Modelleren van commodity strategieen in een...

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Dries Verhaeghe procurement service provider Modelleren van commodity strategieen in een Academiejaar 2010-2011 Faculteit Ingenieurswetenschappen en Architectuur Voorzitter: prof. dr. El-Houssaine Aghezzaf Vakgroep Technische Bedrijfsvoering operationeel onderzoek Master in de ingenieurswetenschappen: bedrijfskundige systeemtechnieken en Masterproef ingediend tot het behalen van de academische graad van Begeleider: Ian Rex Promotoren: prof. dr. ir. Hendrik Van Landeghem, prof. dr. El-Houssaine Aghezzaf

Transcript of Modelleren van commodity strategieen in een...

Dries Verhaeghe

procurement service providerModelleren van commodity strategieen in een

Academiejaar 2010-2011Faculteit Ingenieurswetenschappen en ArchitectuurVoorzitter: prof. dr. El-Houssaine AghezzafVakgroep Technische Bedrijfsvoering

operationeel onderzoekMaster in de ingenieurswetenschappen: bedrijfskundige systeemtechnieken en

Masterproef ingediend tot het behalen van de academische graad van

Begeleider: Ian RexPromotoren: prof. dr. ir. Hendrik Van Landeghem, prof. dr. El-Houssaine Aghezzaf

Dries Verhaeghe

procurement service providerModelleren van commodity strategieen in een

Academiejaar 2010-2011Faculteit Ingenieurswetenschappen en ArchitectuurVoorzitter: prof. dr. El-Houssaine AghezzafVakgroep Technische Bedrijfsvoering

operationeel onderzoekMaster in de ingenieurswetenschappen: bedrijfskundige systeemtechnieken en

Masterproef ingediend tot het behalen van de academische graad van

Begeleider: Ian RexPromotoren: prof. dr. ir. Hendrik Van Landeghem, prof. dr. El-Houssaine Aghezzaf

Foreword

I’d like to thank GIS Europe for their hospitality, Eva and my parents for their patience

and support, and professor Van Landeghem for his feedback.

i

Toelating tot bruikleen

The author gives permission to make this master dissertation available for consultation and

to copy part of this master dissertation for personal use.

In the case of any other use, the limitations of the copyright have to be respected, in

particular with regard to the obligation to state expressly the source when quoting results

from this master dissertation.

Dries Verhaeghe

June 6th, 2011

ii

Modelleren van commodity

strategieen in een procurement

service providerdoor

Dries Verhaeghe

Summary

The goal of this thesis is to develop a model that can guide supply management improve-ments at a procurement service provider. The model should center around commoditystrategy development, as research has demonstrated that it’s the key process in procure-ment. The Belgian company GIS Europe is chosen as the reference procurement serviceprovider.

The thesis commences with an extensive literature review. Literature points out that theKraljic portfolio method and the Michigan State University Purchasing Model are the twomost used models. They are both extensively discussed in the literature study. However,after review of both models, it can be concluded that neither is fully and solely applicableto a PSP.The constructed commodity strategy development model borrows from these two modelsand consists of nine steps cycle. What follows is a case study, in which the model is beingtested on the Belgian procurement service provider. To arrive at quantitative proof thatthe model works, a total cost tool is constructed. It focusses on three main activities:procurement, spot purchasing, and contract purchasing.

Keywords

Supply management, procurement, purchasing, commodity, PSP

Promotoren: prof. dr. ir. Hendrik Van Landeghem, prof. dr. El-Houssaine AghezzafBegeleider: Ian Rex

Masterproef ingediend tot het behalen van de academische graad van Master in de inge-nieurswetenschappen: bedrijfskundige systeemtechnieken en operationeel onderzoek

Vakgroep Technische bedrijfsvoeringVoorzitter: prof. dr. El-Houssaine AghezzafFaculteit: IngenieurswetenschappenAcademiejaar: 2010–2011

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Development of commodity strategies at a procurement service provider

Dries Verhaeghe

Supervisors: Hendrik Van Landeghem, El-Houssaine Aghezzaf, Ian Rex

Abstract: This paper describes a framework for the improvement of supply management at procurement service providers. It focuses on the development of commodity strategies, the most important procurement process. The result is a development cycle, consisting of nine steps. It’s tested at the Belgian procurement service provider GIS Europe. Keywords: Supply management, procurement, purchasing, commodity, PSP

I. INTRODUCTION

Currently, there are two popular procurement models: Kraljic’ portfolio method and the Michigan State University Purchasing model. While the former receives more attention in Europe, American purchasers seem to rely more on the MSU model [1]. The MSU model distinguishes fourteen processes within procurement. Case studies using this model have demonstrated that one of these processes, commodity strategy development, should be the foundation of all supply management improvement initiatives. However, unlike the other thirteen processes, commodity strategy development itself is not well researched. This may be due to the fact this process has a linking role. The other processes could be seen as the sections of commodity strategy development.

II. REVIEW OF KRALJIC AND MSU Kraljic’s model demonstrates that differentiating strategies based on the commodity’s supply risk and profit impact can be of great value to supply management [2]. However, when this model is solely applied to assess and improve supply management of procurement service providers, there will be difficulties. Three criticisms can be given. First, this model is fairly static. Products aren’t able to move around Kraljic’ matrix. Second, the model dictates that every product should be assessed and put into the matrix, which may form a problem for procurement service providers, as they don’t have a typical stable procurement schedule. Spot buys are still an important part of the business, making the product

base not only unpredictable, but also varied and extensive. Third, unlike MSU’s purchasing model, this isn’t a holistic model. It does not take the procurement process itself into account. The MSU is a holistic model. It tries to capture all aspects or processes that make up procurement [3]. When its self-assessment tool is applied to a Belgian procurement service provider, the company scores an average 1.1 out of 10. This score is low, but should not be solely attributed to weak performance of the PSP. It’s an indication that the model is not completely fit for procurement service providers. Not all processes are applicable to PSPs, and the some conditions to get higher scores are neither. In total, eight out of fourteen processes are deemed unreliable. This means that neither model can be completely or solely used to improve supply management at PSPs.

III. MODEL DEVELOPMENT The commodity strategy development process should consist of four big steps. Because of the ever changing client and supplier base, a periodic review is recommended and these four steps should be put into a cycle. Step 1: define the objectives Strategies should cascade from the vision and mission statement down to corporate objectives, and further down to commodity strategies [4]. Commodity strategies are basically the lowest level in the strategy hierarchy. Step 2: define the commodity The case studies and Kotter’s model for change demonstrate that a common ground is very important. Information on six topics should be assessed on availability [5]. Next, schedule stability can be assessed. Research suggests that the implementation of new procurement strategies should start with an assessment of every item’s demand [6]. Third, the importance of the product group must be determined. The classification can be done using the matrix from Kraljic’s portfolio method. A Pareto

analysis can be used to determine the profit impact and the number of capable suppliers as an indicator for the supply risk. Step 3: strategy development First, the commodity objectives should be set. This requires an assessment of the PSP’s strength in comparison with the supplier’s strength. Much like step 2, another 2-by-2 matrix can be used. Combined with Kraljic’s matrix, a 4-by-4 matrix can be constructed. When the commodity is positioned in the matrix, the objectives can be set. Second, the key performance areas must be chosen. Those boil down to key performance indicators, to which a quantitative value can be given when goals are set. Step 4: execution Kotter’s change model can be the commodity manager’s guideline to implement the changes. This implementation, though, is beyond the scope of this thesis.

IV. CASE STUDY The model is tested by applying it to the Belgian procurement service provider GIS Europe. The model is evaluated on a cost basis, and, thus, a cost model should be developed. The cost model distinguishes three kinds of activities: procurement, spot purchasing, and contract purchasing. Both variable and fixed cost were linked to these activities. To do so, cost factors, their drivers and the mathematical relationships between the two were determined. An overview is given in the table below. Activity Factor Driver Procurement Manpower FTEs sourcers Purchasing Manpower FTEs buyers FTEs accountants Price Price spot buy Price contract buy Logistics FTEs handlers ROI Stock value

When applying the framework to GIS Europe, the framework points out several possible scenarios for supply management improvement. After applying the cost model to the current state, the total cost of these future states was calcultated. The total amount of orders and the procurement cost is kept constant. Scenario 1: lower supply risk for Mechanical When procurement efforts in Mechanical are increased by 25%, the total purchasing cost decreases with 11%. To do so, the non-critical commodities gave up an equal amount of procurement resources.

Scenario 2&3: lower cost and price for Services When the price of services is lowered by 50%, the total purchasing price decreases by 10%. When the amount of contract buys increases by 50%, the purchasing price decreases by 12%. Scenario 4: Short term sourcing for bottlenecks Procurement efforts on bottleneck commodities have been freed up, and invested in the Mechanical commodity. When the mechanical commodity has up to 25% more contract buys, the total purchasing cost decreases by 6%.

V. CONCLUSION As no model could be found that was adequate to use for supply management improvement at procurement service providers, a new framework was constructed. It borrows from Kraljic portfolio matrix and the MSU purchasing model. A case study at a Belgian procurement service provider shows that the framework can point out several objectives for supply management improvement. A few scenarios were simulated, and their future state costs were calculated. The decrease in cost proves that the model can be a tool to show which objectives to set within the development of a commodity strategy.

REFERENCES

[1] Brigitte Faber, Nico Lamers, and Reinder Pieters. Models for decision making in purchasing: Kraljic versus Monczka. International symposium on logistics and industrial informatics, 2007. [2] Peter Kraljic. Purchasing must become supply management. Harvard Business Review, 1983. [3] NEVI. De basis: het msu-model. www.purchasingexcellence.nl [4] Robert Monczka, Robert Trent, and Robert Handfield. Purchasing and supply chain management. South-Western, 2002. [5] Robert Monczka, Kennet Peterson, Robert Handfield, and Gary Ragatz. Determinants of successful vs. non-strategic supplier alliances. Decision Science Journal, 29(3), 1998. [6] Douglas Perkins and Angappa Gunasekaran. Improving the effectiveness of purchasing in a small company. Production planning and control, 1998.

Contents

1 Introduction 1

1.1 Research goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1.2 Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

2 GIS Europe 3

2.1 Core business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

2.2 History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

2.3 Company structure and staff . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

3 Theoretical background and best practices 7

3.1 Supply management, purchasing and procurement . . . . . . . . . . . . . . . 7

3.2 Purchasing in small enterprises . . . . . . . . . . . . . . . . . . . . . . . . . 11

3.3 Kraljic Portfolio model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

3.4 Michigan State University purchasing model . . . . . . . . . . . . . . . . . . 17

3.4.1 In- and outsourcing . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

3.4.2 Commodity strategy development . . . . . . . . . . . . . . . . . . . . 19

3.4.3 Supplier management . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

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3.4.4 Strategic cost management . . . . . . . . . . . . . . . . . . . . . . . . 28

3.4.5 Globalization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

3.4.6 Measurements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

3.4.7 Human Resource Management . . . . . . . . . . . . . . . . . . . . . . 38

3.5 Case studies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

4 Model development 42

4.1 Goal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

4.2 Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

4.3 Evaluation of Kraljic’ portfolio model . . . . . . . . . . . . . . . . . . . . . . 43

4.4 Evaluation of the MSU model . . . . . . . . . . . . . . . . . . . . . . . . . . 44

4.4.1 Assessment of a PSP . . . . . . . . . . . . . . . . . . . . . . . . . . . 44

4.4.2 Review of the model . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

4.5 Commodity strategy development framework . . . . . . . . . . . . . . . . . . 53

4.5.1 Construction of a development cycle . . . . . . . . . . . . . . . . . . 53

4.5.2 Define objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

4.5.3 Define the commodity . . . . . . . . . . . . . . . . . . . . . . . . . . 55

4.5.4 Develop a strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57

4.5.5 Execution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

5 Model evaluation 64

5.1 Total cost of ownership tool . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

5.2 Procurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

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5.2.1 Proces flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

5.2.2 Cost factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

5.3 Purchasing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

5.3.1 Proces flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

5.3.2 Cost factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

5.4 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

6 Case study 76

6.1 Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

6.2 Current state . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

6.2.1 Procurement cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

6.2.2 Purchasing cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

6.2.3 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

6.3 Future state . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

6.3.1 Commodity classification . . . . . . . . . . . . . . . . . . . . . . . . . 85

6.3.2 Set objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

6.3.3 Determine key performance areas . . . . . . . . . . . . . . . . . . . . 88

6.3.4 Set goals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89

6.4 Discussion of the results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94

7 Conclusion 97

A MSU scorecards 99

B Pairwise comparison of key performance areas 114

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C Case study data 115

Bibliography 118

List of figures 124

List of tables 126

ix

List of abbreviations and symbols

BOM: Bill of materials

EBIT: Earnings before interest and taxes

MRO: Maintenance, repair and overhaul

MSU: Michigan State University

NEVI: Nederlandse Vereniging voor Inkoopmanagement

NPD: New Product Development

ORP: Order realization process

PSP: Procurement service provider

RFQ: Request for quote

SME: Small and medium enterprise

TCO: Total Cost of Ownership

x

Chapter 1

Introduction

1.1 Research goals

GIS Europe is a procurement service provider (PSP) with the ambition to become the ref-

erence in the outsourcing of non-strategic goods and services.

To increase its productivity, it wishes to improve the supply management aspect of its

operations. Through literature review, best practices should be gathered and the most im-

portant factors in supply management distinguished. These findings should be interpreted

from the perspective of PSPs.

The goal of this thesis is to develop a framework that will contribute to the improvement

of supply management at procurement service providers. The focus will be on commodity

strategy development, as this is the key process that ties the other processes together. The

framework should be qualitative in nature, and be the foundation of future research.

1.2 Method

Conducting a thorough literature review is the first step of this research. Because of the

large scope and nature of the research subject, the literature review is of great importance.

1

Not only will it serve as a guide throughout this thesis, it should be seen as a desk book, in

which the finest research and best practices are gathered. The two most important models

are discussed. Also, because the improvement of supply management is a matter of many

stand-alone aspects, the processes that are a part of procurement are reviewed individually.

The influence of being a small enterprise is also investigated.

What follows in the second step is the review of a series of case studies, in which the

improvement of purchasing functions is handled. The third step is the development of

the framework, which is a qualitative model with commodity strategy development at the

center. The Ghent-based company GIS Europe is used as the reference procurement service

provider. A case study will be performed based on their supply management data.

An introduction to GIS is given in the following section.

2

Chapter 2

GIS Europe

2.1 Core business

The Ghent based company GIS Europe manages its clients’ procurement of non-strategic

industrial goods, non-product related industrial goods and services, and mro goods. These

goods are of little strategic value to GIS’ clients, however, the total cost of the procurement

can be significant (see section 3.4.4). GIS provides companies with a solution, by letting

them outsource this part of their purchasing portfolio and supply management. Their

current mission statement has been written down:

To be the recognized reference for Integrated Supply in Europe by 2011.

GIS offers its clients several, custom solutions. Clients can choose in how far they want

to outsource their procurement. The entire spectrum of the procurement process can be

managed by GIS, ranging from invoice handling to an integrated supply approach. As their

main value adding activity is sourcing, GIS wishes to move its services to the integrated

solutions. Their vision statement:

Customer satisfaction is the main reason of GIS Europe’s existence. We will

achieve this by being the first tier industrial service provider (supplier) in In-

3

tegrated Supply for mro and non-core spend. This objective will be reached

through Sourcing, Purchasing and Logistics expertise of our teams. They con-

tinuously will investigate every opportunity, path or process that will positively

impact our mutual goal, to be world class competitors.

2.2 History

While working at Alcatel and Siemens, founder Marc Benmeridja conceived the idea of GIS

Europe. As project engineer, working closely with the purchasing departments of these

multinational companies, the need for strategic suppliers of non-strategic goods became

apparent. In 1997 he founded GIS. At the time, Marc Benmeridja and his wife were the

only two staff members. Late 2009, the company had 45 people on its payroll.

As their client base became more international, the company started to expand abroad.

With Philips as one their clients, GIS seized the opportunity to establish a Dutch office

at Breda in 1998. In the following five years, GIS expanded with five more offices across

Western Europe, each of them founded to make the most of local client opportunities. A

list of all offices is presented below:

• Belgium (1997)

• The Netherlands (1998)

• Germany and France (2000)

• United Kingdom (2001)

• Italy and Spain (2003)

Today, its client base contains some major clients such as 3M, Alcatel, Alstom, Aerospace,

Boeralis, Bosch, Oce, Philips and Siemens.

4

Integrated supply wasn’t always GIS Europe’s preferred business. In its thirteen years of

existence, the business model has changed to facilitate value creation through sourcing. At

the foundation in 1997, GIS Europe’s main focus was the reduction of its clients’ transac-

tion costs. It handled the purchasing and invoicing of its clients. By bundling all those

invoices into one invoice for the client, transaction costs were reduced, creating value for its

customers. The investment in Navision (2000), an ERP system, allowed the company to

organize its suppliers and product database. Orders and volumes were bundled, resulting in

lower prices. The main focus shifted from transaction costs to the leveraging of commodi-

ties. In 2004, sourcing was introduced. By actively tracking down new, potential suppliers

and setting up partnerships, GIS hopes to create even more value for its customers. Pre-

vious services weren’t abolished, though. However, sourcing should now steer purchasing

and leveraging efforts. It is even offered as a stand-alone service.

2.3 Company structure and staff

As an expanding organization, the company structure can not remain the same as it was

at its foundation. Management has drawn a new structure to facilitate GIS’ functioning in

its desired, future state (figure 2.1).

To improve decision making speed, the organization has been split up vertically into three

levels. The decision making happens in the top level, the executive comite, which will

function as a board of directors. Marc Benmeridja will still take the final decision, though.

Horizontally, it should be noted that sourcing and operations are drawn apart. They are,

or at least should be, two different processes with limited linkage.

5

Figure 2.1: planned company structure, a work in progress

6

Chapter 3

Theoretical background and best

practices

3.1 Supply management, purchasing and procurement

In a first phase of this literature review, the focus is put on the two major aspects of the

research subject: supply management and procurement. To define both terms, a closer

look at the supply chain is required.

External suppliers have gained significantly in importance in the past decade. Finding up to

fifty percent in turnover spent on supply is not unusual [43]. Hence, organizations find they

must be involved in the management of all upstream firms that provide direct and indirect

inputs. They must also be concerned with the network of downstream firms responsible for

delivery and after-market service of the product to the end customer. From this realization

emerged the concept of the supply chain. Handfield and Nichols define supply chain and

its management [22]:

The supply chain encompasses all activities associated with the flow and trans-

formation of goods from the raw materials stage (extraction), through to end

users, as well as the associated information flows. Material and information

7

flows both up and down the supply chain. [...] Supply chains are essentially a

series of linked suppliers and customers; every customer is in turn a supplier

to the next downstream organization until a finished product reaches the ulti-

mate end user. Supply chain management is the integration of these activities

through improved supply chain relationships to achieve a sustainable competi-

tive advantage.

As mentioned, a difference can be made between the upstream and downstream activities

of a company. A similar distinction can be made in the management of the supply chain.

Upstream activities can be put under the banner of Materials management. It focuses on

the coordination of goods, services, and information from suppliers through operations.

Physical distribution management focuses on the downstream activities, i.e. the coordina-

tion of goods, services, and information from operations through end user. Both aspects

can be seen in table 3.1, including examples of activities.

Supply management excludes the downstream network from supply chain management. In

other words, it can be seen as the part of supply chain management that focuses on the

management of inbound goods and services into a firm [39]. It’s important to situate pur-

chasing and procurement within this context. These terms are often used interchangeably

with supply management. In the traditional sense, there is a significant difference in that

purchasing only reflects the acquisition, while procurement implies more elements of the

supply chain such as logistics. This makes procurement a more strategic function, whereas

purchasing is still more transactional. With this in mind, what Monczka et al. define as

tactical purchasing can be seen as purchasing, whereas strategic sourcing can be seen as

procurement [39]. Thus, purchasing can been defined as follows:

Purchasing refers to the day-to-day management of material flows and informa-

tion, without long-term horizon.

Their definition of procurement has a broader scope :

8

Table

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9

It aims to manage, develop and integrate with supplier capabilities to achieve

a competitive advantage.

Expanding on procurement, lean procurement has been conceived. Just like lean manufac-

turing, lean procurement can be seen as a philosophy, techniques, or methodology. Unlike

traditional purchasing systems where price considerations dominate, suppliers are evaluated

and selected on a combination of factors such as: quality, reliability, culture, behaviours,

delivery performance as well as price [15]. The relationship between buyer and supplier is

based on a long-term orientation and requires trust and commitment [40], with the buyer

helping their suppliers adress some of the their operational problems. Ultimately, it boils

down to smaller lot sizes at higher delivery frequencies, and based on a total cost of own-

ership approach [33], ofcourse striving towards a reduction thereof.

Lean manufacturing is a necessary antecedent to lean procurement [26]. As PSPs don’t have

their own production facilities, nor exclusively integrated supply programs, lean procure-

ment should be carefully considered. Also, lean procurement demands geographic proximity

with suppliers to reach the high performance levels.

10

3.2 Purchasing in small enterprises

The Flemish government defines an SME as an enterprise [59]

• with less than 250 employees,

• with a revenue that doesn’t exceed 40 million euro, or with less than 27 million in

assets,

• and who follows the independence criterium.

Within the scope of this thesis, being a small or medium enterprise transcends this legal

definition and its fiscal implications. As Kraljic has demonstrated, the size of a company

is in the eye of the beholder and a nuanced approach to strategy development is required

(see section 3.3).

Purchasing has been explored quite extensively. However, the majority of the articles and

methodologies on purchasing, such as the MSU purchasing model, are conceptual and relate

to large companies [43]. Whether these techniques are suitable for SMEs is questionable.

Zheng et al. [64] state that the limited purchasing power results in a fragmented approach

and little strategy in SME’s purchasing approach. Perking and Gunasekaran have learned

some lessons from their research at SMEs [43]:

• A mechanism for operators to communicate to higher levels is essential

• The implementation of a new purchasing strategy in SMEs should start with schedule

stability and the development of long-term supplier-customer relationships

• Customer-supplier relationships should be exploited to the maximum

• New purchasing strategies and methods supporting frequent purchases of small lot

sizes will help SMEs

11

• Simplifying operations, JIT purchasing, reducing WIP, inventory change manage-

ment and understanding organizational change play a key role in improving the pro-

ductivity of SMEs.

Whereas Perkings and Gunasekaran put JIT purchasing forward, JIT and other lean pro-

curement measures only suit a specific set of preconditions, not easily met by SMEs [47]. A

literature study on the benefits and criticisms on SME lean procurement has been done by

Wilson and Roy and is summarized in table 3.2. Futher comments and literature on SMEs

will be integrated in the rest of this literature review. It’s important to note that GIS does

not strive towards lean procurement. While their goal is an expansion in integrated supply

activities, GIS mostly procures to order, making lean procurement very difficult.

12

Table 3.2: Benefits and criticisms of lean procurement for SMEs [62]

Benefits Criticisms

Inventory reduction Dangerously under buffered supply chains

Quality improvements Too narrow focus on order fulfilment activi-

ties

Reduction in material procurement cycle

time

Lack of bargaining power with larger suppli-

ers

Smaller batch/lot sizes Usually procurement is the last function to

be implemented

More reliable delivery Lack of managerial time and attention

Long-term supplier relationships and the de-

velopment of trust and commitment

Lack of resources for ICT integration into

supply chain coordination systems

Improvement in employee skills, job scope

and morale

Shifting costs back onto the supplier base

No scale in lean procurement training

13

3.3 Kraljic Portfolio model

Two procurement models have become popular: the portfolio method of Kraljic and the

Michigan State University purchasing model. While the former receives more attention in

Europe, American purchasers seem to rely more on Monczka’s MSU model [18]. In this

section and the next, both models will be explained.

Kraljic’ portfolio method should give companies a simple but effective framework for col-

lecting marketing and corporate data, forecasting future supply scenarios, and identifying

available purchasing options as well as for developing individual supply strategies for crit-

ical items and material. It’s a four staged approach to devise strategies, by which supply

vulnerability gets minmized and the most is made out of the potential buying power [28]:

1. Classification

2. Market analysis

3. Strategic positioning

4. Action plans

Phase 1: Classification

The first stage consist of the company assessing every purchased product. Each purchased

product is put in a two-by-two matrix, based on two criteria: profit impact, and supply

risk (see figure 3.1). The four quadrants of the matrix represent product categories, each

suggesting a different supply approach (see table 3.3).

Phase 2: Market analysis

In the second phase, the company has to determine its bargaining strength against that

of its suppliers. Ten supplier and buyer strengths to make the assessment, are given by

Kraljic [28].

14

Table

3.3:

Su

pp

lym

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emen

tap

pro

ach

esof

the

fou

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es

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pplier

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iple

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l

glob

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tly

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ith

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centr

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ated

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ed

15

Figure 3.1: Kraljic’s classification matrix

Phase 3 & 4: Strategic positioning and action plans

The products that were identified as strategic in phase 1, are given one of three different

strategies, based on the company’s strength in relation to the supplier’s strength. To do

so, Kraljic constructs a three-by-three matrix. If the buyer strength exceeds the supplier

strength, the company should exploit the relationship and use a more agressive approach.

When the supplier is stronger, the buyer should diversify. In this case, the buyer should

start looking for other products or suppliers. When neither has the upper-hand, a balanced

strategy is suggested.

The final step consists of making action plans. However, Kraljic limits these plans only to

the strategic items.

16

3.4 Michigan State University purchasing model

The Michigan State University Purchasing Model (MSU model) is end-result of the Global

Procurement and Supply Chain Benchmarking initiative, launched in 1993. After an analy-

sis of both quantitative and qualitative data of circa 150 companies, an internal framework

was set up. It describes the route to ”Purchasing Excellence“. The framework distinguishes

eight key strategic purchasing processes and six enabling processes. The model includes a

self-assessment tool. The scorecards have been added to the appendix. Companies can

give themselves a rating on each of the fourteen processes, based on qualitative criteria.

To receive a higher score, the company has to comply with all criteria of the lower grades.

The strategic processes are:

• Incoursing/Outsourcing

• Commodity strategy development

• Supply base optimization and management

• Supplier partnerships

• Supplier integration in product creation process

• Supplier integration in order realization process

• Supplier development and quality management

• Strategic cost management

The enablers are:

• Strategies and plans

• Organization and teaming strategies

• Globalization

17

• Measurements

• IS/IT systems

• Human resource management

In the following sections, each process is reviewed deeper.

3.4.1 In- and outsourcing

The in- and outsourcing proces concerns the make or buy decision. A company must decide

whether it decides to provide for a product, service or process itself (insourcing) or whether

it wants to have it handled by and purchased from an outside company (outsourcing) [5].

Through outsourcing, companies can benefit greatly from accessing the specialist capabil-

ities of suppliers. The decision between in- or outsourcing may not be taken lightly, as

also insourcing implies costs, not unlike outsourcing. When a company want to produce

internally on a long-term basis, they must back up their decision with continuing R&D,

personell development, and infrastructure investments that match those of the best external

suppliers [49].

The process of the make-or-buy decision has been discusses by Platts [46]. It consists of

three phases: (1) project team selection and specification of what product or activity to

consider for sourcing, (2) data collection in all areas of the company that attribute to the

total cost of the product, and (3) analysis resulting in one figure, concluding whether a

company should make or buy. Other descriptions of the decision process are similar, em-

phasizing the strategic alignment and core competencies, when deciding which products to

consider for outsourcing [39]. Even though many companies still make outsourcing decisions

on an ad hoc basis [21], practical methodologies are available. McIvor suggests different

sourcing strategies [35]. The choice should be based on two variables: the contribution of

the process to competitive advantage, and the relative capability position in the process.

18

3.4.2 Commodity strategy development

A commodity strategy is a plan for every product group or commodity in the company.

It consists of goals, for both short- and long-term strategies. Purchasing policy, supply

base structuring, process structuring and sourcing are amongst the elements that should

be taken into consideration when constructing an executable plan or strategy. By combing

these elements optimally for each commodity, an appropriate strategy can be designed [42].

Alignment is a keyword in this process. Procurement strategies must be aligned with the

higher-level business strategy and require a good internal and external understanding [42].

Commodity strategy development relies heavily on strategy and plan development. Mon-

czka describes a strategy hierarchy, in which the commodity strategies are at the lowest

level [39]. Mission and vision translate directly into corporate strategic planning, the top

level. These strategies are concerned with the definition of business in which the corpo-

ration wishes to participate and the acquisition and the allocation of resources. It should

conceptualize long-term objectives, the purpose of the organization, constraints.

Through business unit strategies and purchasing strategies, the corporate strategic objec-

tives are cascaded onto the commodity strategies. These strategies specify how the respon-

sible commodity team will achieve the goals set at higher levels. The purchasing goals serve

as the driver for detailed commodity strategies-specific action plans that detail how goals

are achieved through relationships with suppliers. One should note that there’s a significant

difference between objectives and goals. These differ on four dimensions: (1) time frame,

(2) measurement, (3) specificity, and (4) focus. While objectives are usually stated in

qualitative terms, goals are more quantitative. Thus, the commodity strategy goals should

be a specific, quantifiable, measurable, and focused translation of the corporate strategy

objectives [39].

The definition of commodity strategy development [42] demonstrates the versatility of com-

modity strategy development. It blends multiple processes defined by the MSU model into

a policy or strategy. Case studies have shown that up to ten processes of the MSU model

are influenced by improvements in commodity strategy development (section 3.5). How-

19

ever, this dependency on other processes’ research might be the reason why little research

is aimed at the development of commodity strategies.

3.4.3 Supplier management

Supply base optimization and management

Supply base optimization deals with the determination of the correct type and number

of suppliers. To ensure that risks are minimal and opportunities maximized, structuring

the supply base is vital [42]. To underline the importance of a small supply base, Ansari

and Modarress claim that the ideal number of suppliers for a product is one [4]. As the

above definition already implies, the two main elements in supply base management are

to determine which suppliers are added to the supply base and which have to improve

or leave the supply base. In other words, supplier selection and supplier evaluation are

crucial in supply base management. Ellram advocates the use of a single model for both

supplier selection and evaluation [16]. Suppliers should be evaluated on the same criteria

as those used for their selection, unless priorities have shifted. If not, the selection model

is looking at the wrong things. Regardless of the type of supplier selection and evaluation

system currently used in the firm, the systems should be linked, using the same criteria

and consistent rating scheme. This offers several advantages:

• Provides focus and consistent communication with the suppliers

• Less work, confusion and lower training requirements

• The model outcome can be used in the qualification process, possibly aligning all of

the firm’s supplier measurement tools.

The overall objective of the supplier evaluation process is to reduce purchase risk and max-

imize overall value to the purchaser. As seen previously and demonstrated by Kraljic, the

degree of effort associated with the selection is related to the importance of the commod-

ity or products in the portfolio matrix. Of over twenty identified supplier characteristics,

20

Dickson put forward cost, quality, and delivery performance as the three most important

in supplier selection [9]. Anderson et al. added a fourth characteristic to that list of most

important factors: flexibility [3]. Rarely, a supplier can excel in all four. Therefore, the

buying company has to make a trade-off.

From an extensive literature review, Weber could conclude that the buying company per-

ceives quality as most important [61]. However, emperical results suggest that the actual

choice of supplier doesn’t match the perceived importance of quality. While they perceive

quality as the most importance characteristic, buyers tend to assign more weight to cost

and delivery performance [60].

There is plenty of supplier selection literature to be found. Most concerns conceptual and

empirical work, and decision support methods. An example of a support method is Wu’s

integrated multi-objective decision-making process in volume bundling cases [63]. Through

analytic network process and mixed integer programming, the number of suppliers and

amount of purchased goods can be optimized in cases of volume bundling.

Monczka confirms the importance of cost, delivery and quality in supplier selection. How-

ever, his complete lists of traits considers eleven elements, which should be weighed accord-

ing to the product type [39]:

• Supplier management capability

• Overall personnel capabilities

• Cost structure

• Total quality performance, systems, and philosophy

• Process and technological capability, including the supplier’s design capability

• Environmental regulation compliance

• Financial capability and stability

• Production scheduling and control systems, including supplier delivery performance

21

• Information systems capability (ERP, bar coding, CAD/CAM)

• Supplier purchasing strategies, policies, and techniques

• Longer-term relationship potential

After the initial evaluation and choice of supplier, a continuous supplier measurement sys-

tem should be put in place. Monczka suggests that the three basic selection criteria should

suffice. Again, measurement can be both quantitative and qualitative. Measurement should

be executed frequently, and put to use accordingly, to assess whether the supplying com-

pany can fulfill the buyer’s current and future needs. One of the most efficient ways to

address supplier development is through the measurements in supplier evaluation. Perfor-

mance improvement is the main reason for supplier development programmes. Even though

there are quite some methods for supplier developments, many are unsuccesful [29]. It is

considers a catalyst for all supplier development programmes, as it shows the different.

Supplier partnerships and trust

Buyer-supplier relationships have extensively been studied. However, only in rare occasions

are these studies conducted from the perspective of an SME [41]. SMEs use different ways

to manage their supply and purchasing relations, and therefor should be treated differently

[45]. Most smes don’t try to engage in co-operative arrangements. They still use an

adverserial business model. This often yields a lower purchasing price, but it assumes that

there are no differences in suppliers’ other vallue adding activities. Those that do try don’t

succeed very well. They continue to apply adversarial engagements in stead of cooperation

[41, 54]. Based on their purchasing strategies and behaviour, Mudambi distinguishes three

types of companies trying to engage in cooperative purchasing, confirming previous research

by Sako: those that use deliberate strategies, those that use emergent strategies, and those

that use close but adversarial strategies. Each deals differently with cooperation, which he

accredits with six dimensions (table 3.4). Based on their strategies towards suppliers, all

three types of companies are able to perform succesful purchasing. This is probably an sme

22

trait, and thus cannot be maintained as companies grow to certain sizes. In those cases,

they have to move away from the emergent category towards either deliberate or adversial,

emulating larger firms’ strategically managed supply (the low- or high trust route).

It is necessary to classify the suppliers in a number of categories to focus attention on

the most important suppliers, to set the right priorities and to manage every supplier

according to his importance [42]. The msu model focusses on partnerships. Collaborations

or partnerships are defined by Spekman [54]:

Collaboration is the process by which partners adopt a high level of purposeful

cooperation to maintain trading relationship over time.

To start a cooperation a definition of shared interest, an estimation of potential benefits,

and specifications for the sharing of these benefits are required. This means potential part-

ners should specify and quantify the benefits of cooperations, and they must understand the

incentives for their potential partners to behave opportunistically and the cost associated

with such behaviour [41]. One study defines the attributes that were found significantly

related to the succesful outcome to a partnership: trust and coordination, interdependence,

information quality and participation, information sharing, joint problem solving, avoiding

the use of severe conflict resolution tactics, and the existence of a formal supplier/commod-

ity alliance selection proces [38]. The most important factor on this list is trust. The same

research has shown that formally commited time and money do not contribute to success.

Because SMEs are smaller, they generally use more flexible forms of bureacracy and man-

agerial control. This makes communication systems and adaptive relationships with sup-

pliers much easier to establish [20].

To select a strategic partner, Spekman suggests two analysis phases [54]. In the first phase,

present and new suppliers are analyzed using traditional approaches. These generally use

traditional measures, such as quality, price and delivery. These measures are important,

and determine whether a company is at least competent and a strong competitor. However,

they do not cover all the issues upon which a long-term partnership should be decided.

23

Table

3.4:SME

sm

eth

od

sof

dea

lin

gw

ith

Typ

esof

firm

s

Dim

ensi

ons

ofco

oper

atio

nD

elib

erat

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trat

egie

sE

mer

gent

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ateg

ies

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seb

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rate

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and

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tal

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ge

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tner

ship

s’j

ust

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pen

’,

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tar

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ng

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trac

tual

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ds;

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ort-

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s

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rove

dco

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lar

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shop

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lem

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tact

lim

ited

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-

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;co

nce

rns

abou

t

con

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enti

alit

y

JIT

pro

cess

es:

Kit

tin

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ero

stock

s;S

hip

-

to-l

ine

Cal

l-off

agai

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bla

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tor

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der

s;15

-day

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y

Sto

ckh

old

ing

for

bu

yer

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le’

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nt

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atsu

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lier

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tes

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asio

nal

sugg

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ons

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e

Cos

tre

du

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ject

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lar,

bu

yer-

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asse

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ent;

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men

t

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gula

r,p

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orie

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d;

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ay-

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t

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ouse

imp

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t

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;u

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pay

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r

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rall

imp

lem

enta

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ips:

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hm

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n;

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ut-

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e

24

In a second phase, strategic partners are chosen. However, criteria required for the as-

sessment are hardly quantifiable. Spekman suggests some questions that can be asked.

In addition, most questions cannot be answered by the buyer company alone. The list is

non-exhaustive:

• Has the supplier signaled a commitment to a relationship and a willingness to allocate

resources such as time, people, and money?

• Does the supplier understand the level of commitment required to achieve long term

performance gains?

• Can the supplier’s capabilities grow along with the buying company’s capabilities?

• Does the supplier have up-to-date technical ability and innovative products and pro-

cesses?

• Is senior management willing to commit to a longer-term relationship

• Will the supplier share information about future product and technology plans?

• How much of the supplier’s business will be committed to the purchaser’s require-

ments?

• What is the financial condition of the supplier?

• Is the supplier honest and trustworthy?

• How well does the supplier know the purchaser’s industry and requirements?

Kraljic has explained that volume and strategic importance are key factors within relation-

ship development [28]. Mudambi et al. [41] state that besides those two, mere company

sizes also matter. Inequal sizes of buyer and seller is a determining factor in cooperation.

The larger company will define the relationship and dictate the amount of cooperation with

the smaller partner. When the acquired volumes are considered low, the sme is considered

25

unimportant and will receive lower attention or priority. Studies indicate that largers com-

panies require for their clients and suppliers to act cooperatively [10]. Hence, SMEs will

increasingly be confronted with skewed partnerships. In such asymmetric relationships, and

especially as a buyer, trust can offer the smaller company an alternative for managing its

relations [64]. The presence of trust has been shown to attribute significantly to purchasing

cooperation [34]. Sako defines trust between a buyer and its supplier [51]:

Trust is an expectation held by an agent that its trading partner will behave in

a mutually acceptable manner (including an expectation that neither party will

exploit the other’s vulnerabilities). This expectation narrows the set of possible

actions, thus reducing the uncertainty surrounding the partner’s actions.

When a company is perceived as trustworthy, ie. has a good reputation, it will improve

business [51]. Other conditions to facilitate trust include technical assistance, information

exchange, and long term commitment. Commitment can be defined as the supplier’s per-

ception of the degree to which the buying company feels obliged to continue business with

its partner. Anderson and Weitz showed that the buying firm’s commitment positively

influenced the supplier’s commitment [2]. Commitment has three components: the expec-

tation of the partnership extending into the future, investment in the partner, and affective

commitment. Cousins argues that there is no clear line between trusting another company

and risk management [8]. When the market provides easy access to alternatives, companies

should give careful consideration to safeguards against opportunistic and non-trustworthy

behaviour [51].

Research has shown that the supplier’s perception of the buyer’s communication does not

influence the supplier’s performance directly [48]. Also, unless the supplier is committed,

evaluation communication does not ensure improve supplier performance. However, the

type of communication does influence the supplier’s perception of the evaluation commu-

nication. When the buyer uses collaborative communication, the supplier perceives it as

having a positive influence on the relationship, increasing commitment. This is confirmed

by Monczka et al. [37]. Both the depth and width (i.e. quality) of the communicated

26

information (i.e. sharing) is important.

Supplier integration

Supplier integration serves two purposes according to the MSU model: the product creation

process and the order realisation process. Integrating suppliers into the order realization

process comprises the series of transformation actions to simplify, standardize and synchro-

nize the operational processes [42]. The product creation process, also called new product

development, is defined by Handfield et al. [23] as:

a series of interdependent and often overlapping stages during which a new

product (or process or service) is brought from the idea stage to readiness for

full-scale production or service delivery.

The process consists of five stages and is depicted in figure 3.2. Concept development and

engineering and design might be responsible for a small portion of the development costs,

they are responsible for as much as eighty percent of the product’s total cost. Supplier

participation and integration at any point in the new product development process can

help lower the costs, reduce development time, improve quality, and provide innovative

technologies.

Based on a series of case studies, Handfield et al. have developed a model for supplier inte-

gration (figure 3.3). The first consists step consists of the make- or buy decision. Handfield

confirms that this step should involve purchasing divisions, next to the product designers,

on the component level. They are responsible for identifying potential suppliers (see section

Figure 3.2: The new product development process

27

3.4.1).

What follows are two risk assessment steps, similar to Spekman’s approach to strategic

partner selection. The first risk assessment makes use of more traditional measurements,

such as cost and quality, to determine whether the supplier is capable of integration. The

second assessment ensures the short- and long-term alignment of the objectives and tech-

nology plans of supplier and customer. However, if the supplier has a good reputation or

history, the first assessment can be skipped. Several research papers supports this decision.

It’s known that when suppliers have a positive history or a proven track record, it will have

positive impact on the integration effort [30, 44]. Dyer and Ouchi suggest that the length

of the relationships will also positively impact the effort [11].

Handfield’s model doesn’t suggest how to integrate the chosen suppliers. Literature sug-

gests that the biggest differentiator for successful integration is supplier membership in

new product development project teams [50]. Also shared education and training makes

a significant impact. To overcome the barriers to integration, relationship structuring is

vital.

3.4.4 Strategic cost management

The final strategic process, strategic cost management, includes the identification of all

costs, their drivers, and the strategies to reduce them throughout the supply chain. There

is a distinct difference between cost and price. Price only considers the trading cost of

acquisition, and is only one of many costs that atribute to the total financial effort the

buying company must make to acquire and process the product or service. In general,

there are three types of costs: fixed costs, variable costs, and semivariable costs, which

have both a fixed and a variable component. Another way of classifying costs is by their

origin. Based on the origin, there are two types of costs: direct and indirect costs [52].

The most distinct concept to decompose and analyze all costs associated with a product

or commodity is Total Cost of Ownership (tco). Ellram is a prominent researcher in this

area. She defines tco [14]:

28

Figure 3.3: Process model for reaching concensus on suppliers to integrate into NPD [23]

29

Total cost of ownership represents an innovative philosophy aimed at developing

an understanding of the ”true cost” of doing business with a particular supplier

for a particular good or service.

She claims that tco is a part of a larger group of cost-driven methods, such as all-in-costs,

life cycle costing, cost-based supplier performance evaluation, and the total cost concept. As

far as cost management is concerned, this thesis only considers the total cost of ownership

approach. Monczka offers a similar definition for tco [39]:

The total cost of ownership is the sum of all expenses and costs associated with

the purchase and use of equipment, materials, and services. So this extends the

total cost approach beyond price, transportation, and tooling

Construction

When constructing the mathematic model to determine the tco of a product, commodity,

or service, it is of vital importance to include the right variables into the equation. Within

the procurement process, Ellram was able to distinguish six categories, to which all possible

costs (variables) belong: management, delivery, service, communications, price, and quality

[17]. Another category system was designed by Ferrin and Plank [19]. They devided 135

possible cost drivers into thirteen categories: operations costs, quality, logistics, technolog-

ical advantage, supplier reliability and capability, maintenance, inventory cost, transaction

cost, life cycle, initial price, customer-related, opportunity cost, and miscellaneous costs.

When designing the model, a specific product or process must be kept in mind. Despite

advantages such as ease of use and a lower development time, the application or flexibility

of one general model for multiple productgroups has its limits [14, 19]. As not all variables

remain applicable for a wide range of products, the accuracy of the model reduces. However,

some variables should be present for every commodity. This allows for a modular approach,

in which those variables form the core.

30

Application

From a series of case studies, Ellram was able to distinguish improvements in five tco

areas: supplier performance measurement, purchasing decision making, internal and exter-

nal communications, insight and understanding into purchased goods/services and supplier

performance, and support of the firm’s continuous improvement efforts [16]. So, besides

its use for process re-engineering, the tco model can be used to enhance supplier selection

and supplier evaluation. Ellram concludes that there are definite commonalities between

the selection- and evaluation-tco-models she has encountered during the case studies. As

mentioned previously, these two processes are closely related and their models should be

linked. Total cost of ownership models designed for evaluation should integrate selection

and vice versa. Ellram states that more research is required in the linkage of these two

processes in one model.

3.4.5 Globalization

The process of globalization is the organization of purchasing activities at world, regional

and local level in order to maximize the global sourcing opportunities and to meet the

business objectives [42]. Global procurement is an area where companies can begin to reap

the benefits of globalization [57]. As the selection pool becomes bigger, companies can start

applying higher standards. Lower prices, higher quality, access to worldwide technology, and

better service are named amongst the advantages [53]. Downsides are increased leadtimes

and uncertainty. It seems buyers understand the potential, as the supply from abroad rises.

Between the late 1980s and 2000, purchases from foreign sources have increased from nine

percent up to more than thirty percent [39].

International procurement can go different lengths in different companies. Trent and Mon-

czka propose five international procurement levels [56]:

• Level 1: Engage in domestic purchasing only

• Level 2: Engage in worldwide buying as needed

31

• Level 3: Worldwide buying as part of purchasing strategy

• Level 4: Regional and global coordination of worldwide purchasing strategies

• Level 5: Integration and coordination of global purchasing strategies with other func-

tional groups and processes

Purchase practices in levels 2 and 3 fall under the banner of International buying. The more

advanced practices of companies of levels 4 or 5 are called Global sourcing. Sophisticated

global sourcing (levels 4-5) is not for every company. The size of the firm plays a role.

The internal and external barriers to cross-border procurement are easier to overcome for

large companies. SMEs suffer from resource constraints related to the scarcity of resources

necessary to face the uncertainty and the risk involved when undertaking activities abroad

[1]. A small buying company active in regional markets probably does not have the need

or capability to pursue anything beyond basic international purchasing. Companies with a

single design and manufacturing facility won’t require a complex sourcing framework. For

those companies, reaching level 3 might be a more realistic option [39].

The need for high-level international procurement can be measured by four variables [39]:

• competitive forces

• customer requirements

• level of worldwide business activity

• and the location of the best suppliers for the specific purchase requirements

Monczka and Trent have identified a set of seven broad characteristics of outstanding global

sourcing, to which all globalization initiatives can be assigned [58]:

• Executive commitment to global sourcing

• Rigorous and well-defined processes

32

• Availability of needed resources, which would include capable personel, the highest

rated succes factor [57]

• Integration through information technology

• Supportive organizational design

• Structured approached to communication

• Methodologies for measuring savings

A 2009 study investigated the perceived importance and actual implementation in varying

companies [36]. Depending on their sourcing levels, companies prioritize on different factors

(table 3.5). Looking at the actual implementation, companies practicing international

buying (levels 2 and 3) are less advanced. Also, the gaps between perceived importance

and actual implementation is bigger at those companies. This suggests that companies

at levels 2 and 3, mostly smaller firms, should focus on closing the gaps to improve their

current sourcing practice first. However, as much as these companies differ in global sourcing

strategies, a study by Bozarth et al. [6] has shown that there is no significant difference

in on-going commodity strategy development between companies practicing international

buying and global sourcing.

33

Table

3.5:

Per

ceiv

edim

port

an

cean

dim

ple

men

tati

onof

glob

alp

rocu

rem

ent

char

acte

rist

ics

[36];

scale

:1=

low

est,

5=

hig

hes

t

Lev

els

2an

d3

Lev

els

4an

d5

Fac

tors

Per

ceiv

edIm

ple

men

tati

onP

erce

ived

Imple

men

tati

on

Exec

uti

veco

mm

itm

ent

togl

obal

sourc

ing:

2.93

2.77

3.97

3.62

Rig

orou

san

dw

ell-

defi

ned

pro

-

cess

es:

3.71

2.89

4.20

3.57

Ava

ilab

ilit

yof

nee

ded

reso

urc

es:

3.52

3.02

4.15

3.53

Inte

grat

ion

thro

ugh

info

rmat

ion

tech

nol

ogy:

2.80

2.49

3.91

3.30

Supp

orti

veor

ganis

atio

nal

des

ign:

2.87

2.41

3.65

3.37

Str

uct

ure

dap

pro

aches

toco

mm

u-

nic

atio

nan

dre

lati

onsh

ipbuildin

g

wit

hsu

ppli

ers:

3.65

3.33

4.16

3.86

Met

hodol

ogie

sfo

rm

easu

ring

sav-

ings

:

3.77

2.67

3.99

3.43

Extr

a:Q

ual

ified

per

sonnel

:4.

042.

954.

013.

53

34

3.4.6 Measurements

The goal of measurements is to support better decision making. It does so by providing

feedback, motivating and directing behavior. Historically, internal performance measure-

ments can first be found at large companies in the beginning of the nineteenth century.

Measurements were financially-oriented, such as the return on investment ratio. Litera-

ture criticizes the use of these accounting measures. They are too historical, encourage

short-term behavior and don’t align with the corporate strategy [32]. As a response, Ka-

plan and Norton suggested the balanced scorecards, which allows managers to look at their

business from four perspectives [25]: customer perspective, internal perspective, innovation

and learning perspective, and financial perspective.

Measurements such as Kaplan’s balanced scorecards put vision at the center. They set

goals, but do not wish to hold hands with the staff to reach those goals. It assumes that

people will adopt the necessary behavior to achieve the goals. Kaplan and Norton claim

that this approach is consistent with procurement initiatives, such as supplier integration

and globalization. The importance of vision is confirmed by Brown’s Strategic Measurement

Model [55]. Portrayed in figure 3.4, it clearly shows the basic rationale behind measure-

ments: they are derived from the company’s corporate strategy and the key success factors

(KPI’s) and should lead towards action.

Performance measurements, explicitely linked to purchasing and procurement, can be de-

vided into two categories: efficiency or effectiveness measures. Whereas efficiency refers to

the relationship between planned and used means to realise a goal, effectiveness refers to

the extent to which management can meet a previously established goal.

Monczka distinguishes eleven categories which most purchasing and supply chain measures

belong to [39]:

1. Price performance

2. Cost effectiveness

3. Purchasing workload

35

Figure 3.4: Brown’s strategic measurement model

36

4. Administration and control

5. General efficiency measures

6. Material status and control

7. Supplier performance

8. Supply chain performance

9. Strategic performance

10. Regulatory, societal, environmental measures

11. Purchasing planning and research

Categories 1, 2, 6, and 7 fall within the scope of commodity strategy development. Price

performance measures compare actual prices to those set in a plan, or to a market index.

Cost effectiveness measures are used to reduce purchasing costs and can be split into two

subcategories: cost changes (monitoring cost over time) and cost avoidance, looking at the

current cost compared to a potential higher cost. Material status and control measures

evaluate the flow from seller to buyer. Four subcategories can be distinguished: identifi-

cation of open purchase orders, identification of open purchase order, that are over-due,

identification of immediate manufacturing material requirements, and measurement of how

well suppliers are meeting delivery schedules.

A particular case of performance measurement is benchmarking. Camp defines benchmark-

ing [7]:

It is the continuous measuring of products, services, processes, activities, and

practices against a firm’s best competitors or those companies recognized as

industry or functional leaders. The information derived measurements is used

as a guide for establishing a company’s own objectives and goals towards best-

in-class performance

37

Camp distinguishes five phases in the benchmarking proces: (1) planning, (2) analysis,

including data and information collection, (3) integration, (4) action, and (5) maturity.

3.4.7 Human Resource Management

Human resource management can be defined as a workforce issue, focussing on five top-

ics: recruitment, training, performance appraisal, compensation, and knowledge transfer

and retention [42]. The importance of human resources have been amply demonstrated.

Kraljic names upgrades skills and experience of the staff a condition for the adaptation of

a purchasing strategy [28]. However, any changes in the staff should in no way disrupt the

close relationship between suppliers and the buyer. Therefore, no radical changes should

be made.

Procurement in SMEs is informal and reactive in nature [13]. Small enterprises are self-

educated purchasers, often without relevant education. This is the reason why many SMEs

aren’t able to take advantage of the known best practices.

From a series of casestudies conducted by nevi, researchers acknowledge the importance

of human resources management, calling it the most important enabling process from the

MSU model (see section 3.5). Professionalizing purchasing has bigger chances of success

in a organizational structure focused on commodities. The change towards world class will

require a trained staff.

The development of organization and teaming strategies can partly put under the banner of

human resource management. This process deals with the way in which the organizational

structure and teaming is able to achieve coordination and collaboration across the business

[42]. From case studies appears that matrix structured organizations require a greater

effort in communications and adressing change management. However, they are often

recommended as a way to integrate clients and suppliers, both internal and external [39].

The case studies concur with this research.

38

3.5 Case studies

In 2001, nevi, the Dutch society for purchasing mangement, launched the first of two

programs to assess and improve the purchasing abilities of Dutch companies. It focuses its

efforts around the msu model. The program, called Purchasing Excellence 1, comprises six

projects, executed in four phases:

1. Benchmarking (project 1)

2. Establish purchasing advantage, with the aid of external consultants and based on

the House of Purchasing and Supply (project 2)

3. Process improvement and the development of knowledge and competencies, with the

msu self-assessment at the center (project 3)

4. Communication and training to spread knowledge in the organization (projects 4, 5

and 6)

Changes throughout the firm were monitored and implemented in accordance with Kotter’s

eight-step model [27].

In project 1, 69 companies were benchmarked against A.T. Kearney’s database, using ques-

tionnaires and company visits [12]. When rated on the dimensions of A.T. Kearney’s House

of Purchasing and Supply, demonstrated in figure 3.5, the results show a significant gap

in test scores of about fifty percent against world leaders, taking into account purchasing

expenditures and the type of industry. The tested companies were aware of the best prac-

tices, but didn’t apply them adequately. It was estimated that these companies would miss

out on a ten percent reduction of purchasing expenditures and an ebit improvement of 21

percent.

It took the participating companies 2.1 years (stdev 1.2 year) to complete projects 2 or 3.

The savings in purchasing expenditure numbered ten percent in average, meeting the aver-

age expectations. One case in particular is worth giving a closer look. Its business model is

39

Figure 3.5: Important processes in A.T. Kearney’s House of Purchasing and Supply

similar to gis’. Similar to a PSP, they offer both integrated supply, taking over the entire

supply chain, and more limited services. Profit is gained by charging fixed margins on the

purchasing price. They are roughly the same size in terms of their puchasing budgets, and

are also rapidly expanding. Over a period of 1.5 years, they managed to decrease their

original purchasing expenditure of 23 milion euro with one milion.

Approximately four years after the start of project 1, nevi was able to make several con-

clusions:

Evaluation of Kotter’s model of change

The Kotter model has proven itself very useful as a tool to monitor the change. Gaps

were made obvious, which allowed for a more targeted approach. Throughout the program,

the creation of commitment has been vital. The authors advise the use of short-term

wins and the involvement of top management to create commitment throughout the entire

organisation. Also, setting quantitative goals is very important.

Evaluation of the MSU model as guideline

Besides being an excellent tool to trace specific aspects that need improvement, the msu-

model has proven itself to be a communications tool. It allowed purchasing staff and

managers to compare improvement initiatives and share best practices. The process of

40

commodity strategy development is just one of fourteen processes. However, the author

stresses that many of the other processes are merely sections of commodity strategy devel-

opment.

Best practices

First, commodity strategy development is a catalyst for performance improvements in all

fourteen purchasing processes. It is recommended to start with commodity strategy devel-

opment, and the others will follow. With commodity strategy development as its founda-

tion, the processes strategic cost management, supplier relationships, and supplier integra-

tion in new product development are the priorities. This has been confirmed by Monczka.

Second, human resources management is the most important supporting process. Third,

involve other departments, besides purchasing. Finally, procurement improvement is a

continuing proces, which requires regular assessments.

41

Chapter 4

Model development

4.1 Goal

In the literature review the aspects and processes of procurement were discussed and best

practices were gathered. While most processes individually have been researched exten-

sively, little been said about commodity strategy development. However, case studies have

shown that commodity strategy is a key process. The process is of a more strategic, qual-

itative nature. It relies on the other processes, linking them together. This is the reason

why an improved commodity strategy development programme also improves ten other pro-

cesses defined in the MSU purchasing model. However, this also explains, why commodity

strategy development itself isn’t well researched.

Because commodity strategy is vital in supply management improvements, this aspect must

be unfolded. The result should be a framework that procurement service providers can

rely on to guide them through commodity strategy development and supply management

improvement. Because of the big scope of this thesis and the nature of commodity strategy

development, the framework should be qualitative, allowing further research.

42

4.2 Method

In the first phase, the two prominent models are being reviewed. How well are they capable

of supply management improvement? Are they fit for procurement service providers? What

follows is the construction of a framework for commodity strategy development with the

gathered knowledge from the literature review.

4.3 Evaluation of Kraljic’ portfolio model

Kraljic’ model demonstrates that differentiating suppliers based on their importance and rel-

ative strength can be of great value to supply management. However, when solely this model

is applied to assess and improve supply management of procurement service providers, there

will be difficulties.

The first problem that will arise is that this model is fairly static. It depends on a snapshot

of the current supply base to make an analysis and determine the strategy. Goods aren’t

able to move around in the matrix through a suggested purchasing process. Second, the

model dictates that every product should be assessed and put into the matrix, which may

form a problem for procurement service providers. They don’t have stable procurement

schedules. Spot buys are still an important part of the business, making the product base

not only unpredictable, but also varied and very large. Third, unlike MSU’s purchasing

model, this isn’t a holistic model. It does not take the procurement process itself into

account.

43

4.4 Evaluation of the MSU model

4.4.1 Assessment of a PSP

With the MSU model, there is a well-researched, holistic tool available. Self-assessment

scorecards are available and added as an appendix to this thesis. Through an assessment of

GIS Europe using this model, the applicability, strengths and weaknesses of this tool in the

analysis of procurement service providers will be made clear. A summary of the assessment

results is given in figure 4.1, based the state of business in the second half of 2009. The firm

scores an average of 1.1 out of 10 with six processes scoring nil. This score can be traced

back to two causes: weak performance in general and an unadapted model. The extent of

the model’s applicability to PSP’s will be discussed in the next section.

Insourcing/outsourcing

The company already relies on external logistical means to make its deliveries. However, it

does not make any make-or-buy decision.

Current score: 0

Commodity strategy development

Products are bundled into commodities based on the type of product. The company’s

huge variety of products increases the difficulty in developing the commodity development.

Currently, only the electrical and chemical commodities are under control, which means

that there’s a single sourcer dedicated to the commodity. The development of a commodity

is opportunity driven. Market research consists of finding new suppliers and only when

there’s a specific order from a customer. This means that there is no long-term planning.

The solely used strategy is leveraging. Volumes are being shifted across suppliers in order

to reduce the price. The difficulty to develop a commodity is largely dependent on the type

of commodity. The mechanical commodity is an excellent example. The vast amount of

44

Figure 4.1: msu assessment of gis

different parts with each its many varieties makes it harder to control than the electrical

commodity.

The electrical and chemical commodity have a dedicated sourcer, but aren’t well developed.

Two major causes can be found:

1. Lacking communication

2. Spot buys

The strategies aren’t well communicated. The current strategies are basically lists of prod-

ucts and the preferred suppliers, drawn up in Office Excel. Buying staff isn’t aware of their

existence. The second reasons are short-term orders, the spot-buys. In these cases, clients

demand a fast solution, and without previous orders, the buyers are forced to source the

products themselves.

Current score: 1

45

Supply base optimization and management

There is no formal supplier selection process. Suppliers aren’t analyzed and rated before or

after transaction. The only selection criterion is price. In some occasions, the client’s old

suppliers are taken over.

Current score: 1

Supplier partnerships

Supplier contact goes hardly any further than price and volume agreements. There is no

framework present to identify possible partnerships and to maintain them. Suppliers called

partners simply get the biggest volume. As relations with suppliers are hardly maintained,

there cannot be any supplier development or joint initiatives and cooperation.

Current score: 0

Supplier integration in product creation process

GIS Europe does not have a product creation process, nor is it ever involved in the product

creation process of its clients.

Current score: 0

Supplier integration in order realization process

Suppliers aren’t involved in the order realization process. There is very little optimization

in the ORP, as the actual procurement of goods based on an ad hoc approach. Goods

are ordered manually, when stock seems to run out or when the clients place an order.

Forecasting of the required goods to GIS Europe’s suppliers or an automated system, such

as kanban or electronically through the ERP system Navision, is rarely being established.

The IT system does very little to support supplier integration. Suppliers are not connected

46

to the system and there is no possibility of information sharing. The current Navision

system is being used as a fairly static database of suppliers and goods.

Current score: 0

Supplier development and quality management

As mentioned, the main focus in supplier selection is price. Quality certificates are of

little meaning. There is no measurement system in place, nor a complaint or evaluation

procedure, so there can be no involvement in the development of strategic suppliers.

Current score: 0

Strategic cost management

Cost reduction relies heaviliy on opportunity driven supplier negotiations and leveraging.

The total cost of ownership is a known term and people responsible for sourcing and buying

try to keep it in mind. However, the total cost of ownership wasn’t calculated at the time

of the assessment. There is no participation of suppliers in cost reduction throughout the

entire supply chain.

Current score: 1

Strategies and plans

The purchasing plan today focuses on leveraging volume, based on mostly limited market

investigation. There is no framework to support differentiated actions towards different

kinds of suppliers.

The company’s main focus is big enterprises, interested in integrated supply. However,

there is no streamlined framework to deal with the accompaning BOM or MRO supply.

Current score: 1

47

Organization and teaming strategies

There is little coordination between different functions in the procurement process. The

biggest gap lies between buying and sourcing. Often, there is communication and discussion

between buyers and sourcers, but without a clear procedure. The developed commodity

strategies should bridge sourcing and buying efforts, but aren’t used.

There is some cooperation between GIS Europe’s different offices across Europe. Products

are being sold and bought through the GIS Europe network, and the developed commodity

strategies are supposed to be shared amongst all offices.

Current score: 1

Globalization

When signing a new client, GIS Europe takes over its historical or current suppliers, which

are often local. It is the sourcer’s responsibility to develop a new strategy, and possibly

replacing this supplier with the preferred one. Depending on the type of part, certain

regions are preferred to source from. Let’s take the electrical commodity as an example.

All suppliers are located in Western Europe, two thirds of them being French. This shows

reluctance to explore new markets. Within GIS Europe, there is very little knowledge of

untapped markets, such as Asia. External sources to explore these markets are hardly ever

used. There is no strategy or process in place to develop global oriented partnerships with

other procurement offices or freelancers. Presence in foreign markets is mostly through own

offices.

The IT system does not support globalization and there are no initiatives to help develop

local, strategic partners into global suppliers. Neither is there a process or procedure to

evaluate these or other suppliers’ possibility of global supply.

Current score: 2

48

Measurements

As cost is the main reason for clients to outsource their products to GIS Europe, currently,

only savings are ’measured’. Savings are easily obtained, as the product price is usually

determined in a RFQ before the actual transaction. Other criteria, such as quality and

delivery performance, are not being measured. The lack of statistics implies that there are

no improvement plans in supplier selection.

Everyone at GIS Europe has notion of the Total Cost of Ownership principle. However, no

one actually calculates, estimates or measures it when sourcing or buying goods.

Current score: 0

IT/IS

Microsoft Dynamics Navision has been implemented to organize the database and leverage

volumes. Whatever its possibilities are, though, in functionality, it has not exceeded Office

Excel or Access. It remains a simple database, with some useful gimmicks. Even though

it could be an integral part of order realization, orders are still being processed manually

and by e-mail.

Current score: 1

Human resources management

Clear job descriptions and the required profiles are ready in case of recruiting. They

are regularly reviewed and updated. The staff’s performance is assessed and personal

development plans are deployed based on those evaluations.

Current score: 7

49

4.4.2 Review of the model

The literature review has shown that a well considered make-or-buy decision can offer a

lot of value for the buying company. In stead of making certain products or services itself,

a company can make use of a supplier’s expertise by insourcing their goods and services.

When reviewing their supply management strategy, procurement service providers do not

have to make this decision. Their clients have already made the decision to outsource with

the PSP as their intermediary. Procurement service provider will not manufacture any

required product or service, making outsourcing their core business. Of course, PSPs do

face this question in other areas of their business. For instance, they could ask themselves

whether they will outsource their employee selection programme. However, this is beyond

the scope of supply management and this thesis.

For the same reasons, procurement service providers will score nil on the process of inte-

grating suppliers in new product development. It’s another aspect that isn’t applicable to

procurement service providers. The other twelve processes are of interest to procurement

service providers. However, after review of conditions presented in the scorecards, only four

scorecards are fully applicable, up to a score of 10: commodity strategy development, world

class supply base, strategy alignment, and IS/IT.

The case studies have demonstrated the importance of commodity strategy development.

The PSP scored a 1 in its assessment of commodity strategy development. After analysis of

the self assessment scorecard and PSP’s core business, it can be concluded that this type

of firm cannot get a higher mark. This would require the introduction of multi-functional

teams. Procurement service providers can’t rely on a wide array of skills from within their

firm, as they don’t manufacture or market goods. However, being an intermediary, these

kind of skills are unnecessary and offer little value to the supply management process. The

PSP’s client has made up its mind, perhaps with the aid of their multi-functional teams,

before placing an order at the PSP. Score 6 requires alignment of internal and external

future technology roadmaps. As mentioned in the literature review, the future technology

roadmap allows for a firm to market and engineer its product in a progressive way. As with

50

multi-functional teams, this provides value for the clients of a PSP, and not for the PSP

itself. However, knowing the clients future technology would allow the PSP to proactively

explore the supply market.

The conditions present in this process’ scoring sheet can be devided into four categories,

depicted in table 4.1: involvement of other departments, focus, evaluation, and supply

market knowledge.

Strategic cost management, supplier relationships, and supplier integration have been

named the other priority processes in section 3.5. The importance of a total cost of owner-

ship procedure is confirmed by the self-assessment of strategic cost management. Evidence

of a structured implementation of the total cost of ownership principle is a prerequisite to

get a score of 2 and higher. However, PSPs wouldn’t be able to get a score higher than 2,

as the next condition is the implementation of cross-functional teams.

Having a documented and structured process to identify, assess, categorize and select po-

tential suppliers can be seen as the foundation of a supplier partnership process. This makes

up grades 1 and 2 of the self-assessment. Higher scores would require having strategic part-

ners, as per 3, there should be evidence of work on a partnership program. However, the

self-assessment score for PSPs is limited to 4, as a higher score requires partner integration

into new product development.

The final priority is integration in new product development. As previously mentioned, this

process is not applicable to procurement service providers.

It can be concluded that the Michigan State University purchasing model offers a great deal

of insight into procurement. However, not all aspects of the self-assessment are applicable

to procurement service providers. The maximum scores a procurement service provider can

get are depicted in figure 4.2. Because the scoring is on a incremental principle, it can be

assumed that some conditions that don’t fit within the PSP context, cannot simply be left

out. Thus, for eight processes, the self-assessments are deemed unreliable.

51

Table

4.1:

Com

mod

ity

stra

tegy

dev

elop

men

tse

lf-a

sses

smen

t

Sco

reIn

volv

emen

tF

ocu

sE

valu

atio

nS

up

ply

mar

ket

2:M

ult

i-fu

nct

ion

alte

ams

Inte

rnal

requ

irem

ents

,

shor

t-te

rmco

stan

dvo

lum

e

leve

ragi

ng

3:U

nd

erst

and

ing

ofst

ruct

ure

and

tren

ds

4:E

xte

rnal

requ

irem

ents

,

lon

g-te

rm

5:P

rior

itiz

eon

crit

eria

asp

er

2,3

and

4

6:F

utu

rete

chn

olog

yro

adm

ap

7:S

pec

ific,

mea

sure

able

,an

d

tim

ed

rive

ngo

als,

alig

ned

wit

hb

usi

nes

sob

ject

ives

.

Fol

low

-up

8:C

omm

un

icat

ion

9:B

ench

mar

kin

g

10:

Su

pp

lier

s

52

Figure 4.2: Maximum scores for PSPs in the MSU model

4.5 Commodity strategy development framework

4.5.1 Construction of a development cycle

The commodity strategy development process will consist of four big steps: definition of

the corporate objectives, definition of the commodity, develop strategy, and execution. The

importance of a product or commodity change together with the PSP’s ever changing client-

and supply bases. Thus, a periodic review is recommended, symbolized with the cycle in

figure 4.3. Because of its periodic nature, parallels with Deming’s PDCA-cycle can be

found.

53

Figure 4.3: Periodic review of the commodity strategy

4.5.2 Define objectives

The definition of the business objectives is chosen as the first step. In any case, the definition

should happen before the development of a strategy, to follow a strategy hierarchy structure

[39]. The business objectives should be aligned with the overal company vision. The vision

should clearly define the desired future state, whereas the mission defines why the company

exists today and how to add value to the customer. But how does the vision and mission

statements of a procurement service provider look like? A closer look at the vision and

mission statement of our example PSP shows a few things:

• Market position: being first tier (vision and mission)

• Core business: industrial service provider (outsourcing) in integrated supply for mro

and non-core spend (mission)

• Method: through sourcing sourcing, purchasing and logistics expertise of their teams

54

In short, the corporate objective is to become the number one outsourcing firm for non-

strategic goods through integrated supply by 2011. The vision and mission don’t go any

deeper into the lower level purchasing objectives. However, there’s a clear mention of sup-

ply management as one of the means. The development of supply management will be an

issue for lower-level strategies (see section 4.5.4).

4.5.3 Define the commodity

Step one: gather the facts

The case studies have shown that a common ground is of vital importance for change.

To increase the chances of succes, this common ground will consist of facts only. Com-

modity managers must determine which information they need, and if/how they can get

it. Research has identified six types of information concerning product groups: customer

demands, product group characteristics, supply market characteristics, value chain char-

acteristics, value chain characteristics of the competitors and supplier characteristics [38].

These six items should be assessed on importance and availability. A rating system can

get rid of any misinterpretations and clearly show which information is still missing to con-

struct the strategy. A template could be made and spread out throughout the company,

so all staff members share the same common ground. An suggestion for a straightforward

template is given in figure 4.4.

Figure 4.4: Example of a template

55

Step two: assess schedule stability

Literature has shown that the implementation of a new purchasing strategy in SMEs

should start with schedule stability. It will increase trust between buyer and seller, which

is a prerequisite for strategic partner relationships. However, in a procurement service

provider, the schedule stability will rely on the type of clients. Two types of client orders

are currently made at GIS Europe: spot buys and contract buys. The ad hoc spot buys

do not guarantee schedule stability, and, thus, cannot provide a foundation for strategic

partner relationships. The purchased goods are low in volume and the required volume

over a long term period is unknown.

In the case of contract buys, long term agreements are made with the PSP’s clients. In

most cases this concerns high volume items. This will directly induce schedule stability.

Also, procurement costs can easily be reduced.

While spot buys probably have a disruptive influence on schedule stability, they should

not be ignored in commodity strategy development. There is still a possibility that these

random orders combined reach acceptable volumes with reliable order intervals. Also, a

contract buy can the foundation and provide enough stability to attach any spot buys to.

Step three: commodity classification

In this third step, the importance of the product group should be determined. Not every

product group is of equal importance to the buying firm and through a classification the

people responsible for the commodity strategies will understand the strategic impact of

each commodity. A classification will be made using Kraljic’ portfolio method, in which

each commodity is assessed on profit impact (value to the PSP) and supply risk (number

of capable suppliers), shown in figure 3.1.

The commodity’s relative contribution to the firm’s profit through purchased goods can

be used as an indicator for the commodity’s importance. A tool to visualize this relative

contribution in relation to the other commodities is the pareto analysis. An example of

such a visualisation is given in figure 4.5. A rule of thumb in pareto analysises is that eighty

56

percent of the profit would orginate from twenty percent of the commodity types. This rule

can be used to make the destinction between commodities of low and high importance.

Circa twenty percent of all identified commodity types would be classified in either the

leverage or the strategic quadrant. These items will likely offer the greatest improvement

opportunities.

The number of capable suppliers, i.e. the selection pool, will be used as an indicator for

the supply risk. This would require (1) a list of possible suppliers, and (2) a method to

determine their capability. There are many possibilities to gather information on suppliers:

current suppliers, sales representatives, information databases, the internet, experience,

trade journals, trade directories, industrial trade shows, et cetera.

Literature has put forward three general characteristics for supplier selection: (1) price,

(2) delivery, and (3) quality. Price is the absolute priority, delivery performance is less

important. Because the commodity strategies are either nonexistent or not communicated,

the buyers continue to work ad-hoc to find a supplier that can meet the delivery date.

So the biggest weight is assigned to price. The supplier information was gained through

requests for quotes or requests for proposals, in which price and volumes are discussed. This

needs to evolve towards a total cost of ownership approach, in which all costs, and not only

the price, are accounted. Also, as the corporate objective is to move towards integrated

supply, the importance of delivery performance will grow. This must be taken into account

in the new supplier selection process.

4.5.4 Develop a strategy

Step one: Set commodity objectives

As Kraljic has taught us in section 3.3, it’s important to differentiate your approach towards

different kinds of commodities. The previous section explained how the importance of the

commodity relative to the supply market provides insight into the strategic impact of the

commodity (section 4.5.3). The procurement service provider’s strength can be considered

as limited. Mudambi, amongst other researchers, has stated that company sizes also matter

57

Figure 4.5: Example of a pareto analysis

[41]. Inequal sizes of buyer and seller is a determining factor in cooperation. The larger

company will define the relationship and dictate the amount of cooperation with the smaller

partner. When the acquired volumes are considered low, the small company is considered

unimportant and will receive lower attention or priority. Hence, SMEs will increasingly be

confronted with skewed relationships. While our example procurement service provider is an

SME, this shouldn’t be the starting assumption when assessing the buyer’s strength. It may

be a small company, but it could also represent large multinationals through an integrated

supply programme. Also, through volume bundling it may rise its appeal beyond that of

the classic SME.

A second classification should involve the individual suppliers’ perspective and strength.

Question that can be posed consider the size of the supply market, the number of capable

suppliers closeby or the amount of distributors. Much like Kraljic’ product portfolio, the

PSP’s strength relative to a supplier’s strength should be set out in a two-by-two matrix.

Four scenarios are possible, each demanding another strategy. This matrix can be put

inside the commodity classification matrix from section 4.5.3, depicted in figure 3.1. It

shows that the sixteen different scenarios and strategies are possible (see figure 4.6).

Placing the commodity into one of these quadrant gives the manager a clear picture of

what the objectives should be and in what direction they should move the commodity. The

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Figure 4.6: Sixteen different strategies within Kraljic’ matrix

transfer to another quadrant can be the core of the commodity strategy. This strategy might

require shifts in current purchasing and procurement efforts, increase certain activities, and

so on.

As not all scenarios are advantageous for procurement service providers, the responsible

commodity managers must select their objectives carefully. Some general rules of thumb

for the commodity managers can be given though. When both the supplier’s and the

buyer’s strength are low (l3, s3, n3 and b3 in figure 4.6), the relationship can be considered

as an unfavourable position. For routine products (n3), this is less of a problem than

it is for strategic and bottleneck goods (s3 and b3). Because of their supply risk, the

low attractiveness of the PSP as buyer poses an unsecure relationship. The commodity

managers must then set up a strategy to move the product to a better quadrant inside the

matrix, such as s2/s4 or b2/b4.

The opposite strenght relationship, where both the supplier and buyer position is strong (l2,

s2, n2 and b2), can offer good circumstances for a partnership. When the PSP is stronger,

it’s in a good position to demand supplier development. When the buyer is stronger, it could

be recommended to diversify the supply base, which would spread the risk over multiple

59

suppliers and move the scenario to the 3- or 4-spaces within the matrix.

Step two: Determine key performance areas

The second step consists of the commodity managers to set the key performance areas for

the commodity. These are the areas in which the firm wishes to excell, but may vary with

different types of commodity, through time, or the positioning withing the matrix of the

previous step (figure 4.6). The key performance areas are derived from the MSU model

and include the following:

• In/Outsourcing

• World class supply base

• Supplier integration in new product development

• Supplier partnerships

• Supplier development and quality management

• Cost management

• Supplier integration in ORP

Through a internal discussion at the procurement service provider and a pairwise compar-

ison, the most important processes at procurement service providers can be determined.

These processes should be intensely upgraded to achieve the desired competitive advantage

stated in the vision. An example of a pairwise comparison is added in appendix B. Because

not all selected criteria will be equally important, priorities must be set. The pairwise

comparison can be used to assign weights to the selected KPAs.

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Step three: Set goals

The key performance areas must be translated into key performance indicators (KPI). These

are quantifiable, measureable outputs, directly related to the key performance area. The

commodity manager must note the difference between driver and lagging indicators. The

drivers are measures that influence the lagging indicators. In other words, while the lagging

indicators are probably the obvious measures, related to the key performance area, they

are actually driven by another factor (figure 4.7). The commodity manager must take the

time to assess all possible factors and ’dig deeper’ than the lagging indicators.

Figure 4.7: Key performance indicators hierarchy

Concerning strategic cost management, one of the priority processes, low priority goods

should only be analysed using price analysis techniques. This concerns the scenarios n1 to

n4 and b1 to b4. There is no need to do a in-depth (total) cost analysis for those kind of

goods, as only their acquisition cost should be lowered [31]. This would imply assessing the

market structure, the economic conditions, pricing strategy of the seller, product specifica-

tions, and quantity discounts.

For the high priority goods, the total cost of ownership approach has been clearly put for-

ward by multiple literature sources, among which the Michigan State Univeristy purchasing

model. A model should be developed, adapted to the characteristics of the procurement

service provider.

The goals can be set after a gap analysis has been performed. This analysis may be aimed

internally or externally. In the case of an internal analysis, the corporate objectives are the

main reference point. In the case of an external gap analysis, the position of the procurement

61

service provider in relation to its competitors or to the best practices is assessed (see section

3.4.6). The MSU model could be considered an external gap analysis, as it’s a collection of

best practices.

Literature has stated on multiple occasions that multi-disciplinary input is of great impor-

tance. Because a procurement service providers don’t have much multi-functional knowl-

edge to rely on, they could try to access the knowledge of potential strategic suppliers to

develop their strategy.

4.5.5 Execution

Step one: make a plan

A plan must be conceived, focused at reaching the set goals. This plan will require creativity

and sourcing skills from the commodity managers. Literature has suggested the use of multi-

disciplinary knowledge. In the case of procurement service providers, this implies external

knowledge.

Step two: execute the plan

The execution of the plan will involve change management. PSP’s are service firms, in

which the sourcers and buyers are left with quite some freedom. This makes it all the more

important to give careful consideration to the change program. Kotter’s model for change

is a tried model applicable for procurement service providers. It consists of eight steps,

displayed in figure 4.8.

This thesis doesn’t go into further detail, as the manner in which these models should be

applied in a PSP environment is not within its scope.

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Figure 4.8: Kotter’s model for change

63

Chapter 5

Model evaluation

To evaluate the conceptual model, quantitative values are required. Thus, a mathematical

model needs to be developed.

5.1 Total cost of ownership tool

Supply management efforts are aimed at cost reduction upstream of the PSP’s logistic chain,

at supplier side. Literature shows that all costs in the supply chain should be considered.

However, up to now, supply management at GIS Europe was mainly aimed at one cost, the

price of acquired goods. Through economies of scale, the total cost was lowered.

A method to evaluate all expenses was brought up in the literature review earlier in this

work: total cost of ownership. By comparing the total cost of ownership before and after

application of chapter 4’s suggested approach, the model’s potential can be evaluated on a

cost basis, the bottom line in supply management.

The first phase to evaluate the suggested model, is the development of a total cost tool.

Literature suggests several types of total cost models. Traditional models account three

types of cost: materials, manpower and overhead, lead back to products or services [24].

As these offer little transparancy, another approach is chosen. In activity based costing,

64

costs, including overhead, is attributed to activities. This provides a better image of the

cost impact of each of the supply management activities. To determine this cost impact,

cost factors are determined. These are the components of the total cost of each activity.

However, a cause-and-effect relationship can be found between these factors and so-called

cost drivers. By a certain mathematical relationtion, these drivers will determine the cost

factor, which will, in turn, determine the total cost per activity.

As described in chapter 2, a procurement service provider performs several activities within

the supply management boundaries. In the remainder of this thesis, the costs will be

attributed to two main activities:

• procurement

• purchasing

A last distinction in activities is made within purchasing. This activity can be devided into

two sub-activities: spot purchasing and contract purchasing. A more detailed explanation

is given in the following chapter.

5.2 Procurement

Procurement aims to manage, develop and integrate with supplier capabilities to achieve

a competitive advantage. Sourcing is an integral part of it, whereas the acquisition itself

(‘purchasing´) is not. A more detailed explanation has already been given in section 3.1.

5.2.1 Proces flow

Three process steps contribute to the total time required to procure an item and close a

contract, demonstrated in equation 5.1:

1. Gather supplier information and set up a database

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2. Analyze and sort suppliers

3. Contact and contract suppliers

Hence, the time required to close a contract can be calculated.

T = Tdb + Tsort + Tc (5.1)

with Tdb: Time to set up a database

Tsort: Time to analyse and sort suppliers

Tc: Time to contract suppliers

The total spent time should be rated over all closed deals. The time should also include

the time invested in the failed suppliers. A generic example is given below.

Example:

It takes two weeks to set up a database of 100 potential suppliers of a certain commodity.

After two days analyzing the potential suppliers, 25 supplier seem fit to supply the requested

part. After one day of setting up RFQs and one week of negotiating, two suppliers are

contracted. The time to contract each of these two suppliers can be calculated. Formula

5.1 requires three variables:

Tdb = 14 days

Tsort = 2 days

Tc = 1 day + 7 days

The total time per two suppliers adds up to 24 days. Hence, the total time to procure

equals 12 days per contracted supplier.

5.2.2 Cost factors

As demonstrated in the process flow, the procurement of suppliers is a time consuming job,

performed entirely by staff members. Hence, only one costfactor determines the annual

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procurement cost P1: manpower. No overhead costs are attributed to this activity. The

manpower cost is driven by two drivers: annual wage cost and number of staff members.

As staff can occupy itself in activities beyond procurement, the manpower dedicated to

this particular activity is expressed in a number of full-time equivalents FTE1. The math-

ematical relationship between the procurement cost, the cost factor, and its drivers is given

below.

P1 = Cman1

= FTE1 ·wage

With the cost of the procurement activity known, it can be lead back to a each handled

contract. Two methods are available. Applying both methods offers offers the advantage

that they can confirm or disprove eachother’s result. The first method makes use of the

mathematical relationship from above. The procurement cost can be rated over the total

number of closed contracts.

The second method relies on the required time to run through the process flow of han-

dling a contract. Knowing the timer per contract and the wage cost per year, it become

straightforward to calculate the cost per contract. A generic calculation example is given

below.

Example:

The time to procure equals 12 days per contracted supplier. A sourcer costs 100000 euro

per year, or 100000 euro per 230 days. Hence, the cost per procured contract is 100000 · 12230

euro.

5.3 Purchasing

Purchasing refers to the day-to-day management of material flows and information, with-

out long-term horizon. Table 3.1 gives an overview of the supply chain and the position of

purchasing. However, this representation is not capable of comprising all aspects of pur-

67

chasing. This section will focus on these aspects, and they way they contribute to the total

purchasing cost.

5.3.1 Proces flows

As mentioned in chapter 2, purchases can occur in two forms: spot buys and contract buys.

Whereas this distinction was made at the PSP’s client side, it’s equally possible to make

it at supplier side. This important distinction will be made during the remainder of this

thesis.

A spot buy is the acquisition of an item or service without long term agreement. Figure

5.1 demonstrates the functioning of a spot buy withing procurement service providers.

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ERP order Manual order

Client

Buyer reception

Fax, letter, email

Item already ordered?

Source suppliers

No

Set up RFQs

Formulate response

Fax, email, letter, ERP

Analyze responses

Fax, email, letter, ERP

Formulate proposal

Fax, email, letter, ERP

Create Purchase Order

Fax, email, letter, ERP

Ship goods

Reception of goods

Navision, EDI

Ordered qty > PO qty?

Stock goods

Ship PO qty

External logistics

No Yes

Procurement service provider

Supplier

Yes(contract buy)

Accept proposal

Yes

Figure 5.1: Purchasing flow of a spot buy

At customer side an order dispatches. This order can be automated through an ERP

system or manual. However, as this thesis focusses on supply management at supplier side,

this is of little concern. An order should be processed in a similar fashion, whether it’s

automated or manual, contract buy or spot buy. When the order arrives a the psp, a buyer

will investigate whether the order requires sourcing. This leads to two options:

1. The item is known: no procurement activities are required

2. The item is unknown or not part of a controlled commodity: procurement activities

are required, sourcing necessary

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The first scenario gives occasion to a contract buy. When the second scenario occurs, a series

of procurement activities have to be performed. Suppliers have to be sourced and RFQs

have to be sent out and analyzed. What follows is a proposal to the customer. After order

confirmation, a purchase order is made. The amount of ordered goods is either directly

deliverd to the customer, or handled at the procurement service provider’s warehouse.

Either way, it’s deliverd to the customer by an external transportation company. After

delivery, the order is accounted.

Purchases are seen as a contract buy, when procurement activities have already arranged

a long term contract with the supplier. As an item or commodity already have a designated

supplier assigned to them, several steps are eliminated from the process flow. Figure 5.2

depicts the flow of contract buys.

5.3.2 Cost factors

The process flows give an indication as to what costfactors attribute to the purchasing cost

P2. Four cost factors are distinguished:

• Manpower cost Cp man

• Price of the item or service Price

• Logistics cost, such as stock costs and transportation, L

• Other overhead, such as IT, management, and offices Co

This totals the purchasing cost as:

P2 = Cman2 + Price + L + Co (5.2)

All four cost factors are used for both spot buys and contract buys. However, the difference

in activities demonstrated in figures 5.1 and 5.2 will eventually lead to different costs,

as each flows influences the costfactors in a different way. Spot buys are per se one-off,

70

ERP order Manual order

Client

Search item/contract

database

Fax, letter, email

Send proposal

Fax, email, letter, ERP

Create Purchase Order

Fax, email, letter, ERP

Ship goods

ERP

Reception of goods

Navision, EDI

Ordered qty > PO qty?

Stock goods

Ship PO qty

External logistics

No Yes

Procurement service provider

Supplier

Long term contract? Yes

No (spot buy)

Accept?Yes

Figure 5.2: Purchasing flow of a contract buy

so the additional procurement processes within those flows have to be repeated for each

customer purchase order. As opposed to contract buys, the sourcing cost isn’t rated over

all contracted suppliers. It does, however, become related to the individual order.

Also, as contract buys make use of extensive procurement, prices might differ. Or logistics

cost may be more or less expensive, depending on the procurement service provider’s policy.

These remarks and more will be handled in the case study further down in this thesis.

The determine the cost drivers, each cost factor is investigated further.

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Manpower cost in purchasing

As shown in figure 5.1, the order handling process in spot buys can be a partly automated

affair. Still, staff is involved in ordering and accounting, which implies that the number of

full time equivalents dedicated to purchasing is, again, a cost driver. The manpower cost

Cman2 is affected by every process involving staff:

• source item and send out RFQs

• analyze quotations

• discuss with client and make the order

• follow-up

• accounting

The mathematical relationship between the costfactor and its cost drivers is determined

by the wage costs. One of the cost driver, the total amount of full-time equivalents

dedicated to purchasing FTEp1, can be broken down into FTEs dedicated to process

steps:

Cman2 = FTEp1 ·wage + accounting

= (FTEsource + FTEanalyze + FTEdiscuss + FTEfollowup) ·wage + accounting

= (a ·FTEp1 + b ·FTEp1 + c ·FTEp1 + d ·FTEp1) ·wage + accounting

met a + b + c + d = 1

Similar to the procurement cost, a second method is available to calculate the manpower

cost, using the required times to perform each process step once. The total time is then

multiplied with the buyer’s wage. The calculations are analogous to the procurement

activity.

As mentioned, also accounting requires manpower. Hence, another cost driver can be

distinguished: the number of full-time equivalents dedicated to accounting supplier

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billings. Calculating the accounting cost per order is similar to the first calculation method

to determine the procurement cost per contract. The wage costs of the full time equivalents

can be rated over all orders, assuming that every order is handled by an accountant. The

accounting cost per order can then simply be added to the purchasing manpower cost per

order. A generic example is given below.

Example:

A procurement service provider holds 10 accountant. Half of their time they are processing

supplier billings. Each of them costs 50000 euro per year to the company. This year 100000

orders were made with suppliers.

Number of FTEs = 10 · 0.5 = 5

Yearly cost = 5 · 50000 = 250000

Cost per order = 250000/100000 = 2.5 euro per order

As opposed to spot buys, contract buys require less manpower. Because deals have

already been made by sourcers, RFQs aren’t sent out and quotes don’t have to be analyzed.

Also, it allows for a more automated placement of purchase orders. The remaining processes

in which staff is involved are:

• discuss selling and making the order

• follow-up

The required time for these two activities doesn’t differ between spot buys and contract

buys.

Price as cost in purchasing

The acquisition price of an item isn’t completely seen as a costfactor, as we want to relate

the cost to an activity. For the same item, a procurement service provider might pay two

different sums of money, depending its bought as a spot buy or bought as a contract buy.

Thus, preferring one activity over the other might induce an extra cost: the increased price.

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It’s this extra cost that is regarded as the costfactor Price. As a consequence the price of

a spot buy and the price of a contract buy are the cost drivers.

The mathematical relationship is simple: order price as a spot buy minus order price as a

contract buy. A generic example is given below.

Example:

Fifty orders of an item are bought as a contract buy at a total price of 1000 euro.

One hundred orders of that same item are bouth as a spot buy at 5000 euro.

Contract buy: 20 euro per piece

Spot buy: 50 euro per piece

The costfactor price is 50 − 20 euro.

Choosing a spot buy over a contract buy would cost 30 euro.

Logistics cost in purchasing

Logistics is considered as the activities concerning the warehouse and transportation. Hence,

the logistics cost L comprises of several (sub)cost factors:

• Transportation (cost Lt)

• Handling (cost Lh)

• Stock (cost Ls)

Transportation cost aren’t considered in this model, as those are being fully charged to the

customer. This renders the logistics cost fully attributable to stock and handling costs.

The handling cost can be determined in a similar way as the accounting cost, with the

number of full-time equivalents dedicated to handling as cost driver. The wage cost

of the FTEs dedicated to handling is rated over all handled orders. It’s very possible that

an item passes the PSP’s warehouse but isn’t put into stock. In this case, the stock value

won’t increase, but the order will be appointed a handling cost.

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The stock cost consists of a overhead cost Lso, comprising costs such as rent and insurance,

and a variable cost Lsv. This overhead cost can be seen as a fixed percentage a of the stock

value. The variable cost is a capital cost, the result of lost returns on the funds fixed in

stock. To compare this return to the funds fixed in stock, a tax rate should be included in

the calculation. Hence, the yearly logistics L cost becomes:

L = Lt + Ls + Lh

= Ls + Lh

= Lso + Lsv + Lh

= a · Stock value + Stock value · (ROI · (100 − tax)) + Lh

Other overhead costs

Other overhead costs, such as management, offices, and IT, are harder to trace back to

activities. They are not included in the cost model.

5.4 Summary

An overview of all activities, cost factors, and cost drivers is given in figure 5.3.

Figure 5.3: Summary of the activities and their cost structures

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Chapter 6

Case study

With the calculation tool set up, it’s possible to evaluate structural changes on a cost

basis. The model is being applied to the Belgian procurement service provider GIS Europe.

First, the cost incurred by the current way of working is assessed. Afterwards, the model

can be applied and some hypothetical future states can be drawn, together with its their

cost values. The cost of the current situation will serve as a reference value against which

changes are compared.

6.1 Method

Data from GIS Europe’s purchasing history, logistics and operational level is gathered.

The reference period is the year 2009. The entire history of POs within the timeframe is

analyzed, allowing the possibility for differentiating amongst commodities, purchase types,

etc, followed by a restructuring of procurement efforts and purchasing orders according to

the model. All purchase orders are taken into considereation when applying this method.

As previously mentioned, no distinction should be made on the origin of the order. Hence,

all order should be treated in the same fashion.

First, the current state is determined. As the cost model from chapter 5 demonstrates,

three activities are distinguished: (1) procurement, (2) spot buys, and (3) contract buys.

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On a commodity level, the costs per activity are determined and demonstrated.

Procurement can be analyzed in two ways, by the number of handled contracts or by the

time per contract. Parameters are preferably deducted from historical data, but also from

GIS Europe’s experience through interviews. The parameters required for the analysis of

the procurement cost using the former method are:

• Number of FTEs dedicated to sourcing

• Sourcer’s wage

• Number of contracts handled with suppliers per commodity

To analyse the purchasing costs three factors are analyzed for both contract buys and

spot buys: manpower, price, and logistics cost. The parameters required are:

• Buyer’s wage

• Time required to go through the purchasing process described in 5

• Number of purchases per commodity

• Total value of purchases per commodity

• Yearly systems cost

• Stock value per commodity

• Time to handle an order in the warehouse

• Number of orders handled in GIS Europe’s warehouse

• Overhead cost

• Desired ROI

• Taxes on profit

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Second, a hypothetical future state is determined. To do so, the core of the qualitative

model is applied. The parts that are applicable on an operational level are used. The other

steps are supportive or prepartory in nature. Within section 4.5, these core commodity

development steps range from commodity classification to the setting of goals:

1. commodity classification

2. set commodity objectives

3. determine key performance areas

4. set goals

The future state is evaluated using the same cost model as the current state.

6.2 Current state

6.2.1 Procurement cost

The input required to reach the procurement cost is added in table 6.1. Full procurement

data is added to appendix C.

Table 6.1: Parameters to calculate the procurement cost

Parameter Value

FTEs sourcing 15

Sourcer’s wage 90000

Total number of handled contracts 516

Using the first calculation method, based on the total number of handled contracts, a cost

of 2616 euro per contract is established. A second calculation method, which uses given

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times to handle the activities in the process flow to close a contract, brings the cost to 2812

euro. The relative difference is 7%. This difference can be considered fairly small, as the

times considered in method 2 are very small and, thus, harder to estimate. Small variety

in these times can easily affect this relative difference.

The first method will be taken into further consideration in the rest of this thesis. As the

difference with method 2 is small, it can be concluded that also these calculated values are

reliable and workable. The procurement costs per commodity are demonstrated in figure

6.1.

Figure 6.1: Current state procurement expenses

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6.2.2 Purchasing cost

Manpower cost of accounting

The manpower cost is the sum of two components: buyer cost and accounting cost.

GIS Europe employs 8 FTEs that handle accounting, totalling the yearly (wage) cost at

400000 euro. Assuming that half the time, the accountants are processing billings from

suppliers, 200000 euro is dedicated to the accounting withing purchasing. For every order

it places, GIS Europe handles accounting. Hence, the accounting cost is rated over all

purchases.

Accounting cost per order =FTEs ·wage · 0.5

all purchase orders

=8 · 50000 · 0.5

227314

= 0.88 euro per order

Manpower cost of buying

As the purchasing flows are different, a distinction is to be made between contract buys

and spot buys to calculate the buying manpower cost. Table 6.2 shows the times used

to determine the current state.

Table 6.2: Times to place an order

Spot buy Contract buy

Source item: 0.5h 0h

Send out RFQ: 0.25h 0h

Place order: 0.5h 0.5h

Follow-up: 0.25h 0.25h

Total: 1.5h 0.75h

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Knowing the buyers’ average cost to GIS Europe, and the time required to place an order,

its straightforward to determine the buyer cost per purchase order:

Buyer cost per order = Time per order ·Hourly wage buyer

= Time per order · 70000 euro

230 days per year · 7.5 hours

Buyer cost per spot buy = 58.33 euro

Buyer cost per contract buy = 29.17 euro

Hence, the manpower cost per spot buy 59.21 euro; the manpower cost per contract buy is

30.05 euro.

Price

As explained in chapter 4, the price of a good or service completely regarded as a cost.

Only the additional price due to the inefficient purchasing method is added to the cost. The

calculation method, excluding capital goods, is demonstrated below. Generally speaking,

the acquisition cost of a spot buy is 193.92 euro more expensive. In other words, through

procurement followed by a contract buy, the price of a product can be lowered by 24% as

opposed to spot buys. More details on input data can be found in appendix C.

Price = Price contract buy − Price spot buy

=Purchase value contract buys

no.contractbuys− Purchase value spot buys

no.spotbuys

=92173768 euro

153760contract buys− 65985410 euro

83169spot buys

= 74.75 euro

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Logistics cost

Two costs can be attributed to the logistic: handling cost and capital cost. A handling

cost occurs when an order is processed, not necessarily stocked, by GIS Europe’s warehouse.

This happens in 60% of all orders. Handling takes 20 minutes, and at a buyer’s wage, this

costs 12.95 euro. However, handling occurs only in 60% of all orders. Hence, the handling

cost is 12.95 · 60% = 7.77 euro for each purchase.

To determine the capital cost, first, the stock value per commodity is determined. The

value of GIS Europe’s stock amounted to 5.6 million euro in 2009. No spot buy items are

kept in stock. Further information about how this stockvalue is divided over the commodites

is unavailable. The value is assumed to spread over the commodities in accordance with the

purchase value of the contract buys of each commodity. Of course, services are excluded.

A calculation example is given below:

Share electro in stockvalue = Share electro in value contract buys

=total purchase value contract buys electro

total value over all contract buys

=25726766 euro

92707226 euro

= 28%

Thus,

Stock value electro = 28% · 5600000

= 1554031 euro

Next, the cost of capital can be determined. Only one year of capital costs is assumed,

even though the lost profits will keep on expanding in the future. Taxes are assumed at

33 percent, expected ROI is set at 10 percent. Input data and calculations are added in

appendix C.

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GIS Europe regards the overhead cost for its warehouse as 23% of the value it holds in

stock. This value is rated over the orders, in proportion to their contribution to the total

purchase value.

The total logistics cost per commodity is shown in figure 6.2

Figure 6.2: Total logistic costs

6.2.3 Summary

The total expenses are summarized in figure 6.3. The total expense in procurement is

1350000 euro, in spot buys 21456080 euro and in contract buys 7630960 euro. The cost per

purchase per commodity is shown in table 6.3.

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Figure 6.3: Current state total expenses

84

Table 6.3: Cost per purchase

Commodity Spot buy Contract buy

Capital goods: 0 43.61

Chem/labo: 260.85 54.41

Electro: 260.85 44.52

Electronics: 260.85 46.60

IT/Telecom: 260.85 45.91

Materials: 260.85 45.17

Mechanical: 260.85 49.72

Office: 260.85 42.85

Packaging: 260.85 42.28

Safety: 260.85 41.32

Service: 253,08 29.99

T&M: 260.85 41.90

6.3 Future state

6.3.1 Commodity classification

As described in chapter 4, to determine the importance of a commodity, two parameters

must be assessed: the importance of the commodity to the procurement service provider

and the supply risk.

The importance of the commodities to GIS Europe is assessed by their impact on

the company’s profit. However, as no data is on profit is released, the commodity’s share

in the purchase value is seen as an indicator for the profit impact. The profit impact is

demonstrated in figure 6.4. Pareto’s 80/20 rule can be found in this graph and used to

make a cut-off point between low-impact and high-impact commodities, which gives:

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• High impact: Mechanical, Service, and Electro

• Low impact: Chem/Labo, IT/Telecom, Materials, Office, Safety, Electronics, Pack-

aging, T&M, and Capital goods.

Figure 6.4: Profit impact of the commodities

The supply risk is assessed using the number of capable suppliers. An indicator for the

number of capable suppliers can be found in GIS Europe’s supplier database: the ratio of

active suppliers over known suppliers. These ratios are given in table 6.4. As with the

importance of commodities, a cut of point must be set to distinguish low and high supply

risk. The cut-off point is put at the median, 37%, which gives:

• Low supply risk: Capital goods, Chem/labo, IT/Telecom, Packaging, Services, and

T&M

• High supply risk: Electro, Electronics, Materials, Mechanical, Office, and Safety

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Table 6.4: Capable suppliers

Total suppliers Capable suppliers %

Capital goods 77 77 100

Chem/labo 793 328 41

Electro 4953 872 18

Electronics 492 178 36

IT/Telecom 451 201 45

Materials 593 78 13

Mechanical 10874 1089 10

Office 968 55 6

Packaging 324 124 38

Safety 1594 79 5

Services 5623 3765 67

T&M 101 89 88

6.3.2 Set objectives

Chapter 4 explains that a further division of Kraljic’s matrix into a 4× 4 matrix requires a

more in-depth view of the individual supplier. Assessment of individual supplier strength

as opposed to the PSP’s strenght is beyond the scope of this thesis. Hence, objectives will

be suggested in Kraljic’s 2 × 2 matrix.

Based on importance of commodities and the supply risk, each commodity can be set out

in Kraljic’ matrix. This is represented in figure 6.5.

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Figure 6.5: GIS Europe’s commodities in Kraljic’ matrix

This matrix gives an indication at what objectives GIS Europe could set:

• Decrease supply risk of Mechanical and Electro and bring them to the leverage quad-

rant

• Give attention to lower prices and costs on Services

• Focus on short term sourcing for bottleneck items from Electronics, Materials, Safety,

and Office.

6.3.3 Determine key performance areas

Next, key performance areas are given to the commodities. Through pairwise the com-

parison added in appendix B, a ranking can be made of possible key performance areas.

The results are summarized in table 6.5. They confirm the findings of the case studies

mentioned earlier in this thesis. Supplier relationships and cost management appear to be

critical areas to commodities like Mechanical and Electro. Unlike the case studies, supplier

88

integration gets a lower rating. This can be explained by the lack of R&D activities at

procurement service providers.

Table 6.5: Key performance areas defined by GIS Europe

# Strategic process Weight

1 World class supply base 14

2 Supplier partnerships 12

3 Manage costs 8

4 Integrate supplier in ORP 4

5 Supplier dev. and quality mgt. 4

6 Integrate supplier in NPD 2

7 In/Outsourcing 0

6.3.4 Set goals

The KPAs eventually boil down to a number of key performance indicators, values to which

quantitative measures can be given. The structure of each KPA is demonstrated in figures

6.6 and 6.7. Whereas this view would suggest that both KPAs are independent from

eachother, in fact, they interact. By shifting procurement efforts to other commodities,

the KPI no. contract buys / no. spot buys is influenced. In turn, this will influence the

purchasing cost.

Figure 6.6: KPIs of supplier relationships

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Figure 6.7: KPIs of cost management

Previous analysis allows to set up a few future state scenarios. Their results will allow an

evaluation of the model to take place. The total procurement costs and the amount of

orders per commodity is kept a constant over current and future state.

Scenario 1: Lower supply risk for Mechanical

A decrease in supply risk would suggest the need for a larger capable supply base. This, in

turn, requires more sourcing efforts shifted towards the Mechanical commodity. Currently

17% of procurement efforts is focussed on Mechanical. When procurement resources are

fixed, sourcing efforts are taken away from other commodities, in this case situated in the

non-critical commodity.

Assuming that the relative increase in procurement resources will increase the amount of

contract buys in the same proportion, no price difference will occur in the cost calculation.

A series of increases have been investigated, up to 25%. Only Capital goods and T&M

have been affected. At 25% the contract bu Results are summarized in figure 6.8.

90

Figure 6.8: Reduction of service prices and its influence on the total cost

At a 25% increase of procurement in Mechanical, the total purchasing cost decreased by

11%. At this point the contract buys of Capital goods were reduced to nil and the contract

buys of T&M were reduced by 35%.

Scenarios 2 and 3: Lower prices and costs on Services

Previous analysis has shown that the Service commodity also requires attention. The service

commodity can increase profitability on two levels:

1. Focus on price reduction

2. Decrease the amount of spot buys

The influence of reduced prices on service goods is shown in figure 6.9. Prices were

reduces up to 50%. At this point, the total purchasing were 10% lower. No shifts in

91

procurement efforts were assumed.

Similar to the decrease in prices, no extra procurement efforts are assigned to the commodity

to reduce the amount of spot buys. Spot buys were converted to contract buys in

equal number. The effect is demonstrated in figure 6.10. An increase of 50% contract buys

decreases the total purchasing cost with 12%.

Figure 6.9: Reduction of service prices and its influence on the total cost

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Figure 6.10: Decrease in spot buys in service

Scenario 4: Focus on short term sourcing for bottleneck commodities

The bottleneck commodities are Electronics, Materials, Safety, and Office. A focus on short

term sourcing can be translated in an increase in spot buys at these four commodities.

Hence, procurement activities are freed up, to invest in Leverage commodities, such as

Mechanical. The effect is shown in figure 6.11. The same calculation method can used as

when the supply risk for Mechanical was decreased. The procurement efforts are shifted

away from Electronics, the bottleneck commodity with the lowest profit impact, towards

Mechanical. This translates into an increase in handled contracts and contract buys.

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Figure 6.11: Increase in spot buys for bottleneck commodities

Increasing procurement in the Mechanical commodity with up to 25%, the total purchasing

cost decreases with 6%. At this point, the procurement efforts in Electro had decreased

with 66%.

6.4 Discussion of the results

After applying the framework from chapter 4, four possible improvement areas were re-

vealed, two of which included shifts in procurement activities to other commodities. Im-

provements in the purchasing cost up to 12% were observed. The costs improvements at

their maximum observed levels are summarized in figure 6.12.

94

Figure 6.12: Summary of the four scenarios

It has become clear that influencing the KPI spot buy/contract buy ratio will deliver the

largest results. This is due to the large share of the variable Price in the cost per purchase.

Increasing the amount of contract buys over the amount of spot buys will influence the

variable Price, and, thus, the purchasing cost.

Some remarks can be made, though. Only primary effects were included into the calculation.

These are immediately calculable through shifts within the cost model. Shifts include the

number of contracts handled, prices, and the ratio of contract buys over spot buys within

a commodity. Secundary effects were not included. A clear example of this is given in

scenario 4. Whereas short term sourcing is recommended by literature, it effects the total

cost in a negative way. However, what is not included in the cost model, is the effects of

increased independence. These effects are hard to quantify, and, thus, not included in the

cost model.

Another remark can be made about the limits of the shifts. In the previous cases, the shifts

were limited to 25 and 50%. However, it’s not possible to say what are realistic limits. Still,

the previous cases give a good picture of what is possible in a certain spectrum of change.

Also, further research is required to make a more founded judgement on the capability of

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suppliers. This thesis made use of the ratio of active suppliers over known suppliers as

the only indicator for capability. Research could identify additional indicators or another

cut-off point.

96

Chapter 7

Conclusion

To improve supply management within purchasing departments, two prominent models are

used in the field: Kraljic’ portfolio method and the Michigan State University purchasing

model. Through a review of these models, it has become apparant that neither is solely and

fully applicable for supply management improvements at a procurement service provider.

The MSU model distinguishes fourteen key processes within purchasing. However, a series

of case studies have demonstrated that there’s one central process, linking the others to-

gether: commodity strategy development. Unlike the other processes, commodity strategy

development itself hasn’t been intensely researched, though. This can be attributed to the

fact that it’s a boundary spanning strategic process, and that the other processes can be

seen as sections of commodity strategy development. Because the priority in supply man-

agement is commodity strategy development, this thesis has constructed a framework to

guide commodity managers as they develop their strategy.

The suggested framework consists of nine aspects, devided into four steps. Because com-

modities evolve over time, and a periodic review is recommended, these four steps have

been put into a PDCA-cycle.

To evaluate the framework, a cost model has been worked out. The model differentiates

between procurement en purchasing. Within purchasing, an important distinction is the

acquisition through spot buy or through contract buy. Through a case study at GIS Europe,

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it seems that through investments in procurement, the price of the goods can be lowered

by 24%. This price difference can be considered a cost and is the biggest contributor to the

purchasing cost. Up to 74% of the spot buy cost, and 64% of the purchasing cost consist

of this additional price. Thus, influencing, the number of contract buys over the number

of spot buys will have a significant impact on the total cost.

The framework points out several possible scenarios to improve the supply management.

The case study at GIS Europe has shown that the framework mainly aims at the alteration

of the ratio of contract buys over spot buys. Application of the cost model on these possible

future states has proven that the framework’s suggestions decrease the total cost.

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99

Appendix A

MSU scorecards

© Purspective 1

Conclusions: Insourcing / Outsourcing

0 No or little evidence of any decision making process on insourcing/outsourcing

1 Ad hoc approach, specific crisis related decisions and implementation, key person focused, capacity driven, with limited review measures. Purchasing only involved in execution/implementation.

2 Systematic, cross-functional decision making process on current core & non-core competencies: based on internal information and short-term objectives. Little evidence of a structured implementation process.

3 As per 2, but based on internal and external information. Purchasing is already involved in decision making process to provide input and knowledge about the current supplier base.

4

As per 3, but based on current and future requirements: decisions are clearly taken with knowledge of own and current supplier’s long term strategies and capabilities (with benchmark studies about competitors’ decisions if appropriate)

5

As per 4, but insourcing/outsourcing decisions are taken with knowledge of current and potential supplier’s short and long term strategies and capabilities. Potential suppliers are identified through market research and supplier assessments

6

As per 5, and insourcing/outsourcing decisions are clearly based on integral cost & cash flow calculations (including fixed corporate and factory/site overhead costs). There is a clear view on all costs and there is an evaluation of all cost elements before and after in/outsourcing. Evidence of clear objective setting and measurement.

7 As per 6, and there is some evidence of a structured implementation process. Well-defined outsourcing agreements are available which cover all relevant issues. Some targets are set.

8

There is a formal and regular insourcing/outsourcing decision making process (as per 6) and there is a formal implementation process. Evidence of a joint planning with clearly defined milestones, based on a clear work breakdown addressing transformations in both the Order Realization and Product Creation Process.

9

As per 8, and there is a formal post decision review process with executive follow-up of targets based on analysis of measures and corrective actions. Evidence that targets and objectives have been achieved.

10 Cross-organizational decision making process (total supply chain focus): globally established core competencies (internally and at customers and suppliers).

100

© Purspective 1

Conclusions: Commodity Strategy Development

0 No Commodity Strategy Development process visible/ in place.

1 Some evidence of Commodity Strategy Development within the purchasing department. No documented strategy. No communication towards key stakeholders.

2

Multi-functional Teams in place to develop Commodity Strategies. People in place to set the charter for those teams, to co-ordinate decisions across different teams, to consciously evaluate the appropriate level & place in the organization (cross-functional, cross-site, cross-business), and to decide on appropriate participants. Evidence of minutes of meetings. Commodity Strategy Development is based on the identification of internal purchase item requirements. Focus on (short-term) costs and volume leveraging.

3

As per 2, but Commodity Strategy Development is also based on thorough understanding of supplier market structure & trends (documented), including current and potential suppliers’ business situation, capabilities and performance.

4 As per 3, and based on the identification of external (customer) requirements. Focus on long term requirements and capabilities.

5

Formal, structured and documented Commodity Strategy Development Process in place, based on total internal & external requirements identification (as per 2, 3 & 4) including a formal evaluation process for prioritizing on quality, cost, delivery, technology, service and environmental requirements. Detailed action plan available showing tasks, accountabilities, timing and critical path actions. Little evidence of communication with key stakeholders and breakthrough goal setting

6 As per 5, but based on alignment of internal (customer) and external (supplier) future technology roadmaps.

7

As per 6, but including SMART (specific, measurable, time-driven) breakthrough goals, aligned with the business and purchasing objectives. Structured follow-up and review of targets with corrective action planning. Evidence of achieved and improving results.

8 As per 7, and with regular communication of the commodity strategies towards key stakeholders (internally and externally).

9 As per 8, and Commodity Strategy Development Process includes benchmarking (to determine World Class levels) and internal & external (across industry, incl. competition) gap analysis.

10

As per 9, and involvement of suppliers in Commodity Strategy Development Process for strategy definition, goal setting and risk/award assessment. Formal Supplier Market Risk Assessment (SMRA) is an integral part of the Commodity Strategy Development Process.

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© Purspective 1

Conclusions: Supply Base Optimization and Management

0 No/little analysis of the supply base, no supply base improvement process in place.

1

There are some initiatives to optimize the current supplier base (e.g. supplier reduction plan available) based on qualitative perception of performance and basic evaluation of costs and risks. Basic differentiation is made between key and non-key suppliers.

2

Formal and documented Supplier Selection process in place, focused on current needs and capabilities. Differentiation is made between commercial, preferred and partner suppliers. Little evidence of differentiated actions in line with this distinction.

3

As per 2, and basic Supplier Rating System in place: at least quality and delivery performance of key suppliers are measured. Little evidence of formal communication towards key stakeholders and no improvement actions planned.

4 As per 3, but Supplier Rating System is completed with a basic Supplier Categorization System (e.g. green -continue-, yellow –potential or actions required-, red –eliminate-) which supports a supply base optimization plan.

5

As per 4, but supplier list is extensively analyzed based on turnover and risk. Documented evidence of the Pareto (80-20) Analysis and Portfolio Analysis. There is little evidence of differentiated actions in line with these analyses.

6

As per 5, but there is clear evidence of differentiated Supply Base Management on the basis of Portfolio/Pareto analysis. Documented evidence of differentiated strategy/actions towards commercial, preferred and partner suppliers.

7

As per 6, but Advanced Supplier Rating system in place: covering on-going production and product creation, criteria are weighted (aligned with business objectives), multi-functional involvement, objective measurement. Evidence of improving results and achieved targets. Information is communicated towards suppliers, and discussed in regular improvement meetings. Following information is available for all key suppliers and communicated towards stakeholders: current status, performance and improvement actions.

8

As per 7, but regular assessments take place for all key suppliers (e.g. process capability studies and profile update processes) in order to clearly understand and communicate current and future capabilities of suppliers (in relation to current and future needs of the business).

9

As per 8, and time and resources are available for fundamental Market Research, based on full understanding of business requirements and supplier base. Documented evidence of market research planning and execution.

10 Differentiated commodity strategies in place (at least score 7 in element 2) in order to optimize the supplier base and to maximize performance with the correct number and correct suppliers.

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© Purspective 1

Conclusions: Supplier Partnerships

0 No identification/recognition of business needs for Supplier Partnerships

1

Formal definition identifies for which categories of suppliers to establish Supplier Partnerships and comprises long term relationships, interdependency and trust development. Formal process in place to identify the criteria and objectives for each alliance, in line with business objectives.

2 Documented and structured process in place to identify, assess and select potential partners against alliance criteria (as defined per 1). Little evidence of formal communication framework and common goal setting.

3 As per 2, and partnerships agreements are available, including documented evidence that you work on a partnership program (commitment to work on issues as per 4 to 10).

4

As per 3, and executive focal point at both companies to lead and manage the relationship. Some efforts to discuss the supplier alliance as a separated agenda point and to start joint improvement programs. Multiple-level communication in all functions is established, including a formal communication framework.

5 As per 4, and partner is integrated in Product Creation Process.

6 As per 5, and shared objectives are set for current projects. There is a joint objective setting and joint planning process in place. Little evidence of alignment of future strategies and objectives.

7 As per 6, and value chain cost are jointly analyzed. Open door policy to share cost calculations and cost breakdowns.

8 As per 7, and clear evidence of a joint aggressive continuous improvement agenda, based on self-assessment benchmarked against World Class. Continuous review of partnership against objectives

9 As per 8, and joint/mutual education and training program in place. Evidence of achieved targets and improving results.

10 As per 9, and there is a formal alignment of future technologies, objectives and strategies. Complete openness to share future product and technology information.

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© Purspective 1

Conclusions: Supplier Integration in Product Creation Process

0 No or little evidence of supplier integration in PCP. No PCP policy available.

1 PCP policy/procedure available, including role of purchasing and determining tasks and responsibilities at every milestone for purchasing and suppliers.

2 As per 1, and formal make/buy decision making process in place to identify project needs for external technologies & capabilities. Evidence of purchasing involvement in the PCP from early start (in pre-concept phase).

3 Selection of suppliers is based on clear understanding of (development & process) capabilities against those needs identified per 2. Further (process) assessments if necessary.

4

As per 3, and formal decision making process to determine moment of supplier involvement, based on degree of development responsibility and development risk. Some evidence of target setting and contracting (at least non-disclosure and intellectual property agreement).

5 As per 4, and project objectives are clearly set (including timing, quality and costs), and translated into purchasing and supplier objectives. Development contracts available in which supplier objectives are defined.

6 As per 5, and regular meetings are scheduled. Cross-functional multiple-level communication established to address project objectives (more than product functionalities). Resident Engineering organized if appropriate.

7

As per 6, and supplier performance is measured and reviewed against expectations. Corrective actions are planned and implemented if necessary. There is a formal advanced supplier rating system for supplier performance in PCP. There is evidence of improving results and achieved targets.

8 As per 7, and an open door policy of sharing appropriate technology roadmaps, costs and customer information is practiced. Evidence of key supplier involvement in pre-concept stages of development.

9

As per 8, and internally/externally linked information systems (e.g. extranet. EDI, CAD/CAM, databases, PDI) facilitate information exchange in order to reduce throughput time and development costs. There is a formal post-review process in place to evaluate development projects with the supplier and to determine future improvement programs.

10 As per 9, and preferred supplier lists are available per technology cluster, supported by worldwide searches, continuous industry monitoring, and joint technology roadmap discussions.

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© Purspective 1

Conclusions: Supplier Integration in Order Realization Process

0 No/little evidence of actions and programs to improve the order realization process and to integrate suppliers into the ORP.

1

Evidence of internal optimization of the production planning process. Formal internal communication is organized involving marketing, manufacturing/logistics, and purchasing to align market demand, production capacity and supply.

2 As per 1, and there is an automated integrated scheduling and order processing system in place to optimize internal information exchange.

3 As per 2, and there is evidence of targets for reduction of lead times and throughput times as part of the purchasing improvement plan (only internally discussed).

4 As per 3, and there is evidence that key first tier suppliers are involved in the requirement planning and scheduling process. Automated forecasts are shared with those suppliers.

5

As per 4, and there is evidence of an active process to reduce incoming good inspection and some evidence of leading edge supply (e.g. ship-to-stock, ship-to-line, automatic bar coding) resulting in less process steps and lower inventory levels.

6 As per 5, and there is evidence of cross-organizational teams (buyer and supplier) to reduce inventories, lead times, and throughput times. Evidence of an action plan, implementation of actions and review of targets.

7 As per 6, and information systems allow information sharing externally with multiple tier suppliers and customers (e.g. extranet, EDI)

8

As per 7, and there is a comprehensive alignment and integration over the full supply chain with both multiple tier suppliers and customers for planning, inventory reduction, invoicing, etc… (e.g. self-billing, supplier held inventory, kanban outside organizational borders)

9

As per 7, and there is evidence that supply chain capabilities are maximized through optimal design of systems and procedures resulting in practices such as reliance on actual consumer demand and limited forecasting to drive order realization, very low inventories in basic forms located with second and third tier suppliers, fully integrated enterprise requirements planning (ERP) and quick response systems.

10 Cross-organizational Supply Chain benchmarking resulting in World Class improvement programs.

105

© Purspective 1

Conclusions: Supplier Development And Quality Management

0 No/little evidence of structured follow-up on supplier quality and improvement programs.

1 All key suppliers are externally certified and/or went through a formal qualification process.

2

As per 1, and formal system in place for basic measurement of supplier performance (e.g. supplier rating). Little evidence of communication of these results (towards suppliers) with appropriate analysis and corrective action planning.

3 As per 2, and ad hoc response to supplier problems (e.g. poor quality or late delivery): reactive supplier development.

4

As per 3, and formal complaint procedure in place in order to communicate efficiently internal complaints towards suppliers. Evidence of follow-up of suppliers’ corrective actions based on these complaints and the supplier rating results.

5 As per 4, and supplier visits and/or days are organized for supplier recognition and to communicate structurally business strategy and purchasing objectives. Several formal supplier audits have taken place.

6

As per 5, and there is evidence of process studies and audits at all key suppliers in order to fully understand all suppliers’ current and future capabilities. This information is documented, regularly updated and effectively communicated towards key stakeholders.

7

As per 6, and process control systems have been agreed with all appropriate suppliers. There is statistical evidence of stability & capability from those suppliers or there is evidence that corrective actions are planned.

8

As per 7, and there is evidence of Strategic Supplier Development: pro-active response, concentrating efforts to most important commodities and suppliers. Trained and dedicated personnel is accessible for supplier quality and development. On site supplier assessments have been organized (e.g. industrial supplier scans, quick scans)

9

As per 8, and advanced quality measures are in place: cost of non quality is measured and targets are set and communication towards suppliers and key stakeholders. Evidence of a zero defect program. Evidence of improving results and achieved targets.

10 As per 9, and supplier surveys and joint/mutual trainings are organized to learn in two directions and to establish common improvement programs (with targets and follow-up)

106

© Purspective 1

Conclusions: Strategic Cost Management

0 No/little evidence of cost improvement programs

1 Evidence of basic purchase price management: focus on negotiation & leveraging

2

As per 1, but evidence of the structured implementation of the Total Cost of Ownership principle (e.g. in supplier selection criteria). A formal TCO-procedure is implemented for some key components and/or special purchases (e.g. equipment, spare parts)

3

As per 2, but employee suggestion programs and cross-functional teams to discuss cost reduction opportunities (in house Strategic Cost Management). Little evidence of involvement of suppliers and the application of cost models for a.o. supplier selection.

4 As per 3, and supplier contracts (longer term) include improvement incentives or cost-containment (efficiency) targets. Some evidence of joint (supplier-buyer) brainstorming for cost improvement opportunities.

5

As per 4, and evidence of Target Costing in the Product Creation Process: cost down budgeting (starting from the price the customers wants to pay, bringing it down to what the maximum price for a component should be) is implemented for all projects.

6 As per 5, and there is evidence of structural application of several cost models to select suppliers and drive cost structure improvement programs. Evidence that purchase cost price follows at least market price erosion.

7

As per 6, and there is evidence of joint (supplier-buyer) brainstorming for cost improvement opportunities, e.g. cross-organizational Value Analysis/Value Engineering teams, aim&drive programs. Evidence of actions and results.

8 As per 7, and there is a structured and formal organized incentive program to solicit supplier cost reduction ideas, e.g. profit & gain sharing contracts, supplier suggestion programs, idea awarding.

9

As per 8, and cross-functional teams with supplier and customer involvement systematically establish total cost targets and measures. Follow-up (measurement and review) of those cost improvement actions. Evidence that targets are achieved.

10 As per 9, and there is a formal, structured and documented cross-enterprise supply chain cost improvement decision making process in which all suppliers and customers are taken into consideration.

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© Purspective 1

Conclusions: Strategies and Plans

0 No purchasing plan exists.

1 Purchasing plan exists but only describes departmental actions to be implemented.

2

Purchasing plan is derived from detailed understanding of the current supplier market structure and opportunities. Categorization systems for General Expenses (NPR/NPI) and BOM (e.g. portfolio analysis) support different actions towards differentiated suppliers.

3 As per 2, but with clear purchasing objectives aligned with business objectives and laid down in overviews such as the balanced scorecard or the Hoshin plan.

4

As per 3, but realization of purchasing plan is part of formal business planning and review process. Purchasing plan is integral part of Business plan. Purchasing objectives are aligned with business and other objectives. Targets are actively pursued and adjusted (when applicable) by Business Management.

5

As per 4, but purchasing plan is well communicated towards key internal stakeholders including the central commodity teams (e.g. presentation in development or management team meetings and/or distribution of copies). Little evidence of communication of (parts of) the purchasing plan towards key suppliers.

6

As per 5, with evidence that self-assessment results have been used to determine purchasing objectives and to set priorities for improvement actions in the purchasing plan. Some targets in the purchasing plan are focused on the internal efficiency (e.g. resources, IT, process optimization) and not only on the (external) supplier optimization.

7 As per 6, and purchasing plan is deployed through intensive discussions and approval in multi-disciplinary teams. Top management and key stakeholders buy-in is actively pursued and obtained.

8

As per 7, and relevant parts of the purchasing plan are communicated and discussed with key suppliers (preferred and partner suppliers) via for example the commodity strategy development teams. Evidence that outcome of discussions and targets are used for (future) update of the purchasing plan.

9 As per 8, and Supply Market Risk Assessment is an integral part of the purchasing action plan.

10

As per 9, and purchasing plan is supported by benchmarking of processes: objectives are based on gap analysis with Best-in-Class and competition. All appropriate targets for internal efficiency (e.g. resources, IT, process optimization) are taken into account.

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© Purspective 1

Conclusions: Organization and Teaming Strategies

0 No coordination and teaming across functions and organizations. Purchasing performs a clerical/administrative role.

1 Little coordination between purchasing functions of local organizations within BU.

2

The purchasing organization is completely involved in all areas of purchasing spend (all BOM, General Expenses (NPR/NPI) and resale expenditure), timely enough to contribute to the supplier selection and contracting phase. Initial purchasing (upstream activities such as contracting, involvement in Product Creation Process and market research) is implemented as a separated set of activities next to more procurement/ operational purchasing (downstream activities such as expediting and ordering). Little evidence of strategic purchasing activities.

3 As per 2, and purchasing performs a tactical and strategic role. Head of purchasing at sites is member of the local Management Team. Reporting level is first or second level executive at BU and company-wide.

4

As per 3, and some evidence of coordination of purchasing across BU’s. Purchasing is a global versus regional/local organization with some company-wide, cross-location purchasing leveraging throughout the company. Some cross-functional teams to enable purchasing processes.

5 As per 4, and several cross-functional teams are installed at local level to enable supplier evaluation, -selection and -integration in Product Creation Process.

6

As per 5, and strategic purchasing is implemented as a separated set of activities integrated into more initial and operational activities. Typical strategic purchasing activities are formally and structurally performed such as fundamental market/technology research, commodity strategy development and involvement in pre-development.

7

As per 6, and all appropriate cross-functional teams are in place at local and global level and a mandatory part of supplier evaluation/selection and supplier integration process. Steering Group in place to set the charter for those teams, to co-ordinate decisions across different teams, to consciously evaluate the appropriate level & place in the organization (cross-functional, cross-site, cross-business), and to decide on appropriate participants.

8 As per 7, but cross-functional/cross-location teams are also mandatory part of the development process at the supplier (with dedicated supplier development managers).

9 Appropriate external customers and suppliers are member of the cross-functional/ cross-location teams to enable purchasing process as per 7 & 8.

10 Current purchasing organization and structure is perfectly aligned with BU strategies, objectives and structures and fully supports and maximizes strategic, initial and operational purchasing.

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© Purspective 1

Conclusions: Globalization

0 Initiatives are typically focused at the local site level. Known suppliers are primarily local.

1 Evidence that local buyer has investigated opportunities outside organization/local borders. Awareness about global initiatives by corporate and BU purchasing.

2 As per 1, and there is evidence that international or global purchasing offices have been considered (and used if appropriate), and/or local purchasers abroad support purchasing in less accessible regions.

3 As per 2, and market research and supplier selection process is in place to identify local, regional and global suppliers

4 As per 3, and there is evidence that the local organization has been considering (and participated where possible in) national and global contracts.

5 As per 4, and there is some evidence of the use of IS/IT systems which clearly enable globalization. Reliable global data are available, provided by the system

6

As per 5, and organization structure and reporting relationships are in coordination with global strategy (e.g. lead buyer responsibilities have been defined, local purchasing organizations have been developed). Evidence of involvement in some global teams.

7 As per 6, but all appropriate worldwide councils are established to facilitate learnings and create maximum benefits. An organization has been set up to look with global leadership.

8 As per 7, and there is extensive use of IS/IT systems which enable globalization, including a global databank of supplier profiles.

9 As per 8, and there is evidence of development initiatives for selected/qualified local suppliers in order to become global suppliers (where applicable).

10 As per 9, and sourcing decisions are key issues in the decision making process to determine the set-up of local operations (e.g. satellites, industrial campus).

110

© Purspective 1

Conclusions: Measurements

0 No integrated set of supplier / purchasing performance measures.

1

Basic set of supplier performance measures in place: quality, price behaviour, delivery responsiveness and support for on-going production are measured over time against target. Classification system for Purchased Goods and Services is implemented.

2 As per 1, and there is evidence that purchasing measures are aligned with purchasing and business objectives.

3 As per 2, and formal criteria are in place to identify which suppliers should be measured. Feedback about performance against target is provided to key stakeholders and regularly reviewed.

4 As per 3, but measurement data is used to set up common breakthrough improvement plans with suppliers. There are some improving trends in the supplier performance.

5 As per 4, and there is an advanced integrated set of performance indicators in place to measure supplier performance in the Product Creation Process.

6 As per 5, and measures for purchasing process efficiency are in place (for purchasing process optimization). Those measures are visualized, communicated and understood throughout the organization.

7 As per 6, and yearly and regular Self-Assessments are organized to measure supply and purchasing performance against the World Class Excellence Model.

8

As per 7, and qualitative and quantitative total cost-based performance measurement over the life cycle of the purchased item, which includes price behaviour, quality, delivery and supplier non-performance costs, are established and regularly used for sourcing, design and continuous improvement. Results are continuously improving.

9

As per 8, and purchasing performance measures are part of an integral set of business performance measures and reviewed regularly (at least quarterly) and formally at management level (e.g. Business Balanced Scorecard, Hoshin plan)

10 Measurement data are used with suppliers and customers to identify, isolate and analyze the key product cost drivers throughout the Supply Chain.

111

© Purspective 1

Conclusions: IS/IT Systems

0 No Purchasing Information System in place. No network connection for the purchasing department in place.

1 There is a stand-alone Purchasing Information System in place for purchasing order processing.

2 Purchasing Information System is part of the integral business information system (e.g. SAP MRP, MfgPro) in order to optimize the complete Order Realization Process.

3 As per 2, and there is an email/internet connection for the purchasing department in place

4 As per 3, and evidence of Purchasing Performance Indicators generated automatically by the Information System.

5 As per 4, and Information System supports supplier involvement in Order Realization Process: cross-organizational links in place such as extranet and EDI.

6 As per 5, and evidence of the use of data warehouses which support strategic purchasing by enabling volume leveraging, standardization and centralized commodity management with distributed procurement as well.

7 As per 6, and Information Systems support purchasing decision making and analysis process (e.g. cost modelling)

8 As per 7, and Information Systems enable supplier involvement in Product Design (e.g. extranet, CAD/CAM links).

9 As per 8, and evidence of extensive use of internet technology opportunities (e.g. E-commerce, supplier search)

10 As per 9, and evidence of a formal and pro-active participation in IS/IT management to identify purchasing needs and implement strategies. IS/IT policy in place, aligned with corporate IS/IT policy.

112

© Purspective 1

Conclusions: Human Resource Management

0 No or little evidence of Human Resource Management support for the purchasing process.

1 Availability of updated purchasing profiles (including function descriptions and skill requirements). Use of these profiles for recruitment.

2 As per 1, and evidence of individual performance appraisal and individual business targets/objectives setting for every purchaser. Little evidence of personal development objectives.

3

As per 2, and there is evidence of a reward and recognition plan related to purchasing performance. Explicit link between the achievement of purchasing objectives and the outcome of performance appraisals (for all people involved in the purchasing process). Reward and recognition plan related to multi-functional/location team performance in place.

4

As per 3, and there is a continuous and formal process in place to review individual skills (required vs. available) and to recruit and/or train to fill the gaps. Evidence of the use of function profiles and Human Resource involvement in this process.

5 As per 4, and there are purchasing specific HRM policies and objectives in place, including succession planning, training and recruitment (at BU and site level).

6 As per 5, and purchasing is formally included in the annual MD review (career path planning) of respective entity.

7

As per 6, and personal development plans are in place (including individual training and career path planning) based on purchasing profiles, gap analysis, and performance appraisal. Regular reviewed with purchasing manager and individual.

8

As per 7, and entity shows active pursuing of career planning across functional disciplines at all levels. Some purchasers have experience outside the purchasing department and some other departments employ ex-purchasers.

9 As per 8, and entity shows active pursuing of career planning across locations and BU’s. Some purchasers have international experience and/or experience in other BU’s and locations.

10 As per 9, and there is evidence of multi-functional performance appraisal. Formal process to set team targets and to review performance against targets regularly.

113

Appendix B

Pairwise comparison of key

performance areas

Figure B.1: Pairwise comparison

114

Appendix C

Case study data

Figure C.1: GIS Europe’s procurement input

115

Figure C.2: GIS Europe’s 2009 acquisitions

116

Figure C.3: Logistic inputs and values

117

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List of Figures

2.1 planned company structure, a work in progress . . . . . . . . . . . . . . . . . 6

3.1 Kraljic’s classification matrix . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

3.2 The new product development process . . . . . . . . . . . . . . . . . . . . . 27

3.3 Process model for reaching concensus on suppliers to integrate into NPD [23] 29

3.4 Brown’s strategic measurement model . . . . . . . . . . . . . . . . . . . . . . 36

3.5 Important processes in A.T. Kearney’s House of Purchasing and Supply . . . 40

4.1 msu assessment of gis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

4.2 Maximum scores for PSPs in the MSU model . . . . . . . . . . . . . . . . . 53

4.3 Periodic review of the commodity strategy . . . . . . . . . . . . . . . . . . . 54

4.4 Example of a template . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

4.5 Example of a pareto analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

4.6 Sixteen different strategies within Kraljic’ matrix . . . . . . . . . . . . . . . 59

4.7 Key performance indicators hierarchy . . . . . . . . . . . . . . . . . . . . . . 61

4.8 Kotter’s model for change . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

5.1 Purchasing flow of a spot buy . . . . . . . . . . . . . . . . . . . . . . . . . . 69

124

5.2 Purchasing flow of a contract buy . . . . . . . . . . . . . . . . . . . . . . . . 71

5.3 Summary of the activities and their cost structures . . . . . . . . . . . . . . 75

6.1 Current state procurement expenses . . . . . . . . . . . . . . . . . . . . . . . 79

6.2 Total logistic costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

6.3 Current state total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

6.4 Profit impact of the commodities . . . . . . . . . . . . . . . . . . . . . . . . 86

6.5 GIS Europe’s commodities in Kraljic’ matrix . . . . . . . . . . . . . . . . . . 88

6.6 KPIs of supplier relationships . . . . . . . . . . . . . . . . . . . . . . . . . . 89

6.7 KPIs of cost management . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

6.8 Reduction of service prices and its influence on the total cost . . . . . . . . . 91

6.9 Reduction of service prices and its influence on the total cost . . . . . . . . . 92

6.10 Decrease in spot buys in service . . . . . . . . . . . . . . . . . . . . . . . . . 93

6.11 Increase in spot buys for bottleneck commodities . . . . . . . . . . . . . . . 94

6.12 Summary of the four scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . 95

B.1 Pairwise comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

C.1 GIS Europe’s procurement input . . . . . . . . . . . . . . . . . . . . . . . . 115

C.2 GIS Europe’s 2009 acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . 116

C.3 Logistic inputs and values . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117

125

List of Tables

3.1 Components of supply chain management, adapted from [39] . . . . . . . . . 9

3.2 Benefits and criticisms of lean procurement for SMEs [62] . . . . . . . . . . 13

3.3 Supply management approaches of the four product categories . . . . . . . . 15

3.4 SMEs methods of dealing with . . . . . . . . . . . . . . . . . . . . . . . . . 24

3.5 Perceived importance and implementation of global procurement character-

istics [36]; scale: 1=lowest, 5=highest . . . . . . . . . . . . . . . . . . . . . . 34

4.1 Commodity strategy development self-assessment . . . . . . . . . . . . . . . 52

6.1 Parameters to calculate the procurement cost . . . . . . . . . . . . . . . . . 78

6.2 Times to place an order . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

6.3 Cost per purchase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

6.4 Capable suppliers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

6.5 Key performance areas defined by GIS Europe . . . . . . . . . . . . . . . . . 89

126