SOURCES OF SUPPLY & PRICING
OUTSOURCING AND MAKE OR BUY
Two Make or Buy Categories:
1. Products which user does make or can now make if necessary
2. Products for which there is presently no in-house capability to produce
The organization has three choices:
1. Make its entire requirement for a particular item
2. Make none (outsource all)
3. Make some, outsource some
Factors influencing make or buy decisions:
- Time and Capacity (both of which are cost considerations)
- Control of production or quality
- Design secrecy
- Need for a reliable source of supply
- Degree of specialization (of skill or equipment or both) to produce item(s)
- Quantity required
- Capital Investment and/or Physical space requirements
- Stability of workforce or production levels over time
- Multiple-Source Policy (make some, buy some to ensure availability)
- Purchasing Considerations (reduce number of items to purchase)
Sources of supply- Principles:
Review: A firm has two categories of suppliers: Itself and outside vendors. This discussion assumes that the make or buy decision has been made and we are now dealing with selection of outside sources of supply.
- Source Selection: Degree of formality depends upon size and complexity of acquisition.
- Small Purchases ($100K in Government at this time, private industry is company specific)
• Larger Purchases (Contracts) may be:
• Negotiated (Request For Proposals - RFP)-
- Proposals evaluated, formal source selection
- Technical solution, overall value are criteria
• Sealed (Invitation For Bids - IFB)-
- [Public] bid opening
- Price differentiation is main criteria
IMPORTANCE OF AND FACTORS TO CONSIDER IN SOURCE SELECTION:
- Assurance of supply/Risk assessment (History)
- Past performance
- Size of supplier relative to size of order
- Number of suppliers (when is a single source justified? multiple sources?) [Loyalty works both ways.]
- Advantages accrue to maintaining a continuing Buyer-Seller relationship
- Consider the concept of a "Friendly supplier"
- How can this help a buyer?
- Early Supplier Involvement
- Partnering: A collaboration between buyer and seller(s)
- Advantages?
- Disadvantages?
Traditional short-term competitive-based approaches to source selection are often offset by cost-based arguments for longer-term relationships, such as:
- Advantages accruing from learning curve over time
- Supplier’s willingness to invest in productivity enhancements
- Supplier’s willingness to undertake R&D to enhance products
Developing Sources:
Sometimes a satisfactory supplier must be created
- Private industry does this to increase/ensure competition, thus increasing profit.
- Government does this to: Expand industrial base - Promote socio-economic programs
Buying locally has potential advantages/disadvantages:
- Advantages include:
- Close buyer/seller cooperation
- Certain delivery dates
- Lower prices (due to transportation, etc.)
- Shorter lead times
- Faster rush order processing
- Ease of dispute resolution
- Disadvantages:
- Loss of economy of scale if local firm is small
- Inadequate technical assistance
- Less production flexibility
- More susceptible to shortages
BUYING FROM MANUFACTURER OR DISTRIBUTOR?
Consideration must be given to distribution costs, markups, etc.
Miscellaneous considerations:
- International purchases (Buy American Act)
- Environmental "green" purchasing
- Socio-economic programs such as doing business with minority/women-owned firms
- Conflicts of interest
- Ethics
- Reciprocity
SOURCES OF SUPPLIER INFORMATION:
- Internal supplier information files
- Supplier catalogs (printed or electronic)
- “Net-Sourcing” (using the Internet to locate and vet sources)
- Trade registers/directories
- Trade journals
- Yellow pages
- File of mail advertisements
- Sales Personnel
- Trade show exhibits
- Company Personnel
- Other purchasing departments/ purchasing associations
- Responses to synopsized advertisements
SEE CASE- SPRINGFIELD PURCHASES A GARBAGE TRUCK
SOURCES OF SUPPLY- PRACTICES:
Evaluating potential suppliers:
Three broad types of competition:
1. Price
2. Technological
3. Service
Some Considerations for Supplier Evaluation:
- Financial condition
- Plant facility
- Management (stability, track record)
- Service
- Quality History
- Delivery History
- Ability to meet "Just-in-Time" requirements
(Government does the above as a pre-award survey to ascertain vendor responsibility)
POST-SELECTION ISSUES:
- Assistance to suppliers (financial, technical, contractual)
- Supplier motivation and Performance-base contracting
- Premise is that supplier must want to perform
- Buyer must check performance
- Supplier motivation comes in several forms:
- Positive (continued business through award of additional contract term, bonus or performance incentives, maintenance of reputation, profitability)
- Negative (loss of business, loss of performance incentives, poor reputation, penalties)
SEE CASE- THE TIDEWATER GAS AND ELECTRIC COMPANY
PRICING PRINCIPLES
- Competition normally brings fullest extent of price adjustment, i.e. reduction in order to be competitive
- Firms are to be expected to earn a fair and reasonable profit. Profit established in relation to:
- Supplier risk
- Size of order
- Level of skills required to manufacture
- Reliability required
- Firm's position relative to supply and demand
- Degree of innovation expected of firm
Methods of verifying/obtaining the right price:
- Published price lists (asking vs. selling) are not always firm
- Competitive bidding (IFB) is best method when:
Dollar value of purchase is large enough to justify
- Specifications are clear
- Adequate competition exists
- Sellers are qualified and want to compete
- Sufficient time exists to solicit and evaluate bids
- Negotiated Procurement (RFP) used when:
- Cost estimates are uncertain due to development time, technological changes, economic uncertainty
- Price is not the only concern, quality, schedule, service also important
- Difficult to describe accurately in specifications
- Complex issues related to providing special tooling, title to design work, etc. are best resolved through negotiation
Price Analysis vs. Cost Analysis
Price Analysis: The examination of a seller's price without examination and evaluation of the separate elements of the cost and profit making up the price.
Price analysis is normally used when [evaluating] advertised procurements.
Cost Analysis: Review and evaluation of a seller's actual or anticipated cost data.
Types of Costs:
- Variable costs are those associated with performing a specific project [contract].
- Fixed costs are incurred simply by being in business; therefore they must be allocated to specific contracts.
Cost Analysis is a significant undertaking. If price analysis indicates that the price is reasonable, cost analysis may not be needed.
Factors affecting cost:
Capabilities of management
- Technology
- Efficiency of labor
- Amount/quality of subcontracting
- Plant capacity/continuity of output
- Composition/reasonableness of overhead cost
- Price of materials
- Costs of labor [wages, benefits, etc.]
Cases:
Springfield
Tidewater
