

conditions.

Problems such as how to value, and what is an appropriate payment for,

partially completed work on a now-canceled purchase order are best

settled before the situation arises.

Breach of contract

Under a commercial contract, the supplier is obligated to deliver the

goods according to the contract’s terms and conditions, and the

purchaser is likewise obligated to accept and tender payment for the

goods according to the terms of the agreement. A breach of contract

occurs when either party fails to perform the obligations due under

the contract (without a valid or legal justification). A breach may

entitle the of offended party to certain remedies or damages.


Problem Statement It is important to distinguish between an offer and an invitation to treat. The

mode of communication also determines whether general or postal rule

applies . Consideration, intention to create legal relations (commercial) and

legal capacity are important for contract formation.

a. Rongping was not obliged to sell the iphone for $8.99 to Johnny, because

the price on the shelf was an invitation to treat and not an offer as illustrated

in the case of Fisher v Bell (1960).

b. In Connie’s case, the mode of communication. It is through fax, which

implies instantaneous means of communication. Hence, communication

must actually be received by the offeror as in Entores Ltd v Miles Far East

Corporation (1955). There is no contract formed. The contract is only

complete when the acceptance is received by the offeror (Connie) and the

contract is made at the place where the acceptance is received (Connie’s

house fax machine). However, do note that Rongping is ready to accept the

offer. Hence Connie cannot sue the company.

c. In Wei Kang’s case, past consideration is no consideration. Hence,

Rongping has no obligation to let Wei Kang use his voucher.


Problem Statement There are also factors that may vitiate a contract such as incapacity, the

subject of the matter is not legal and valid, duress and undue influence,

misrepresentation and mistake.

A breach of contract occurs when either party fails to perform the obligations

due under the contract (without a valid or legal justification).

For contract cancellation, the basis and terms of cancellation should be

agreed on in advance and made part of the terms and conditions.

Regarding the Harrier Jet commercial from Pepsi (US law case):

In 1996, John D.R. Leonard attempted to buy the Harrier jet with 15 Pepsi

Points and a check for $700,008.50. This amount of money was to cover the

remaining Pepsi Points, which could be bought for $0.10 per point, and the

$10 shipping and handling fee. Pepsi however refused to process the

transaction.

Leonard subsequently filed a suit. In 1999, US District Judge Kimba Wood,

presiding over Leonard v. Pepsico, Inc., ruled in favor of Pepsi, stating that

"No objective person could reasonably have concluded that the commercial

actually offered consumers a Harrier jet.”


Learning Objectives

Explain the process of contract formation and the essential elements of

a valid contract

Discuss the factors vitiating a contract, contract termination and breach

of contract


P10 – The fitness for purpose!


DEVELOPMENT






The fitness for purpose! Jia Wei, a logistics analyst for Trans-Logistics was shown a GPS truck tracking unit installed on a refrigerated truck by Open-Track, a GPS supplier one month ago. A brochure describing the details of the GPS truck tracking unit (MT420) was given to him after he has seen the unit in the truck. For a few weeks of sourcing and collecting brochures and quotations from respective suppliers, he decided to engage Open-Track to install 20 sets of GPS truck tracking unit to its fleet of 20 refrigerated trucks. The purpose of this is to enable the transportation manager to track the drivers and monitor their movement and record the vehicle mileage. In addition, it helps him to check whether the drivers are over speeding, making unnecessary stops and alert him of emergency. Each GPS truck tracking unit is connected to the refrigerated truck’s cigarette lighter plug. After an inspection of the completed installation, he signed a document to say that he was completely satisfied. However, after Trans-Logistics used the GPS truck tracking unit for merely two weeks, some GPS truck tracking unit had failed to work properly and even caused damages to the trucks. Upon investigation, the problem resulted from

a. Faulty components in the GPS truck tracking units under high temperature (cause damage to the truck). The devices are actually of the model MT320.

b. Loose power adapter that connects the GPS truck tracking unit to the cigarette lighter plug (result it to fail to work properly)

Jia Wei complained to Open-Track but was reminded of the document that he had signed. How would you advise Jia Wei regarding the rights, duties, and remedies arising out of the incidents involving Trans-Logistics and Open-Track?

GSM Antennae

GPS Antennae

GPS Truck Tracking unit


P10 The fitness for purpose!


Development


Scope of Sale of Goods Act Sales of goods are the most common type of business transaction in any

economy. They range from the very simple e.g. sale of an item in a shop to

a retail consumer, to the highly complex and valuable, e.g. sales of a ship.

Hence the legal rules that facilitate and regulate sales of goods are

therefore of the greatest importance to the economy and society of every

country.

The sale of goods in Singapore is primarily governed by Sale of Goods

Act (Cap 393, 1999 Rev Ed).

The Sale of Goods Act (SGA) applies to domestic sales, sales which take

place within Singapore. In addition to Sale of Goods Act, depending on

circumstances, there might be other statutes that impose obligations on

the seller, such as Sale of Drugs Act and Sale of Food Act.

Sales of goods contracts between parties in different countries are

regulated by CISG – United Nations Convention on Contracts for

International Sale of Goods. In Singapore, it is adopted as Sales of

Goods (United Nations Convention) Act (Cap 283, 1996 Rev Ed).


Terms or Representation,

Express or Implied Puffs/Sales talk are not intended to be legal binding and relied upon.

Terms of a contract describe the duties and obligations that each party

assumes under their agreement.

Representation is a statement which may have encouraged one party to

make a contract but itself is not a contract/part of a contract.

Express terms are terms that the parties to a contract have specifically

discussed and agreed upon whether oral or in writing.

Implied terms are terms that are absent but the court “reads into” the

contract. It can arises from:

The last category is of great importance in sale of goods law, which features

the well-known terms implied by the Sales of Good Act (SGA) into every

sale of goods contract except those where the parties have agreed to and

are permitted to exclude them. SGA refers only to implied conditions and

implied warranties and not to implied innominate terms.

Court Statute Usage/Custom

Fact, Law E.g. SGA


Classification of terms: Conditions,

Warranties or Innominate Terms Conditions – term vital to main purpose of contract and a breach will

entitle injured party to repudiate and claim damages.

Warranty - term less vital to contract. Breaches creates action for

damages but not repudiation. (Note: different from consumer context of

warranty)

Innominate Term - complex terms which combine condition and warranty.


Application of Sale of Goods Act A “contract of sale of goods” is defined as a contract by which the seller transfers

or agrees to transfer the property in goods to the buyer for a money consideration

called the price. The omission to state a clear price, or some mechanism for

determining it, may well lead to the conclusion that the parties have not truly

reach an agreement. A contract in which price which is left “to be agreed” was not

binding. [Courtney & Fairburn v Tolaini Bros (Hotels) Ltd (1975)]

The SGA calls a contract under which the ownership passes at the time of contract

a “sale”. A contract under which the property is to pass at a later time, or on the

fulfilment of a condition is called an “agreement to sell”, which becomes a sale

once the property has passed.

SGA does not apply to:

Contracts of barter (or exchange) of goods

Exchange of goods for services

Hire-purchase contracts [Helby v Mathews (1895)]

Where services provided are mainly not for the making of the goods themselves,

the contract is treated as contract for service.

If the services are for the purpose of making the goods, then it is more likely to

be a sale of goods contract.


Implied duties of a seller

- Implied Terms in Sale of Goods ActDuty Status of term SGA Section

Time of Delivery Not necessarily a condition under the

SGA but usually treated as such by

courts

10

Delivery of right quantity Not strictly a condition, but similar in

effect as buyer may reject wrong

quantity

30

Title (Right to sell) Condition 12 (1)

No encumbrances Warranty 12 (2) (a)

Quiet Possession Warranty 12 (2) (b)

Conformity to description Condition 13 (1)

Conformity to quality of sample Condition 15 (2)

Satisfactory quality Condition 14 (2)

Fitness for particular purpose Condition 14 (3)


Section 10 - Delivery Time,

Section 30 - Delivery Quantity

Delivery under the SGA means to make the goods available to thebuyer. Whether the goods must be sent or collected is a matter for thecontract.

Delivery Time - Usually the contract would stipulate a date (or period)for delivery of the goods, and a failure to deliver by such time willamount to a breach of contract, giving a right to damages if the delaycauses loss to the buyer. The SGA does not specify whether terms as totime of delivery are “of essence of the contract”. Under s(10), it is up tothe contract to resolve this.

Delivery Quantity – The quantity of goods sold is necessarily anexpress term of the contract, as it vary in each case. Delivery of wrongquantity is thus a breach of contract. Hence the buyer may reject thegoods where the wrong quantity is delivered. Exceptions: difference isso slight that it is unreasonable to do so or they may have agreed that adeviation from exact quantity is permissible.


Implied Terms – Section 12

– Title, encumbrances, quiet possession

Section 12 (1) provides that it is an implied condition that the seller

has the right to sell the goods or in the case of an agreement to sell,

will have the right to sell when property or ownership is to pass to the

buyer. Since this term is a condition, if it is breached, the buyer can

repudiate the contract, reject the goods and sue for any damages.

If paid, he may be able to claim total refund of the price. [See

Rowland v Divall (1923)]

Section 12 (2) (a) provides that it is an implied warranty that the

goods will be free from any charges or encumbrances not made

known to the buyer before the contract. Buyer may claim damages

but cannot terminate the contract if the term is breached.

Section 12 (2) (b) provides that the buyer must enjoy quiet possession

of the goods. Quiet possession means the buyer must be able to deal

with the goods in a way he wants to, without any lawful interference

from a third party which is brought about by an act or default of the

seller.



- Sale of goods by description

Section 13 (1) provides that where there is a contract of sale of goods by description, there is an implied condition that the goods will correspond with the description.

The seller must supply goods which fit the description given to the buyer inthe contract. Importance in determining whether it is a sale bydescription, is whether the buyer relied on the description in enteringthe contract [Beale v Taylor (1967)] or he exercised his own judgement.[Harlingdon and Leinster Enterprises Ltd v Christopher Hull Fine Art Ltd(1991)]. In the later case, it is not a sale by description.

If section 13 were breached, the buyer would have the right to repudiate the contract, reject the goods and sue for any damages.



- Contract for sale by sample

A contract for sale by sample exists where there is an express orimplied term that the bulk must correspond to the sample in quality.The fact that a sample is given to the buyer does not automaticallymean the contract is a sale by sample. There must be a term to it.

[Natferrous Pte Ltd v Tradelink Hardware Pte Ltd (2005)]

If section 15 (2) is breached, the buyer would have the right torepudiate the contract, reject the goods and sue for any damages.


Implied Terms – Section 14 (2)

- Satisfactory Quality

Under section 14(2), where goods are sold in the course of business,

there is an implied condition that the goods supplied are of “satisfactory

quality”.

Section 14 (2B) provides that the quality of goods includes their state

and condition, and the following are appropriate cases aspects of quality

of goods:

a) Fitness for all purposes for which goods of the kind in question

are commonly supplied

b) appearance and finish

c) Freedom from minor defects (=> Minor defects, even if easily

repairable may render the goods unsatisfactory quality)

d) Safety

e) Durability

Only goods sold in the course of a business applies. Private sales

are excluded.


Buyer’s Knowledge of defective quality

Exceptions to section 14(2). Section 14(2) does not apply:

1. If defects were drawn to buyer’s attention before the contract was

made or

2. If the buyer examined the goods before the contract and that

examination ought to have revealed the defects. [Note that the buyer is

under no duty to examine the goods. If he does, the question is whether

someone else carrying out similar examination would have discovered

the defect.]


Implied Terms – Section 14 (3)

- Fitness for a particular purpose Note that goods’ fitness for their normal purposes is required as an aspect of

satisfactory quality.

Section 14(3) provides that when the seller is selling in the course of business

and the buyer expressly or by implication makes known to the seller any

particular purpose for which the goods are being bought, there is an implied

term that the goods must be reasonably fit for the purpose.

Seller is liable: E.g. Purpose was implied [Grant v Australian Knitting Mills

Ltd (1936)] [Case: The buyer bought a pair of underpants from the seller. Due to

the presence of chemical in the underpants, the buyer developed a rash that

turned into dermatitis. The court held that there was a breach of sections 14(2)

and 14(3).] . Hence if you are buying food from food court, you do not need

to expressly state that it must be fit to be eaten. It is implied.

Seller not liable: E.g. Specific purpose not make known [Hamilton v

Papakura District Council (2002)] [Case: Drinking water was supplied by a

seller to a tomato grower who used it for hydroponic cultivation. However the

buyer did not sufficiently make it known to the seller that water was used for

particular purpose which requires a higher quality needed for such crops. Hence

the seller was not liable.]


Manufacturers Liability

Manufacturers Liability – When a buyer buys goods from a seller, thecontract is between the seller and buyer and buyer cannot claimdefects in goods against the manufacturer (3rd party).

[General Rule]

Exceptions - 3 Situations :

Under manufacturers guarantee/warranty

Manufacturer made express undertaking to buyer

Negligence for defective goods (Tort)


Excluding Liability imposed by Sale of

Goods Act

Under Section 6(1) of the Unfair Contract Terms Act (UCTA), it is

provided that any clause trying to exclude liability for breach of section

12 of the Sale of Goods Act is totally invalid.

Further under Section 6(2) of the Unfair Contract Term Act provides

that, in consumer sales, any attempt to exclude liability for breach of

section 13, 14 or 15 would be invalid.

E.g. A logistics company buys a painting to decorate its office. Since

the painting is not an integral part of business and the contract to buy

a painting is not a regular kind, it is consider a consumer sales.

Section 6(3) of Unfair Contract Term Act provides non-consumer

sales, liability for breach of section 13, 14, 15 may be excluded if

reasonable.

E.g. Business buy goods for resale

E.g. Business buy goods required for an integral part of a business

E.g. Contract is a regular kind by business


Duties of Buyer

Buyer’s Duty to accept the goods

Where the seller has delivered the goods to the buyer in compliance

with the contract, the latter must accept and pay for them in

accordance with the agreement.

Buyer’s Duty to pay for the goods

The buyer has a duty to pay for the goods if they meet the terms of

the contract.

Obligation arises when 2 things occur:

The goods must be delivered by the seller

The ownership of the goods must be passed to the buyer


Passing of property/Risk The essence of a sale of goods transaction is the transfer of

ownership from the seller to the buyer. It is important because:

It determines what the seller’s remedies are (if buyer has not paid for the

goods and seller may sue for the price of goods) or buyer remedies are (if

seller does not supply the goods and buyer may sue for damages)

Who has the risk? Risk usually passes with property or ownership.

What happens in the event of buyer’s bankruptcy or liquidation? If the

seller has the property, the goods are his and he can keep them or take

them back from buyer. If property has passed to the buyer, and the buyer

has possession of the goods, the seller can only sue him for the price.

Property passes generally according to the contract/intention of the

parties. However, it is possible for the parties to separate ownership and

risk, indeed it is common. If the contract is silent then SGA provides 5

Rules for ascertaining the parties intention. (Section 18 Rule 1 to 5)

Risk addresses the question of who should bear the loss, should

something happen to the goods after the making of the contract. SGA

Section 20 (1) provides that otherwise agreed, risk passes with property.


Problem Statement The sale of goods in Singapore is primarily governed by Sale of Goods

Act (Cap 393, 1999 Rev Ed). Sales of goods contracts between parties

in different countries are regulated by Sales of Goods (United Nations

Convention) Act (Cap 283, 1996 Rev Ed).

A “contract of sale of goods” is defined as a contract by which the seller

transfers or agrees to transfer the property in goods to the buyer for a

money consideration called the price.

The implied terms for duties of seller in the Sale of Goods Act covers

Time of Delivery, Delivery of right quantity, Title (Right to sell), No

encumbrances, Quiet Possession, Conformity to description, Conformity

to quality of sample, Satisfactory quality, Fitness for particular purpose.

For buyer, the implied duty is to accept the goods and pay for the goods.

The essence of a sale of goods transaction is the transfer of ownership

from the seller to the buyer. Property passes generally according to the

contract/intention of the parties. However, it is possible for the parties to

separate ownership and risk


Problem Statement For the case of Trans-Logistics versus Open-Track, the fact that the

buyer has seen the unit in the truck does not mean that the contract is a

sale by sample. There must be a term to it to effect. In this case, it was

not mentioned in the contract. Hence it cannot be considered a sale by

sample as in the case of Natferrous Pte Ltd v Tradelink Hardware Pte

Ltd (2005). Hence it is most likely a sale by description.

For sale by description, there is an implied condition that the goods

delivered will match the description given by the seller as in SGA S (13)

as in Beale v Taylor (1967). Jia Wei was given a brochure with

description of MT420. It turns out that the failed devices are XT320,

which is not suitable for tropical climate. Since SGA S (13) is breached,

the buyer would have the right to repudiate the contract, reject the

goods and sue for any damages.


Problem Statement

Regarding the loose power adapter that connects the GPS tracking unit

to the cigarette lighter plug that failed to work properly and faulty

components in the GPS tracking unit under high temperature (cause

damage to the truck) and the devices are of the model MT320. Based

on SGA S 14 (3), the installed systems are not fit for purpose as in Grant

v Australian Knitting Mills Ltd (1936) and also not of satisfactory quality

as in SGA 14(2B). Since it is a breach of condition, the buyer would

have the right to repudiate the contract, reject the goods and sue for any

damages.


Learning Objectives

Discuss the protection provided by the implied conditions and

warranties contained in the Sale of Good Act

Discuss the duties of buyer and seller and consumer protection in

sales contracts

Differentiate between ownership, risk, delivery and acceptance of

goods and examine which passes under Sale of Good Act


P11 – Take them to a higher level!


DEVELOPMENT






Take them to a higher level! LVNGZ is a global producer of laptops and it obtained the following items from various suppliers for its laptop production.

LCD

Battery

Memory Modules

Hard disk

Laptop Keypad

Integrated Wireless Card

Motherboard

Laptop camera

Processor

Bag

Power Adapter

Operating System

Based on ABC analysis, the following items were highlighted for performance monitoring:

S/N Item Annual Spend

1 Power Adapter Approximately 8% of annual dollar value

2 Laptop Camera Top 10% of annual spend

3 Integrated Wireless Card Approximately 15% of annual dollar value

4 Processor Top 20% of annual spend

The top management’s direction is to develop suitable performance metrics for different category of annual spending so as to manage the supplier better.

Category based on ABC analysis

Strategy to use

Cat A To focus on quality and delivery performance

Cat B To focus on volume purchase and cost effectiveness

Cat C To reduce risk and ensure supply continuity

Cat D To focus on operational efficiency

Donavan, the procurement manager was tasked to:

come out with suitable metrics to measure the performance of the current suppliers. He may also make use of scorecard.

suggest suitable measures for improvement The CEO has also stated to him that the performance measurement has to be “SMART” (Specific, Measurable, Actionable, Relevant and Timely). Could you help him to accomplish the tasks?


P11

Take them to a higher level


Development


The Supply planning process The actual supply planning process starts with information derived from the annual

sales forecast, production forecast, and general economic forecast.

Sales forecast will provide a total measure of the requirements of materials,products, and services to be acquired by purchasing.

Production forecasts will provide information on the location at which thematerials, products, and services will be required.

Economic forecast will provide information useful in estimating general trends forprices, wages, and other costs.

In most organizations, less than 20 percent of the number of line items purchasedaccount for over 80 percent of the dollars spent. Once high-value purchases havebeen identified, the broad forecast can be broken down into specific plans.

The next step is to make price and supply availability forecasts for each of the majorcategories or commodities. The estimates of material and service consumption arebroken down into monthly and quarterly time periods. These quantities arechecked against inventory control data that take into account lead times and safetystocks and compared to price trend and availability forecasts to develop a buyingplan. Market conditions must be considered.


Supply Budgets - 4 Common budgets

Supply budgeting

process

Materials (operations)

purchase budget

MRO budget

Capital budget

Administrative or

operating budget

1. Begins with an estimate of expected operations, based on sales forecasts and plans.

2. Typically has a planning horizon of one year or less

3. Except high-dollar, complex, long-production-cycle products : aircraft or power plants (multiyear budget )

1. Covers a purchase plan, typically for a 12-month period, for maintenance, repair, and operating supplies

1. Often has a multiyear horizon, based on the firm’s strategic plan for product lines, market share, and new ventures.

2. Decisions can be made on projected capital purchases based on production needs, obsolescence of present equipment, equipment replacement needs, and expansion plans.

1. Based on anticipated operating workloads, includes all of the expenses incurred in the operation of the supply function.

2. Includes salaries and wages; space costs, including heat and electricity; equipment costs; information technology charges; travel and entertainment expense; office supplies; educational expenditures for supply personnel; postage, telephone, and fax charges; and subscriptions to trade publications.


What is purchasing performance

measurement system? A purchasing performance evaluation system represents a formal, systematic

approach to monitor and evaluate purchasing performance. Management can useperformance measures as a means to influence behaviour and a means ofsignalling and track performance progress. Modern purchasing performancemeasurement and evaluation systems contain a variety of measures. Most of thesemeasures fall into the following categories:

Effectiveness and efficiency measures.

Financial and non-financial measures

Why measure performance? 4 reasons:

Support Better Decision Making. Measurement can lead to better decisions bymaking performance and results visible.

Support Better Communication. Performance measurement can result in bettercommunication across the supply chain

Provide Performance Feedback. Measurement provides the opportunity forperformance feedback

Motivate and Direct Behavior. Measurement motivates and directs behavior towarddesired end results.


Key Performance measurement concepts

- Effectiveness and efficiency

Efficiency achieve agreed goals – it is in effect an operating ratio of effortagainst results. This may depend on organisational factors such as theworkload, certain procedures, the information system used, the headcount,often focusing on transactions. E.g. price performance, average time fromreceipt of order requisitions to placement of order.

Effectiveness, meanwhile, is the extent to which a goal can be met, using achosen course of action. Supplier development, value analysis, forward buyingprogrammes and lead-time reduction all impact on assessments of Purchasingeffectiveness. E.g. On-time delivery

Effectiveness EfficiencyPerformance

Extent to which

goals can be met

using a chosen

course of action

Differences between

planned and actual

resource use

Extent to which Purchasing

achieves set goals, with

given resources


Key Performance measurement concepts

- Financial and non-financial measures

Financial measures - Simple workload statistics, such as the number ofpurchasing employees, number of purchase orders raised, the number ofrequisitions received, and department costs, do not necessary reflect the keyarea of significance to the organisation as a whole. Hence the department thatdeliver the best price savings or efficiency statistics may not be effective incontributing to the organisation’s overall goals.

Non-financial measures – Various attempts has been made to integrate non-financial measures of performance into organisational measurement criteria.While it is difficult to quantify performance in such areas as supplierdevelopment, interdepartmental relationships and negotiation skills, they areoften the very activities which need to be monitored and simulated, in orderfor purchasing to deliver the appropriate goods and services to internal userseffectively.


Purchasing performance measurement

categories

Most purchasing performance measurement falls into one of the categories:

Price performance Cost effectiveness Revenue

Quality Time/Delivery/

Responsiveness

Technology/Innovation

Physical environment and

safety

Asset and integrated

supply chain management

Administration and

efficiency

Government/Social Internal customer

satisfaction


Metrics related to key business drivers

Cost

Total Cost of ownership (TCO)

Cost Avoidance

Inventory Reduction

Percentage change in cost

vs previous year

Average cost per order

Order/Schedule changes

Time

On-time delivery

Cycle time reduction

Order to delivery cycle

Purchased product lead

time

Product development

time

Quality

Supplier quality escapes

Quotation errors

Shipment errors

Warranty data

Incoming quality

In-process quality

Technology/

Innovation

Product development capabilities

Innovative ideas

Best practices

Number of supplier

partnerships/

alliances

Supplier e-sourcing

capabilities

Spend under management


Price performance measures

- Actual Price Compared to Plan Actual Price Compared to Plan. Common price performance measures are the

difference between actual and planned purchase prices. Measurement of plannedpurchase price variance can occur at different organizational levels. One levelincludes actual-to-planned purchases for the total material budget; this is anaggregated price performance measure. Other levels show comparisons thatprovide greater detail. For example, purchasing may calculate actual-to-plannedprice variances for each individual purchased item.

There are various formats for measuring Purchase Price Variance:

1. Purchase price variance = Actual price - Planned price

2. Purchase price variance percentage = Actual price/Planned price

3.Total purchase price variance = (Actual price - Planned price) X Purchase quantityor estimated annual volume

4. Current year dollar impact of purchase price variance = (Actual price - Plannedprice) X (Estimated annual volume X Percentage of requirements remaining)

Units of Measure: Dollars or percentages



-Actual Prices-to-Market Index

Actual Prices-to-Market Index. Purchase price to market index measuresprovide information about the relationship between actual prices andpublished market prices. These measures are most appropriate for market-based products where pricing is primarily a function of supply and demand.This also applies to standard and readily available products. Index measurestake into account the difference between a published index number over adesignated period (such as a quarter) and the change in the actual price paid.The following illustrates this concept:

1a. Market-based index for Item AAA @March 31, 2008 = 128

1b. Market-based index for Item AAA @June 30, 2008 = 131

1c. Market index change = (131 - 128)/128 = 2.34% increase

2a. Actual price paid for Item AAA @March 31, 2008 =$149

2b. Actual price paid for Item AAA @June 30, 2008 = $152

2c. Price paid change rate ($152 - $149)/$149 =2.01% increase

3. Comparison to market 2.34% - 2.01%Better by 0.33%



- Price Comparisons and target pricing Price Comparisons Between Operations. Actual price comparisons between plants,

divisions, or business units for similar items also occur. These comparisons providean opportunity to identify purchase price differences within a firm. This providesvisibility as to which unit is negotiating or securing the best purchase price. Thecomparison activity can also help identify commonly purchased items betweenunits for purchase consolidation. Actual-to-actual price comparisons betweencompanies is also attempted by a number of firms to determine true pricecompetitiveness.

Although firms are increasingly focusing on cost versus price, price performancemeasures are still popular, especially with firms that lack detailed cost data. Priceperformance measures are also commonly used when purchasing raw materials,other commodity or standard-type items, components, systems, and contractservices.

Target Prices Achieved. Target pricing is the process of determining what theexternal customer is willing to pay for a product or service and then assigningspecific cost targets to the components, assemblies, and systems that make up theproduct or service.

Target cost per unit = Target price – Target profit per unit


Cost-effectiveness Measures

- Cost changes The measures in this category focus attention on efforts to reduce purchase costs.

Cost measures fall into two general categories: cost changes and cost avoidance.The use of cost measures requires a word of caution. The method used to achievecost reductions is critical. A cost reduction based on mutual cooperation is thesame, on paper as a cost reduction resulting from heavy-handed pressure on asupplier. While the end result (i.e., a cost reduction) appears to be the same, theprocess used to achieve that result can have longer-term implications. Cooperationmay reduce costs through joint improvement while heavy-handed cost pressuremay force a supplier to cut corners, resulting in poor quality.

Cost Changes. A cost-change measure compares the actual cost of an item or familyof items over a period of time. A cost change is the increase or decrease in costresulting from a change in purchasing strategy or practice brought about by anindividual or a group. The primary measure of concern to companies is costreduction achieved which is calculated by taking (new price - prior price) xestimated volume.

For example, if the new price was $8.00/unit, and the prior price was $11.00/unitwith an estimated volume of 10,000 units for the next budget period, there wouldbe a projected cost reduction of $30,000. Actual usage would determine the finalcost reduction achieved.


Cost-effectiveness Measures

- Cost avoidance

Cost Avoidance. Cost avoidance represents the difference between a price paidand a potentially higher price (which might have occurred if purchasing had notobtained the lower price through a specific effort or action). For example,assume that purchasing paid $5 per unit for an item in the past, but thesupplier now quotes a price of $5.50 per unit.

If the buyer negotiates a price of $5.25 per unit, then he or she achieves a costavoidance of $0.25 per unit, even though the price is still $0.25 higher than theprior price. Unfortunately, finance often argues that cost-avoidance savingsrarely show up on a firm’s profit line. An example is given below:

Supplier Original

unit price

of a

processor

(ITP5Q4)

Supplier New unit

processor

(Quotation)

Current

requirement

Cost saving/

Cost Incurred

Remarks

SZ Intl $330 SZ Intl $365 79

($2,765.00)

Cost

incurred

YH

Trading

$298 79

$2,528.00 Cost saving

ZLTech $318 79$948.00 Cost saving

Best cost saving


Quality Measures

- Customer Defects per Supplier

Supplier quality must be judged by total performance throughout product life. Goodquality results in customer acceptance of the product with minimum investment by theproducer to ensure that quality. It does a buying organization little good if the purchasedmaterials pass incoming inspection and latent defects appear in the product in thecustomers’ hands. Create a process that tracks supplier-assignable defects throughoutthe usage process and reports that information to supply management so correctiveaction can be taken with suppliers.


Quality measures - Field Failure Rates by

Purchase Item and by Supplier

Field Failure Rates by Purchase Item and by Supplier. This measures the incidenceof failures of components, assemblies, and systems/services when actuallyincorporated into the final product or service and supplied to external customers.As a measure, it indicates failures after sale, and organizations will tend to aim for azero incidence of such failures. However, in some industries (e.g., equipmentrental) this measure becomes a key measure of customer satisfaction.

%100received supplies ofnumber Total

rejected supplies ofnumber Total RateReject x

Supplier Rejection rate

Zoom Cam 3/30 x 100% =10%

Sonic Cam 2/15 x 100% = 13.3%

Clear Cam 1/16 x 100% =6.25%

Sonic Cam has a highest rejection rate.

Clear Cam is better as it has lowest

rejection rate.


Time related measures- Cycle time

reduction

CUSTOMER

Retail outlet

Customer

order

transmittal Transmittal of

backorder items

Order

delivery

Express

order delivery

FACTORY

Order processing,

assembly from stock, or

production if no stock

WAREHOUSE

Order processing

and assembly

Total Order Cycle Time

Order transmittalOrder processing

and assembly

Additional stock

acquisition timeDelivery Time+ + +


Delivery/Responsiveness measures

- On time Delivery

On time delivery

Note: Appropriate date reference:

Buyer can use supplier’s promised delivery date OR the requestor’s need date asthe denominator. Using a supplier’s promise date increases the likelihood that theshipment will be on time (increasing delivery predictability), but the buyingorganization’s needs may not be served.

period in supplierby promised unitsof Number

period in supplier a fromreceived unitsof Number(OTD)delivery time On

Based on the delivery chart, the On Time Delivery

(OTD) is measured by number of unit

received/number of unit promised. In this case, Clear Cam has the best

OTD.


Delivery/Responsiveness measures

- Delivery Performance

For delivery performance:

The only two dates that matter are the “need” and “delivered” dates.

Where the two match, there is acceptable delivery.

e.g. if the number of days is shorter, that would be better.

In this case, Clear Cam has a better delivery performance.


Asset Management measures

-Cost of carrying inventory and lead time

Example: You have quotations from 3 suppliers regarding the unit cost and leadtime to deliver the required wireless card. Given the inventory carrying cost is78.8% per year, how do you make decision on the purchase in order to reducethe total purchase cost in the process of managing your supply? Assume 50weeks per year and time factor is factored into the quoted price.

Carry cost per week = 78.8% per year cost to carry/50 weeks per year

= 1.576% per week

Time factor = Quoted Price x 1.576% per week cost to carry x weeks of leadtime Contribute to

better cost

performance

Supplier Price $ Lead Time (Week) Adjusted

Price

FZ Technology $78.25 10 $86.88

Uni1 $78.65 6 $84.35

THTT Import $79.10 4.5 $85.33

Onet $77.20 8 $86.93

The longer a supplier’s lead time and the greater the uncertainty of delivery,

the more inventory a customer will carry as insurance.


The Supplier Scorecard approach to

purchasing performance measure

A supplier scorecard provides a quantitative and consistent process to measuresupplier performance categories critical to the success of the company.Identification of low scoring categories for improvement is important.

Example:


Physical Environment and Safety Measures Companies are tracking the achievement of environmental and safety goals

and costs associated with compliance—both voluntary compliance and wherelegislation enforces compliance. The objective is to drive performanceimprovement to achieve self-imposed or regulatory goals.

E.g. In unit total cost calculations, if a supplier complies with the policy issue,credit its total cost by the amount of the defined limit. This creates a positiveincentive for the supplier to comply. For example, an organization values greenbuying and wishes to foster the use of recycled materials, so it establishes a12% credit for recycled content of a certain level. Suppliers that meet therequirement receive a 12 percent credit in total cost. Suppliers that do notmeet the requirement are not penalized, but they receive no credit.

Green

Credit


Approach to handle suppliers using

Supplier Scorecard

Causes of poor performance could be due to e.g. unclear specifications,commodity price changes, and so forth. Hence, one should

Maintaining balance. It may not benefit the buying organization to have asupplier who is 100 percent in price and delivery and only 70 percent in quality.

Allowing time to meet with poor-performing suppliers to determine causesand correction strategies.

Making certain that a critically important but poor-performing supplier is notautomatically dropped.

This combination of data and cut score provides a basis for discussion withcurrent and potential suppliers about expected versus actual performance.Performance can be monitored, definitions can be negotiated, and issues canarise that promote healthy discussions between buyers and suppliers. The cutscore should be reviewed periodically to ensure that it reflects the buyingorganization’s needs as driven by its market, desired margin, customer, andquality requirements.


Miscellaneous approach to purchasing

performance measure - SERVQUAL

The SERVQUAL approach is particularly useful for the evaluation provided to internal customers by purchasing staff. SERVQUAL Survey statements

The 22 standardized statements can be used to canvass customer’s view ondimensions of service quality. Responses to these questions using a 9-point Likertscale are used to enable customer satisfaction to be assessed and benchmarked.


SERVQUAL Questionnaires

Example of SERVQUAL questionnaires:

Operational Performance

Most raw materials and parts received are in conformance with specifications.

All raw materials and parts arrive within the delivery date.

The quantity of materials purchased in inventory meets the company’s quantityperformance objective.

The materials’ target cost (standard cost or budgeted cost) is met.

Internal Customer Satisfaction

Customer departments are satisfied with the speed with which we react to theirrequirements.

Customer departments are satisfied with the attention and dedication thatpurchasing show for their problems.

Other format of questionnaires


SMART test to determine quality of

performance metric

Ideally, the specific performance measures used to monitor and evaluateperformance should possess certain characteristics. The SMART test (Specific,Measurable, Actionable, Relevant and Timely) is frequently used to provide aquick reference to determine the quality of a particular performance metric.

Specific: Objectives should explicitly state what they want to achieve. It shouldalso be ‘Strategic’, meaning objectives must align fully with the strategic aims ofthe organisation.

Measurable: Objectives should be quantifiable and meaningful to gaugeachievement

Achievable: Objectives should be context specific and realistic

Relevant: Objectives should be relevant to specific function

Time bound: Objectives should be set with an explicit time-frame for completion

Example:

To reduce supply base by 20% within 1 year

To reduce inbound supplier costs by 15% within 2 years

To reduce supplier lead times from US by 5 days by July 2010


Problem Statement

Category based on

ABC analysis

Strategy to use Metrics

Cat A

(Laptop Camera)

To focus on quality and delivery

performance

Rejection rate,

Delivery performance,

Shipment errors

Cat B

(Processor)

To focus on volume purchase and

cost effectiveness

Cost avoidance,

Inventory carrying cost

Cat C

(Integrated Wireless Card)

To reduce risk and ensure supply

continuity

On-time delivery

Cat D

(Power Adapter)

To focus on operational efficiency Total order cycle time,

Purchase price variance

Possible metrics:


Problem Statement As we see, Most purchasing performance measurement falls into one of the

categories: price performance, cost effectiveness, revenue, quality,time/delivery/responsiveness, technology/innovation, physical environmentand safety, asset and integrated supply chain management, administration andefficiency, government and social, internal customer satisfaction.

A supplier scorecard approach can be used to develop metrics for supplierperformance and the low scoring categories are identified for furtherimprovement.

An alternative approach to purchasing performance measure is to make use ofSERVQUAL . The SERVQUAL approach is particularly useful for the evaluationprovided to internal customers by purchasing staff.

Ideally, the specific performance measures used to monitor and evaluateperformance should possess certain characteristics. The SMART test (Specific,Measurable, Actionable, Relevant and Timely) is frequently used to provide aquick reference to determine the quality of a particular performance metric.

Measurements drive behavior. A good measurement system will engender thedesired behavior in both supply management and suppliers and will lead to thedesired business results.


Learning Objectives

Explain the supply planning process, supply budgets andperformance measurement systems

Identify measures and indicators to evaluate supplier’s performance

Devise metrics to measure supplier’s efficiency and effectiveness


P12 – Vicious or Virtuous


DEVELOPMENT






Vicious or Virtuous Sche-Freight Ltd is a leading international provider of integrated logistics services and it operates a storage warehouse at the logistics hub near the air cargo complex. Currently, the local trucking services for import and export cargoes were outsourced to a 3PL provider, Kinlmen Logistics. However, the relationship seems adversarial over past nine months. Routine supplier meetings took place monthly at the buyer’s premise but the focus was mostly on operational issues. The following were conversation that has taken place and the associated issues:

Kinlmen Logistics Sche-Freight Ltd

Port of destination not needed as you are just doing delivery for export/import shipment to/from the airport

If you cannot meet the KPI, you will need to reduce your logistics service charges or we will look for someone else.

We have helped you to handle many urgent shipments. Have you received our invoices? Some of them are more than 60 days.

It is part of your job as a service provider to handle urgent shipments! Please clear with our Accounts Payable department.

We have tried to look for your warehouse supervisors for misplaced shipments in the warehouse, but they were not helpful.

I need the Port of destination information for transportation planning in my system.

Ahem! They may be busy. Try harder next time.

…

Lack of

communication

Limited

exchange of

info

The supplier market is highly

competitive with many

capable 3PLs providing

equivalent service

Little joint effort to

improve on current

process

Shiva, the CEO of Sche-Freight Ltd has found the situation undesirable. He has tasked you to examine the current issues and propose to the top management during next week’s board meeting to suggest any suitable course of action. While preparing for the meeting, Kinlmen Logistics has announced that in the following months, it would embark on a new project to develop its technological capabilities to provide value-added services to its customer.


P12

Vicious or Virtuous


Development


Type of relations and supply chain

The key strategic decisions in supply management centers on which supplier topursue and what kind of relations to maintain with suppliers. Anyorganization’s desire to satisfy its customers and to provide continuingimprovement in its customer service is dependent on its suppliers to help itaccomplish this goal.

The ability of any organization to connect the two external links (customer &supplier) through its internal organization (buyer) will, to a large extent,determine the effectiveness of its total supply chain. Since, in any chain, theweakest link determines the strength of the whole chain, it is important thatthe strength of each link be equal and congruent. It is also a relatively simpleperspective that greater strength in any one link can create a customer-dominant, internally dominant, or supplier-dominant chain.

Supply LinkInternal

LinkCustomer

Link


Main differences between transactional and

relationship purchasing

Transactional (Traditional relationship) Relationship purchasing (Partnership)

Focus on short discrete purchasing Focus on supplier retention

Short-term orientation Long-term orientation

Arm’s length Closeness

Simple buyer-seller relationship Complicated, including internal relationship

Emphasis on price, quality and delivery in the offered product. No innovation.

Emphasis on improving price, quality, delivery and other factors, such as innovative design as a collaborative exercise between purchaser and supplier

Moderate supplier contact High level of supplier contact, with each contact being used to gain information and strengthen the relationship

Little sharing of information; opaqueness Significant sharing of information, including cost information; transparency

Reverse auctions may be applicable Reverse auctions generally not applicable


Purchaser-supplier satisfaction matrix

Any buyer-supplier relationship could fallinto any of the 4 quadrants in the matrix.However, only quadrant A represents adesirable region in which a reasonablystable relationship can be maintained.

In each of the other quadrants, attemptsby the purchaser or supplier or both toincrease satisfaction may worsen thesatisfaction of the other, therebylowering stability in the relationship.

Clearly, quadrant D, with both partiesdissatisfied, represents a highlyundesirable and unstable relationship.

The middle position of(5,5) should reallybe considered as a minimum acceptablegoal for both sides, and few agreementsshould be reached by the purchaserwithout achieving at least this place.


Tools and techniques for moving positions

in the matrix

A number of supply management and marketing means may be used to shift positionson the satisfaction chart. The use of some of these will adversely affect the perceptionsof the other party, and these might be called “crunch” tools or negative measures.Others are likely to be viewed in less severe terms and might be considered “stroking”methods or positive approaches.

For example, crunch tools for the purchaser include

Complete severance of purchases without advance notice.

Refusal to pay bills.

Refusal to accept shipments.

Use or threat of legal action.

For the supplier, examples would include

Refusal to send shipments as promised.

Unilateral price increase without notice.

Insistence on unreasonable length of contract, take or pay commitments, onerousescalation clauses, or other unreasonable terms and conditions and use of take it orleave it propositions.


Tools and techniques for moving positions

in the matrix (Con’t)

“Stroking” techniques by the purchaser would include

Granting of substantial volumes of business long-run commitments or 100 percent requirements contracts.

Sharing of internal information on forecasts, problems, and opportunities to invite a mutual search for alternatives.

Evidence of willingness and ability to work toward changed behavior in the purchasing organization to improve the seller’s position.

Rapid positive response to requests from suppliers for discussions and adjustments in price, quality, delivery, and service.

On the supplier side, examples could be

Willingness and ability to make rapid price, delivery, and quality adjustments in response to purchase requests without a major hassle.

Invitation to the purchaser to discuss mutual problems and opportunities.

The giving of notice substantially in advance of pending changes in price, lead times, and availability to allow the purchaser maximum time to plan ahead.


Model of supplier relationship

– Bensaou Model Bensaou suggests four buyer relationship profiles:

For each profile, Bensaou identifies distinguishing product, market andsupplier characteristics.

Finally, he suggests that the four profiles can be arranged in a matrix to indicatewhether the buyer’s and supplier’s tangible or intangible investments in therelationship are high or low.

Tangible investments, in this context, are buildings, tooling and equipment.

Intangible investments are people, time and effort spent in learning supplier—purchaser business practices and procedures and information sharing.

Bu

yer’

s sp

ecif

ic

invest

men

ts

High Captive

Buyer

Strategic

Partnership

Low Market

Exchange

Captive

Supplier

Low High

Supplier’s specific investments



– Bensaou Model

How differently should a company manage one type of relationship from another?

Bensaou also identified three management variables for each profile:

Bensaou model involves the 3 analytical steps:

The strategic selection of relational types (contextual profile) to match theexternal conditions relating to the product, the technology and the market

The identification of an appropriate (management profile) for each type ofrelational design

Matching the design of the relationship, which could be over- or under-designed, to the desired management profile.

Captive Buyer

•information-sharing practices•characteristics of ‘boundary-spanner’ jobs•the social climate within the relationship

Strategic Partnership


Market Exchange


Captive Supplier




– Bensaou Model (Contextual Profile)Captive buyerProduct characteristics:• technically complicated• based on mature, well-understood technology• little innovation and improvement to the productMarket characteristics:• stable demand with limited market growth• concentrated market with few established players• buyers maintain an internal manufacturing capabilitySupplier characteristics:• large supply houses• supplier proprietary technology• few strongly established suppliers• strong bargaining power• car manufacturers heavily depend on these suppliers, their technology and skills

Strategic partnershipsProduct characteristics:• high level of customisation required• close to buyer’s core competency• tight mutual adjustments needed in key processes• technically complicated part or integrated subsystem• based on new technology• innovation leaps on technology, product or service• frequent design changes• strong engineering expertise required• large capital investment requiredMarket characteristics• strong demand and high growth market• very competitive and concentrated market• frequent changes in competitors due to instability or lack of dominant design• buyer maintains in-house design and testing capabilityPartner characteristics:• large multiproduct supply houses• strong supplier proprietary technology• active in research and innovation (R&D costs)• strong recognised skills and capabilities in design, engineering and manufacturing

Supplier specific investment

Bu

yer

sp

ecif

ic i

nvestm

en

t

High

HighLow



– Bensaou Model (Contextual Profile)Market exchangeProduct characteristics:• highly standardised products• mature technology• little innovation and rare design changes• technically simple product or well-structured complicated manufacturing process• little or no customisation to buyer’s final product• low engineering effort and expertise required• small capital investments requiredMarket characteristics:• stable or declining demand• highly competitive market• many capable suppliers• same players over timeSupplier characteristics:• small ‘mom and pop’ shops• no proprietary technology• low switching costs• low bargaining power• strong economic reliance on automotive business

Captive supplierProduct characteristics:• technically complicated products• based on new technology (developed by suppliers)• important and frequent innovations and new functionalities in the product category• significant engineering effort and expertise required• heavy capital investments requiredMarket characteristics:• high growth market segment• fierce competition• few qualified players• unstable market with shifts between suppliersSupplier characteristics:• strong supplier proprietary technology• suppliers with strong financial capabilities and good R&D skills• low supplier bargaining power• heavy supplier dependency on the buyer and economic reliance on the automotive sector in general

Supplier specific investment

Bu

yer

sp

ecif

ic i

nvestm

en

t

Low

HighLow

Step 1



– Bensaou Model (Management Profile)Captive buyerInformation-sharing mechanisms:• ‘broadband’ and important exchange of detailed information on a Continuous basis• frequent and regular mutual visitsBoundary-spanner tasks’ characteristics:• structured tasks, highly predictable• large amount of time spent by buyer’s purchasing agents and engineers with supplierClimate and process characteristics:• tense climate, lack of mutual trust• no early supplier involvement in design• strong effort by buyer towards cooperation• supplier does not necessarily have a good reputation

Strategic partnershipsInformation-sharing mechanisms:• ‘broadband’ frequent and ‘rich media’ exchange• regular mutual visits and practice of guest engineersBoundary-spanner tasks’ characteristics:• highly ill defined, ill structured• non-routine, frequent, unexpected events• large amount of time spent with supplier’s staff, mostly on coordinating issuesClimate and process characteristics:• high mutual trust and commitment to relationship• strong sense of buyer fairness• early supplier involvement in design• extensive joint action and cooperation• supplier has excellent reputation

Market exchangeExchange-sharing mechanisms:• ‘narrowband’ and limited information exchange, heavy at time of contract negotiation• operational coordination and monitoring along structured routinesBoundary-spanner tasks’ characteristics:• limited time spent directly with suppliers’ staff• highly routine and structured tasks with little interdependence with supplier’s staffClimate and process characteristics:• positive social climate• no systematic joint effort and cooperation• no early supplier involvement in design• supplier fairly treated by the buyer• supplier has a good reputation and track record

Captive supplierInformation-sharing mechanisms:• little exchange of information• few mutual visits, mostly from supplier to buyerBoundary-spanner tasks’ characteristics:• limited time allocated by buyer’s staff to the supplier• mostly complicated, coordinating tasksClimate and process characteristics:• high mutual trust, but limited direct joint action and cooperation• greater burden put on the supplier

Step 2


Bensaou Model Analysis

– Buyer-supplier contextual profile An analysis based on the existing relationship suggests that the buyer-supplier

relationship profile is that of a market exchange.

Product/Service characteristics:

Highly standardized service

Technically simple

Little innovation

Low engineering effort required

Market characteristics:

Stable demand

Highly competitive market

Many capable supplier

Supplier characteristics:

No proprietary technology

Low switching cost

Low bargaining power


Bensaou Model Analysis

– Management profile

Since the profile is that of a market exchange, let’s examine the managementvariables of the relationship:

Information-sharing practices:

Limited exchange of information

Supplier meetings took place only once a month at the buyer’s premise and the focus is mostly on operational problems

Characteristics of ‘boundary-spanner’ jobs:

Limited time spent directly with suppliers’ staff – Sche-Freight’s staff were busy

Highly routine and structured tasks with little interdependence with supplier’s staff

The social climate within the relationship:

No systematic joint effort and cooperation

No early supplier involvement in design


Bensaou Model Analysis - Matching the

relationship requirements and capabilities In the current situation, by looking at the management profile and examining the

management variables of the relationship, it tells us that the current managementpractices of the buyer matches that of market exchange. Similarly for thecontextual profile, it matches that of market exchange as well. Hence the design ofthe relationship matches, based on Bensaou Model. (In this case, relationshiprequirement is low and actual relationship capabilities is also low).

However, as the supplier improves on its capabilities and move towards a GPSenabled transportation 3PL, the current relationship would be under-designed.Hence Sche-Freight would need to change its way of managing Kinlmen.

Rela

tio

nsh

ip

req

uir

em

en

ts

High Under-designed

relationship

Match

Low Match Overdesigned

relationship

Low High

Actual relationship capabilities

Step 3

Managing a portfolio of relationships


Bensaou Model Analysis - Matching the

relationship requirements and capabilities

There are two kinds of successful relationships:

High requirements – High capabilities

Low requirements – Low capabilities

There are also two paths to failure:

Under-designed relationship

Overdesigned relationship

For example, firms that invest in building trust through frequent visits, guestengineers, and cross-company teams when the product and market contextcalls for simple, impersonal control and data-exchange mechanism areoverdesigning the relationship. This is not only costly but also risky, given thespecialized investment involved, in particular, the intangible ones (e.g. peopleinformation or knowledge).


How buyer-supplier relationship may

develop over time Developing partnership relationships with suppliers takes time. Thus, a supplier or a

preferred supplier (operational level) may develop into a supply partner (tactical level)and then to a design partner (strategic level). Each level is normally of a longer andmore permanent duration than the preceding one.


Early Supplier Involvement (ESl)/Early

Purchasing Involvement (EPI)

The opportunity to affect value in the acquisition process is significantlygreater in the early stages (need recognition and description) than in the laterones. Involving the supplier and the buyer in these early stages can lead toimprovements in processes design redesign or value analysis activities.

The drive to cut cycle time improve competitiveness and reduce cost compelsmany organizations to include supplier(s) on cross functional teams. A suppliermay participate with the hope of securing the business or as part of an ongoingpartnering/alliance relationship. Confidentiality issues often must be dealt withup front, and it must be clear to the supplier(s) if involvement guarantees thebusiness or not.

By making suppliers part of the process—it could be called “design forprocurability.” Others call it “early supplier involvement” or ESI. Moreover, ifsuppliers involve their suppliers in the process, the purchasing organization hasaccess to a wide pool of talent all focused on the needs of its customers. Whenthe supplier is making investment decisions, hiring decisions, or new-productor process or system decisions, these can be made keeping the customer-partner’s future needs in mind, it is this latent potential for improvement thatthe partnership tries to tap.


Reasons for termination of relationship

No relationship can or should be expected to last forever as organizationsoperate in a dynamic environment. The ending of a relationship does notnecessarily mean failure and there may be positive as well as negativeoutcomes for one or both of the parties involved.

Reasons for termination include:

changes in business direction(s) an existing partnership may no longer havevalue if either the purchasing or supplier organization has shifted itsstrategic direction

product obsolescence - the product or service provided by the supplier isbecoming obsolete without any replacement options

the supplier is unable to meet service levels certain objectives basic to thepartnership can no longer be met

economic factors a supplier has become ‘at risk’ financially, with the dangerof potential liquidation


Reasons for termination of relationship short-term attitude either partner may consider that the long-term benefits

of the partnership have not been realized sufficiently quickly or have beeninsufficient to warrant a continued commitment to a particularsupplier/purchaser

external economics a recession may force suppliers to cut back on productdevelopment, training and other resources, such as product engineers, and,consequently, they will be unable to meet the ‘continuous improvement’objectives of the partnership

mergers and acquisitions such ventures can create new business models foreither the purchaser or supplier

corporate divestiture may create a situation where, because parts of thebusiness have been sold, the organization can no longer provide a productor service

instability and inconsistency acquisitions or disposals of companies orrapid changes in key personnel or organizational philosophy often adverselyaffect year of previous relationship-building based on trust and stability


Process of termination When considering the process of relationship termination, relationship aspects

such as timing, relationship aspects, legal considerations and succession issuesare important aspects of termination.

Timing Whenever possible, the timing of the termination should be synchronized

with the expiration of the agreement currently in force. Giving too muchadvance warning to a supplier can lead to a deterioration in service.Conversely, termination may not come as a surprise to a supplier that hasreceived regular negative feedback on performance. Decisions may alsohave to be made on whether the termination should be immediate orgradual.

Relationship aspects. 3 Ps that can aid in minimizing possible hostilityencountered in the termination process: Positive attitude. It recognizes that both organizations will survive apart and

that recriminations will help neither. Pleasant tone. A pleasant tone can be more effective than harsh words. Professional treatment. Professional justification for the termination is

essential. Termination is not a personal issue.


Process of termination

Legal considerations

Among this are financial consequences, confidentiality agreements,intellectual property issues, security issues, obtaining clear signedrecords of any settlement, employee rights

Succession issues

Before deciding to terminate, it will be necessary to ensure thatsteps have been taken to ensure a continuity of supplies. This willentail:


Problem Statement A first cut in analyzing the issue is to identify what kind of relationship

exists in a simple term. In this context, it is a transactional one rather thana partnership.

In examining the current issues, first we make use of 2 matrices:

Buyer-Supplier Satisfaction Matrix is used to determine how satisfiedare buyer and supplier in the relationship. Both parties seems notsatisfied as in quadrant D. The relationship is undesirable and unstablerelationship and suitable “crunching” or “stroking” strategies can beused.

Bensaou Model suggests using the right management profile to matchthe contextual profile of the relationship. Upon analysis, it shows thatthe relationship is that of market exchange and the management profilematches the contextual profile. However, as the supplier improves on itscapabilities and move towards a GPS enabled transportation 3PL, thecurrent relationship would be under-designed. Hence Sche-Freight Ltdwould need to redesign the relationship.


Problem Statement Sche-Freight Ltd may consider improving on information exchange with

the supplier, increasing the time spent with the supplier to understandtheir problem, improving on the systematic joint effort with thesupplier and involving the supplier early in new initiatives.

ESI/EPI should be considered because involving the supplier and thebuyer in the early stages can lead to improvements in processes designredesign or value analysis activities.

Hence, the management would also need to consider whether thesupplier could be developed further, tactically or strategically instead ofjust at operational level. In the same way, if the relationship has to beterminated, it has to be done in an appropriate manner and consideringaspects of timing, relationship aspects, legal considerations andsuccession issues.


Learning Objectives

Assess the difference between Traditional relationship & Partnership

Apply Bensaou Model or equivalent to decide ways of managingdifferent type of supplier relationship.

Assess what ESI is and key issues

Identify requirement for termination of relationship

Effective supply chain management requires choosing a type of relationshipappropriate to product and market conditions and adapting managementpractices to that relationship. – Bensaou


P13 – Can I predict the weather?


DEVELOPMENT






Can I predict the weather? Min Hui is a purchasing manager of a well-known Asia’s corn sweeteners and syrup producer that produces corn sweeteners in Singapore. As raw material accounts for 50% of the total cost for producing the corn products, the purchasers have a great deal of responsibility on their shoulders.

Corn Corn Sweeteners Min Hui would need to take into account of the expected need of the production department, the inventory on hand, the carrying cost of inventory and finally the commodity market trends for corn. The storage cost is $0.05 per bu per month. The company can buy 5000 bushels (bu) of corn between July to December 2010 to be used for producing corn sweeteners for sale on 31st December 2010 to all the outlets locally and regionally. It is expected that the December cash price for corn would be higher than that in July. Historically, the price of corn is fairly volatile and good risk management is needed. The following table shows the price of corn per bu in the cash market and the futures market.

Could you help her to devise the purchasing strategy for corn? (Assume a suitable cash price for the month that you would like to buy corn and suitable futures price where necessary).

$3.4150/bu

$3.840/bu

The bushels in which grains are

bought and sold on commodity

markets are all units of weight.

1 bushel (bu) of shelled corn ≡56lb

$3.726/bu

http://en.wikipedia.org/wiki/Commodity


P13 Can I predict the weather?


Development


Raw materials and Commodities Raw materials initial inputs to a manufacturing process.

E.g. steel, synthetic resins, and rubber compounds. Manufacturers thatassemble products for sale consider manufactured parts and components asraw materials.

Commodities the natural materials from which manufactured items areproduced.

E.g. oil, minerals, ores, and agricultural products that are used in themanufacturing process.

Raw materials and commodities are not mutually exclusive.

In some cases, original commodities are used in production of goods that thenbecome raw materials for other manufacturers. So, what would be considereda commodity by one firm could be the basic raw material for another.

E.g. ore is used in the production of steel. Steel is then used by automobilemanufacturers as a key raw material. In this case, ore is raw material for thesteel producer and steel is raw material for the automobile manufacturer.

Because raw materials are incorporated into the final product, they arereferred to as direct materials.


The Principal Commodities

Commodities

Agricultural products

1. Fibers (wool, cotton)

2. Grains (wheat, corn, soybeans, rough rice)

3. Food (coffee, coffee, orange juice)

4. Livestock(cattle, hog, pork bellies)

Energy

1. Crude oil

2. Heating oil

3. Natural gas

Metals

1. Copper

2. Aluminum

3. Gold

4. Silver

5. Platinum

Other

1. Weather

2. Currency

Note: Commodity classification in Commodity trading is different

from the basis of use as in Harmonized Commodity and Coding

System (HS Code).


Link between raw materials and

organizational success There are three broad areas of activity in which a manufacturing organization’s

profitability may be influenced. They are the

Acquisition of goods and services

Conversion of those goods and services into a salable product

Marketing of that product

Because raw materials/commodity represent a high percentage of amanufacturing organization’s total goods and services expenditure, they alsooffer the greatest opportunity to reduce that expenditure.

Accordingly, sound management of raw materials acquisition generally offersthe most significant impact on unit cost of manufactured goods. Manufacturingcost per unit, in turn, impacts market price for finished products, profitability,market share, and ultimate success of the organization.


Key Macro Influences on Raw Material Supply

Management Strategy Both internal and external influences must be factored into raw material

purchasing strategies. Key macro-influences include internal operating andmarketing strategies. A sales forecast leads to a manufacturing plan, includingcapital and operating budgets. Supply strategies are then developed to meet theplanned needs of manufacturing and other supporting functions. Value-addingsupport of operating strategies requires close supply management coordinationwith operations. Supply management’s plans also incorporate market andeconomic conditions, and other financial influences that lead to specific financialstrategies.

The price of (sensitive) commodities fluctuates daily. Hence the buyer would aim totime purchases to fulfill requirements at the most competitive prices. Maineconomic and political factors that influence market conditions include

Interest rates

Currency fluctuations

Shortage supply factors, such as crop failures

Government policies, such as import control or stockpiling

Relationship between export/import countries

Inflation, such as increased material and labor cost


Purchasing Timing

Purchase timing involves risk management. The purchasing managercontemplates action on a request for materials or services. He or she selects avendor, negotiates terms of quality, delivery, and price, and advises persons in-house when to expect delivery. Little risk occurs here. Or, the purchasingmanager observes rising prices in the marketplace, or perhaps major eventsabout to happen to make materials scarce. He or she contemplates orderinggoods beyond current needs, for future delivery, so as to lock in prices beforethey rise. Risk management comes importantly into the picture.

The purchasing field recognizes four time-types of buying:

Type of Buying Covers Requirements for

Hand-to-mouth Up to 30 days

Buying to current needs 30, 60, or 90 days

Forward buying 3—12 months

Speculative buying Beyond 12 months


Supply Management Financial Strategies –

Hand-to-mouth

A company may adopt hand-to-mouth purchasing if its materials requirementscan be fulfilled promptly from local or nearby markets, prices are steady andquantity discounts are not available.

It may also follow this policy in case it is short of working capital or storagespace, or its purchasing specialists have forecasted an anticipated decline inprices of its materials. When prices are falling, he or she shifts to buying for thenext 30 days. A hand-to-mouth strategy seeks to purchase in small quantitiesto meet immediate need.

The policy is also suitable when the products are in the process of redesigningwith the result that its materials needs may change.

Note: The company adopting this policy runs the risk of interruptions inproduction schedules due to stock-out of materials resulting from latedeliveries, or shortage of materials.



Buying to current needs

This strategy is useful when the commodities are seasonal in nature or whenthe demand is seasonal in nature. Hence the company may buy all or part ofthe requirements in anticipation of price increase. The raw materials arepurchased at a time when market prices are low and there is a probability ofupward swing in prices in future.

When prices are rising, the purchaser buys larger quantities for longer periodsof need—90 days or even longer. This would be buying to current needs.



Forward Buying

Forward buying involves all purchasing in excess of the usual minimum stockafter normal output and delivery requirements are considered. It excludesadvance purchases made with the object of realizing speculative profits. Someof the more common objectives of forward buying include:

Providing a margin of insurance against possible supplier or carrier interruptions

Taking advantage of quantity discounts

Minimizing transportation costs by consolidating shipments

Protecting against the risks of potential shortages of materials

Securing materials of desired qualities when they are available

The standard unit of order must consider factors such as the storage spacerequired and available for use, the amount of funds available and the cost ofmoney, the risk of physical deterioration during the period of storage, the costof placing orders and receiving the goods, the quantity discounts available, andthe applicable freight rates covering various weights and quantities.

Note: It involves the price risk in unstable markets and additional carryingcharges



Speculative Buying

Speculative purchasing. Speculative strategies are also implemented inanticipation of price increases. However, purchase quantities are typically inexcess of anticipated need with a view toward selling the excess at a profitafter prices rise sufficiently. However, industrial buyers from large organizationnormally do not indulge in speculation.

The distinction between forward buying and speculative buying lies in theirrespective rationale. Forward buying is a response to operationalconsiderations or supply—demand conditions. Speculative buying isconducted with the hope of profiting from price changes. Forward buying is aregular procurement practice; speculative buying is not.

When materials are to be bought for speculation, policy approval should beobtained from the highest executive authority in the organization.

Note: The risk is that any unused or unsold inventory may have to besalvaged at a loss.


Hedging, Carrying charges, Price Risk Motivation for Hedging - There is risk involved in purchasing commodity at

today’s price to produce product for future delivery. The technique of hedgingis premised on a belief that customers will expect future pricing of thoseproducts to reflect then-current commodity prices.

Price risk can occur for a number of reasons. For agricultural commodities,price risk may occur due to drought, near record production, an increase indemand, decreased international production, etc.

Hedging is a procedure designed to offset the risks resulting from adverseprice fluctuations in a cash commodity. In simplest terms, hedging amounts toentering simultaneously into two transactions of a like amount—one apurchase, the other a sale—in two markets whose prices are known to moveup and down together by approximately the same amounts.

Carrying charges. Usually the price of a futures contract is higher than the cashcommodity. The difference is represented by all or part of the charge ofcarrying (i.e., the cost of storage, insurance, and interest charges) the cashcommodity to the futures month. For example, if cash wheat in April is sellingfor $5 a bushel and carrying costs are 5 cents a bushel per month, July wheatfutures would theoretically sell for $5.15 per bushel (=3x$0.15 as Apr to July =3 months).


Hedging with Forward or Futures Contract Forward contracts are more appropriately viewed as trade

agreements negotiated directly between two parties for atransaction that is scheduled to take place in the future. Theyare negotiated directly between two parties in the OTC (nonexchange-traded) markets. A typical participant in a forwardcontract is a commercial/investment bank which serve as a roleof a market maker and is contacted directly by the customer.

Advantage of this private arrangement is the terms of thecontract are completely flexible between the two parties.However a disadvantage is that it is illiquid and might be difficultor costly for a counterparty to exit the contract before itmatures.

Futures contracts standardize the terms of the agreement(expiration date, identity and amount of the asset) to the extentthat it can be exchange traded. A person wishing either to buy orsell in the futures market gives the order to a broker and pass tothe trader in on the exchange trading floor.


Hedging in futures market

Hedging in the futures market is a two-step process. Depending upon thehedger's cash market situation, he will either buy or sell futures as his firstposition.

For instance, if he is going to buy a commodity in the cash market at a latertime, his first step is to buy futures contracts. Or if he is going to sell a cashcommodity at a later time, his first step in the hedging process is to sellfutures contracts.

The second step in the process occurs when the cash market transaction takesplace. At this time the futures position is no longer needed for price protectionand should therefore be offset (closed out).

If the hedger was initially long (buying hedge), he would offset his position byselling the contract back. If he was initially short (selling hedge), he wouldbuy back the futures contract.

Both the opening and closing positions must be for the same commodity,number of contracts, and delivery month.


Cash Price, Futures Prices

Cash/Spot Price Futures Price

FUTURES PRICES

$3.840/ bu

$3.4150/bu


Cash Price, Futures Prices

(If this occurs in Dec)

Cash/Spot Price Futures Price

FUTURES PRICES

$4.042/bu

$3.617/ bu

Dec 2010


Comparison:

Hedging with futures versus Cash buying

1. Cash Market only 2. Cash Market + Futures Market

Buy corn in Jul based on prevailing sales priceand process as corn sweetener for end Sep delivery to customer.

Sale transaction (Contract on July to deliver corn sweetener in Dec) executed in Jul based on price of corn in Jul.* Although Mfg can buy in Jul, he decided to buy later, say in early Dec.

Buy corn Futures in Jul @current price in futuresmarket

Sell corn Futures in Dec @futures price in futuresmarket.

*Additional charges: Storage, interest and insurance on corn

Minimal Carrying cost No cost of physical carryinginventory

Example: A manufacturer buy corns to be delivered as corn sweetener on 31st Dec2010. Two methods: 1)Cash Market only, 2)Hedging

“Buying hedge”

(Simultaneous purchase and sale in 2 markets i.e. Cash & Futures)


Comparison:

Hedging with futures versus Cash buying1. Cash Market only 2. Cash Market + Futures Market

July: Buy 5,000 bu@$3.415/bu(at purchase price)

If you buy 5,000 bu@$3.415/bu in Julcompared toDec: Actual Buying of 5,000bu @$3.617/buLoss: $0.202/bu

Jul: Buy 5,000 bu@$3.840/buDec: Sell 5,000 bu@$4.042/buGain: $0.202/bu

Impact: If the price of corn increases in December

As price rises, profitmargin is cut as salesprice is predicted basedon the price of coffee inJul.

+Additional charges (e.g. storage)incurred.

In Jul: Hedge by Sale in Cash Market and Buy in Futuresmarket.In Dec: Cash price already rises. Purchase to produce fordelivery. Sell futures contract in futures market.The loss in cash market (-$0.202/bu) would be offset by thegain (+$0.202/bu) when Dec futures contract is sold. (Note:Loss in cash market is due to the cash market purchase pricein Dec is which is higher than in Jul). Ignore brokeragecommission/transaction cost:Net buying price of corn = $3.415/bu


Hedging with Commodity Futures Option Option contract offer similar trading alternatives to forward and

futures contract. However, a futures contract differs from an optionbecause an option is the right to buy or sell, while a futures contract isthe promise to actually make a transaction on an underlying securityor commodity at a later date and at a predetermined price.

The biggest difference between options and futures is that optionpurchases have losses limited to the amount paid (premium) for theoption, whereas futures have no effective limitations on losses.

An American or American Style option can be exercised at any time upto option’s expiration date.

An European or European Style option can only be exercised at theoption’s expiration date.


Moneyness of Options

Moneyness of Options

Call Option (Buy) Put Option (Sell)

S>X In-the-money Out-of-the-money

S=X At-the-money At-the-money

S<X Out-of-the-money In-the-money

S=Price of the underlying asset. X=strike price

Strike/Exercise price (X) is the price specified for purchase or sale in anoption contract.Option Premium is the initial price that the option buyer must pay to theoption seller to acquire the contract.Call option gives the holder the right to purchase an asset at a specified priceon or before a certain date.Put option gives the holder the right to sell an asset at a specified price on orbefore a certain date.


Option Premium and leverage As with any call position, the option holder will only exercise at the expiration

date if the prevailing price of the underlying asset (S) exceeds the exercise price(X), i.e. in-the-money. Otherwise, the options can be let to expire worthless.

Example:

E.g. In July, the call option on corn (with expiry date on 26-Nov-2010) with anexercise price of $3.415/bu would cost the buyer $0.54/bu of corn covered by thefutures position. Suppose on expiration, the price of corn futures is $4.042/bu.The option holder exercise the option with a price of $0.54/bu for 5,000 bu ofcorn.

Option premium for this future call is

= $0.54 X 5,000 = $2,700

If instead corn futures is purchased, it would cost

= $3.415 X 5,000 = $17,075

Hence with the call option, buyer has been able to control 5,000 bu of corn for aninvestment of $2,700.

[Leverage] and the maximum loss if occurs is this premium.


Problem Statement Commodity is generally classified into agriculture products, energy and metals.

Because commodity represents a high percentage of a manufacturingorganization’s total goods and services expenditure, they also offer the greatestopportunity to reduce that expenditure.

Purchasing timing for commodity is important and it requires risk managementand there are four types of buying in the purchasing field.

As there is risk involved in purchasing commodity at today’s price to produceproduct for future delivery, hedging is used to offset the risks resulting fromadverse price fluctuations in a cash commodity.

Hedging can be used with forward contract, futures contract or options.

As we see from the technique applied, hedging with futures results in breakingeven in the purchase of corn.

Hedging with commodity futures option can also be used. In this case, theoption call buyer is able to control the quantity of corn with an optionpremium. The maximum loss if occurs is also this premium and there is nocarrying charges.


Learning Objectives

Explain what are classified as commodity and its peculiarities

Evaluate how does price of commodity affecting the finished

products.

Deploy various buying technique to mitigate risks

http://www.google.com.sg/imgres?imgurl=http://static.howstuffworks.com/gif/corn-syrup-questions-1.jpg&imgrefurl=http://recipes.howstuffworks.com/tools-and-techniques/corn-syrup-questions.htm&usg=__VH7AWtMvThQb0vZJ_53zoXBjXGY=&h=265&w=400&sz=33&hl=en&start=4&um=1&itbs=1&tbnid=xWRK0aREeRFT4M:&tbnh=82&tbnw=124&prev=/images?q=picture+of+corn+sweetener&um=1&hl=en&sa=X&tbs=isch:1


P14 – E-Procurement…A speedy acquisition process!


DEVELOPMENT






E-Procurement…A speedy acquisition process!

Data-Safe Ltd is a company whose business areas cover server products primarily for the data centre. Hence, it would need to source from many suppliers in the market to provide the company the required materials for its business. However, there are inefficiencies in the current procurement method and process as illustrated below:

Buyer

Approval process for purchase as per company procurement policy

Create purchase Order

Acknowledge receipt of order (email, phone)

Supplier

Print Purchase Order

Email/Fax/Mail

to Supplier

Pack and ship goods

Prepare Invoice

Buyer’s

Accounts

Payable

department

3 way match of invoice,

receipts and

PO

Prepare order to buyer

Buyer’s

Receiving

department

After approval of payment:

Payment by cheque to the supplier

Based on current traditional procurement process, there are a lot of non value-added activities and also tedious efforts. In addition, it has encountered frequent stock-out issues, errors in manual order entries and difficulties in tracking deliveries from suppliers and payment to them. As the main business is in the private sector, Data-Safe also wishes to expand its business to supply goods to the government agencies and wish to participate as a trading partner. Advise Jinwei, the Manager in charge of procurement, an initiative to improve on the current buying situation and how the company can start participating as a trading partner for public procurement.


P14 E-Procurement...A Speedy

Acquisition Process!


Development


Inefficiencies in Traditional Procurement Non value-added activities such as data entry, correcting errors in paper work,

expediting delivery or solving quality problems. For high-value items, a great deal

of time is needed to be spent on the procurement activities to qualify suppliers,

negotiating prices and relationship building. If the buyers are busy with details of

smaller items, they do not have time for the purchase of high value items.

Inefficient vendor management method - monitoring

No seamless track and trace – no visibility of shipment

Stock availability is obtained from legacy system which may not be accurate

Maverick buying – unplanned purchase of need items quickly, which is at a

higher price. Often due to delayed shipment or urgent request.

Tedious effort in invoice reconciliation and dispute resolution – 3-way

match of PO, invoice and receipt.

Electronic Commerce 2008, Efraim Turban, et al.


Buyer and Supplier compromises in

traditional procurement


E-Commerce and its variations E-Commerce relates primarily to transactions, or the buying and selling of

products or services on the Internet. It usually refers to a website that has an

online storefront or catalogue and the facility for electronic order processing.

It should be noted that e-commerce may also be conducted via more limited

forms of electronic communication, including e-mail, fax and the emerging

use of telephone calls over the Internet. Variations include:

B2B – Business make online transaction with another business

B2C – Business make online transaction with individual consumer

G2B – Government buy or provides good or services from or to business

G2C – Government buy or provides good or services from or to citizens

M-Commerce – Transactions and activities conducted in full/part in a

wireless environment, e.g. using cell phone

C2B – Individual using internet to sell products or services to organizations

C2C –Consumer transact directly with consumer, e.g. individual selling

residential properties and cars

Note: G=Government, B=Business, C=Consumer, M=Mobile


E-Commerce applications E-Business incorporates a wide range of production, customer and

internal processes that are only indirectly related to commercial

transactions.

Production-focused processes include electronic links with suppliers,

especially manufacturing resource planning (MRP II), enterprise

resource planning (ERP) and advanced planning and scheduling (APS).

Customer-focused processes include online customer support and

customer relationship management (CRM).

Internal or management-focused processes include automated

employee services, training, information sharing, video conferencing

and recruiting.

E-Supply chain management (E-SCM) is concerned with streamlining

and optimising the whole supply chain by means of internal applications,

with the aim of ensuring maximum sales growth at the lowest possible

cost. This includes setting up an internal online purchasing system, joining

an industry wide electronic marketplace and implementing e-SCM across

the entire value chain.


E-Commerce applications (con’t) E-Sourcing refers to the process and tools that electronically enable any activity

in the sourcing process, such as quotation/tender submission and response, e-auctions, online negotiations and spending analyses.

E-Procurement refers to using the Internet to operate the transactional aspectsof requisitioning, authorising ordering, receiving and payment processes for therequired services or products.

E-Marketplace Like an exchange, a marketplace is a website that enablespurchasers to select from many suppliers. With e-marketplaces, the buyer is incontrol as open marketplaces enable purchasers to evaluate all potentialsuppliers for a particular product or service and make informed decisionsregarding what and where to buy(Public, Private or consortia).

E-Catalogue refers to a web page that provides information on products andservices offered and sold by a vendor and supports online ordering and paymentcapabilities.

E-Auction refers to an electronic market, which can exist in both business-to-business and business-to-consumer contexts. Sellers offer goods or services tobuyers through a website with a structured process for price setting andfulfilment.


E-Marketplace

www.alibaba.com

www.chemconnect.com


E-Catalogue

http://www.dell.com/html/us/segments/bsd/ecatalog/0808/ecatalog.htm


E-Procurement Method

-B2B reverse auctions system

A reverse auction is a

tendering system in which

suppliers are invited to bid

on the fulfilment of an

order and the lowest bid

wins. A buyer may open

an electronic market on its

own server and invite

potential suppliers to bid

on the items the buyer

needs. The invitation to

reverse auction is RFQ.



E-Procurement Method –

Group purchasing system Group purchasing refers

to the aggregation of

orders from several buyers

into volume purchases so

that better prices can be

negotiated. There are 2

models: internal

aggregation and external

aggregation.



Aggregation and internal marketplace Internal aggregation: Large companies usually buy millions of MRO

yearly. Companywide orders, from several plants for identical items areaggregated using web and are replenished automatically. Besideseconomies of scale (lower prices for large purchases) on many items,administrative and transaction costs are reduced.

External aggregation: Many SME would like to enjoy quantitydiscounts but have difficulty finding others to join group purchasing toincrease procurement volume. They can make use external of 3rd partyto find partners. The objectives is to provide SME with better prices,selection and services by aggregating demand online and then eithernegotiating with suppliers or conducting reverse auction.

Internal marketplace refers to the aggregation of catalogs of allapproved suppliers combined to a single internal electronic catalog.It also allow for easy financial controls. As buyers make purchases,their account balances are displayed. Once budget is depleted, thesystem would not allow new purchases to go through. (Popular inpublic institution and government entities)


E-Procurement Method -

Internal marketplace for desktop purchasing

Desktop purchasing implies

purchasing directly from

internal marketplaces without

the approval of supervisors or

purchasing department and it

is done using a purchasing

card (P-card). It reduces the

administrative cost and cycle

time involved in purchasing

urgently needed or frequently

purchased items of small dollar

value.



Major issues that companies must consider

when planning e-procurement initiatives Fitting e-procurement into the company e-commerce strategy. If the

company were to outsource e-commerce, then it can be done in an

exchange or it can buy at the seller’s web.

Review and changing the procurement process itself. E-procurement

may affect the number of purchasing agents, where they are located and

how purchases are approved.

Providing interfaces between e-procurement and integrated enterprise-

wide information systems, such as ERP or supply chain management.

Coordinating buyer’s information with that of sellers. Sellers have many

potential buyers. Hence some sellers may develop an integration-oriented

procurement system for its buyers. It allows buyers to gain real-time

technical information on the products, as well as on product availability,

delivery times, commercial terms and condition.

Consolidating the number of regular suppliers and integrating with

their information systems or business processes. Having fewer

suppliers More collaboration; Buy more results in quantity discount;

Minimize number of connectivity issue


How electronic contracts and transactions

are governed by the law in Singapore?

Electronic Transactions & Contracts

The Electronic Transactions Act (Cap. 88, 1999 Rev Ed) (“ETA”) clearlydefines the rights and obligations of the transacting parties. It alsoaddresses the legal aspects (e.g. validity) of electronic contracts, use ofdigital signatures and concerns for authentication and non-repudiation.Any party, including businesses, entering into contracts onlineshould be familiar with this law.

The Electronic Transactions Act (Cap. 88) PART IV - ELECTRONIC CONTRACTS covers the following:

Formation and validity of contracts

Effectiveness between parties

Attribution

Acknowledgment of receipt

Time and place of despatch and receipt


Electronic Signatures and Digital Signature

defined in ETA Electronic signature is defined as “any letters, characters, numbers or

other symbols in digital form attached to or logically associated with an

electronic record, and executed or adopted with the intention of

authenticating or approving the electronic record.” An electronic

signature can take any number of forms such as digital imagery of

handwritten signature, signature on touch pads and merely typing a

name on a word document.

Digital signature refers to a form of secure electronic signature. This

means a prescribed security procedure or a commercially reasonable

security procedure agreed by the parties that verifies the authenticity of

the signature as to both source and content such that it is unique to the

person using it.


Digital signature model and electronic

records

Three models of digital signature law:

Prescriptive Model – mandates the use of PKI technology for use indigital signatures. Argentina, Germany, Italy, Malaysia, Russiatakes this approach.

Hybrid Model – more market driven and provide for specialpresumptions (e.g. authenticity presumption) for some forms oftechnology (e.g. PKI technology) upon satisfying certainrequirements. Singapore, EU, Bermuda are some countries thattake this approach.

Minimalist Model – truly technology neutral approach and offersbasic legal recognition in lieu of detailed standards. US, UK,Australia, NZ adopt this approach.

Electronic records refers to tangible medium that is stored in anelectronic or other medium that is retrievable in perceivable form. TheETA also provides rules relating to the retention and securing ofelectronic records. E.g. e‐mail messages, word‐processed documents,electronic spreadsheets, digital images and databases


PKI Technology

To use PKI technology, there must be an arrangement whereby a third

party is entrusted with the duty to verify an authenticate the user’s

identity. PKI technology enable users to be authenticated to one another

by using the information in each other’s identity certificates known as

“public keys” to encrypt and decrypt messages exchanged between

them. Hence each party will have 2 keys, a “private key” to digitally sign

messages sent and a “public key” to authenticate messages received.

In general, a PKI package includes client software, server software (e.g.

certification authority) , hardware (e.g. smart cards) and operational

procedures.

Digital Signature

DIGITAL

FINGERPRINT

=

MESSAGE

DIGEST

+

SENDER’S

PRIVATE

KEY

=


PKI Technology (Explained)

Sender use private key to encrypt

The message digest, resulting in a

digital signature

The hash function converts

the message to a string of digit

-message digest

Sender encrypts both original message

and digital signature using the recipient

public key (digital envelope)

Upon receiving, the receiver will use the private key

to decrypt the content of digital envelope to produce

a copy of a message and sender signature.

Receiver used sender’s public key to decrypt the sender

signature, resulting in a copy of original message digest .


The Objectives of Government Supply are

Basically the Same as the Private Sector

Assurance of continuity of supply

Avoidance of duplication and waste through standardization

Maintenance and improvement of quality standards

Development of a cooperative environment between supply and the

agencies and departments served

Obtaining maximum savings through innovative supply and application

of value analysis techniques

Administering the supply function with internal efficiency

Purchase at lowest like cycle cost


Singapore Government E-procurement

(G2B) MinistriesStatutory

Boards

Organs

Of States

GeBIZ


GeBiz – Government Purchasing Policy

Fundamental principles

Fundamental Principles of Government purchasing policy:

Transparency: The Government’s procurement objectives, criteria and procedureswould as far as possible made known to suppliers.

Fair and Open Competition: This will encourage suppliers to give their bestoffers. Suppliers are given equitable access opportunities and they are able tocompete on a level playing field.

Value for money: Government will procure from sources that can best meet itsrequirements and which offer the best value. Value for money is derived from theoptimal balance of benefits and costs on the basis of total cost of ownership. Assuch, value for money does not necessarily mean that a tender must be awardedto the lowest bidder.

GeBIZ has the features of private sector business

portals e.g. convenient on-line shopping experience

but adheres to public sector procurement disciplines

which are compliant to the requirements of WTO-GPA:

Transparency

Open And Fair Competition

Value for Money


Step1: Register at GeBiz

Register as a trading partner at

GeBiz so that Data-Safe can

participate in bidding

GeBIZ is an Integrated One-Stop Electronic

Business Centre which:

provides a convenient channel for Public

Sector officers to interact with their trading

partners for procurement and revenue tender

activities

enables suppliers to trade with the entire

government

Organs

of States

Statutory

Boards

Government

Procurement

Executives

Ministries

Workplace

Public Sector

IntranetInternetUsers Users

Partner Enterprise

InternetInternet

Local

Suppliers

GlobalSuppliers

Other

Market

Places GeBIZ

Fixed line, Dial-up,

Broadband, Wireless

etc.


Step 2: Register at Vendors@Gov for

suppliers

With the Electronic-Invoice System, vendors can enjoy the following benefits:

Convenience: Track the status of invoices without hassle.

Accuracy: Receive accurate payments as the information is captured at

source.

Prompt: Receive prompt payments in accordance with credit term.

Register as a supplier at Vendors@Gov

so that Data-Safe can submit e-invoice to

initiate payment request


Problem Statement Traditional procurement process has many inefficiencies and E-Procurement

attempts to provide resolution to the problems encountered.

There are also many major issues that companies must consider when

planning e-procurement initiatives and there are several ways of

implementing E-Procurement, which includes B2B reverse auction, group

purchasing and desktop purchasing.

As a buyer, Data-Safe may want to sign up as a buyer in the available E-

Marketplace to improve on the sourcing. If resource permits, it may also

implement its own internal system with the suppliers.

As in formal contract, electronic contract is also governed by the law of

Singapore via The Electronic Transactions Act (Cap. 88) .

There are three models of digital signature law: Prescriptive, Hybrid and

Minimalist. Singapore adopts the Hybrid model approach.

As a supplier, Data-Safe can sign up as a trading partner in the Gebiz

website so as to participate in bidding. It should also register at

Vendors@Gov so that it can submit e-invoice to initiate payment request.


Learning Objectives Explain the inefficiencies of traditional procurement procedures

Compare E-Commerce, E-Business, E-SCM and E-Procurement

Discuss the legal aspects of purchasing and advantages of e-

procurement

Discuss the characteristics of public supply and acquisition procedures


P15 – Opportunity to develop new

capabilities


DEVELOPMENT






Opportunity to develop new capabilities Logking Logistics has been building its business around transportation of general cargo between Singapore, West Malaysia and Southern Thailand for about 15 years, and is keen to expand its services into warehousing. One of its customers is a major supplier of toddler’s toy called TodPick. It had been working closely with Logking to deliver its products to Malaysia and southern Thailand from Singapore. TodPick is considering outsourcing its warehouse operations to further lower their operations cost and improve cash flow.

Currently, TodPick is leasing a warehouse and paying their staff by the month, regardless of whether there is demand for their goods or not. Their current cost per month of running for warehouse operations is estimated to be $66,530. They prefer to pay by the logistics services they require, as more demand and revenue justifies the cost of services required. The following is the situation at TodPick:

Average pallets in storage per month 800 pallets

Average pallets for in-handling per month 320 pallets

Average pallets for out-handling per month 250 pallets

Number of line items per month 900 line items

Cheng Wan, the Chief Operating Officer for Logking is excited about the prospect of expanding its capabilities for a ready customer. He then tasks you and your team to find out all the costs of running warehouse operations and propose to TodPick the charges per logistics service.

To provide TodPick with more options, your team is also required to propose alternatives besides Logking managing TodPick’s warehouse operations.


P15 Opportunities to develop new

capabilities


Development


General reason for make decision

The quantities are too small and no supplier is interested or available inproviding the goods

Quality requirement is exact/unusual which requires special processingmethods suppliers cannot provide

There is a greater assurance of supply

It is necessary to preserve technological secrets

It helps the organization to obtain lower cost

It allows the organization to take advantage of idle equipment/labor

It ensures steady running of corporation’s own facilities, leaving supplier tobear the burden of demand fluctuation

It avoid the dependency on single source

The purchase option is too expensive

Distance from supplier is too great


General reason for buy decision The organization may lack managerial/technical expertise in production of the

items

The organization lack production capacity or time

There are more options in potential sources and substitute items

There may not be sufficient volume to justify in-house production orinvestment into in-house capabilities

A highly capable supplier is available nearby

It provides the organization the ability to bring a product or service to marketfaster

The challenges of maintaining long-term technological and economic viabilityfor a noncore activity are too great

The company wishes to avoid exposure to seasonal, cyclical or risky marketsituations that could adversely affect employment or investment

The customer has expressed a brand preference

There is a need for special techniques/equipment in order to produce the finalproduct


Strategic Outsourcing in purchasing Outsourcing can be defined as the complete transfer of a business process that

has been traditionally operated and maintained internally to an independently ownedexternal provider.

A complete transfer means people, facility, technology, equipment and other assetsare no longer maintained internally once the business process is outsourced.

Outsourcing ≠ make-or-buy decision.

Outsourcing ≠ contracting (meaning: purchase of goods or services to facilitate abusiness process owned by the buyer)

Why business outsource business processes:

Cost minimization is accomplished by reducing direct operating costs, eliminatingoverhead costs, and transforming fixed costs into variable costs

Refocusing the organization to its core competencies is accomplished by focusingwhat the organization does best and/or transforming the business to focus on newproducts and services.

Improvement in operating performance is accomplished by increasing quality,increasing productivity, and obtaining new capabilities technologies from externalsources.

Increased market share and revenue is accomplished by assessing the providersnetwork and accelerating expansion into new markets.

Source: Purchasing and Supply Management, Benton (2010)


Benefits of outsourcing

Some of the specific benefits of outsourcing are to:

Reduce and control operating costs

Improve quality

Change company focus

Acquire external capabilities

Refocus scarce resources for alternative uses

Reduce cycle time

Obtain cash infusion

Reduce risks

Gain Flexibility

Turn fixed costs into variable costs


Reasons for outsourcing logistics services

Globalization- Organizations are increasingly sourcing, manufacturingand distributing on a global scale. This renders their supply chains verycomplex to management. Thus, their logistics activities are increasinglybeing farmed out to experienced 3PLs, how have global reach and theappropriate IT platforms

Effectiveness – Logistics many not be the core activity of theorganization. By outsourcing logistics, organization can re-focus on theircore competences and manage their resources more effectively

Cost – By outsourcing logistics, organizations can reduce both fixed andvariable costs as 3PLs leverage on their economies of scale

Value added services – 3PLs now are also able to offer value addedservices like multi-country consolidation, channel management, aftersales support as well as life cycle management


Reasons for not outsourcing logistics

services

Organisation strategy is to develop logistics as a core business.

Downsizing of operations creates extra capacity.

Does not make sense. Model is too complex/ savings are insignificant.

Risk of choosing the wrong partner- savings not realised, service levelfailure, cultural fit.

Difficult to trust or rely on an external party for success-low maturity ofmarket.

IT systems- would create too much dependency.

LSP works with competitors


3rd Party Logistics (3PL) 3PL – 3rd Party Logistics providers are now able to offer integrated outsourced

logistics services to companies for part or all of their supply chain functions.

3PL usually specialize in integrated warehousing & transportation services, thatcan be customized to meet different market demands and products

Examples of 3PL Logistics include Fedex, DHL, CWT, Yang Kee Logistics

The underlying premise of supply chain management is that the supply chainsystems and services must be integrated

E.g. order management system must talk to the warehouse managementsystem

Much of the systems and service integration is driven by informationtechnology capability, which includes

End-to-End Product visibility

Collaborative planning, forecasting and replenishment

Demand driven production


Source : The State of Logistics Outsourcing - 2009 third-party logistics

Outsourced Logistics Services


IT-Based Services Provided by 3PLs Web-enabled communications (3PL-User)

Visibility Tools (e.g. tracking/tracing, event management)

Warehouse/Distribution Centre Mgmt

Transportation Management (execution)

Barcode generation and scanning

Radio Frequency identification and asset tracking (RFID)

Transportation management (planning)

Collaboration Tools (e.g. inventory levels, production schedules)

Customer order management

Suplier relationship management (e.g. procurement,payables)

Supply chain Planning (e.g. forecasting, inventory planning, network optimization)

Internet based transportation-logistics exchanges(auctioning)

Global trade management

Customer relationship management

Yard management


IT based Services and Gap

Source : The State of Logistics Outsourcing - 2009 third-party logistics


Total Cost to Logistics Services Charges


Fix cost = total in handling cost/(no of

working hours x no of workers

Process mapping and

measurement to improve

outbound units moved per hour

{(In-handling fixed cost per hour + labour cost per hour) / inbound units moved per hour}

+ material cost



Problem statementGiven that situation at TodPick is as below:

1. Average pallets in storage per month = 800 pallets

2. Average pallets for in-handling per month = 10 containers x 32pallets/container = 320 pallets

3. Average pallets for out-handling per month = 250 pallets

4. Number of line items per month = 3 orders a day x 20 days x 15 lines perorder = 900 line items per month

To obtain the total cost per month, TodPick should multiply the charges by theirvolume and compare to their current cost

The total cost per month for the retail company if they decide to outsource is

= (800 pallets x $49.18) + (320 pallets x $7.27) + (250 pallets x $8.18) + (800 linesitems a month x $8.15)

= $51041.33

Compared to their current monthly cost of $66,530, it is cheaper to outsource

Note: Assuming the new operations team continue to use IT & Systems and Office & Equipment at negligible cost


Problem statementOther benefits of outsourcing:

- Instead of bearing the sunk cost of facility, it is translated to better cash flow

- If business is slow, then the pallets stored can be sold off first, reducingstorage cost

- Focus on core competency on development and marketing of product

Alternatives besides developing warehouse operations capability:

Offer just the in-plant logistics (covers movements within the manufacturingplant of raw materials, components and sub-assemblies - either to or fromstocking points or line-sides, for turning into finished goods, as well asbringing finished products out to the factory gate) instead of taking over thewhole premises

Transportation company can strategize to get a larger warehouse for a lowerrate, and operate the warehouse more customers to further reduce unit cost

Investigate the cost of shifting warehouse operations to Kuala Lumpur tomeet demand in Malaysia and Singapore

Do not take over the warehousing operations

Take over the lease, and take over just the storage operations, and offer thesame service to other companies


Learning Objectives

Discuss sourcing and decide what to outsource, what not to outsourceand what to in-source

Differentiate the different types of make-or-buy decisions and costfactors that affect the decision on what to outsource for logistics

Identify value-added logistics services that will reduce the overall costs

Compare the cost of logistics operations and charges to make adecision on outsourcing logistics operations

Procurement & Supplier Development.

Career

Transcript of Procurement & Supplier Development.