NOTES PROCUREMENT CHAPTER 3

CHAPTER 3: SOURCING IN PROCUREMENT

Definition of Sourcing
Refer to buying materials or components from suppliers instead of making them in-house. Raw material
that supplier or vendor are to supply to the firms and have closer relationship between suppliers/vendors
and buying organizations towards JIT buying.

The difference between procurement, purchasing and sourcing

Procurement
 Procurement is concerned with acquiring of goods and services.

Purchasing
Purchasing simply involves buying and selling of the goods and services.

Sourcing
Sourcing is finding a least expensive supplier for those goods.

Vertical Integration

• Strategy where a company expands its business operations into different steps on the same production

path, such as when a manufacturer owns its supplier and/or distributor.

• Help companies reduce costs and improve efficiency by decreasing transportation expenses and reducing

turnaround time, among other advantages.

• More effective for a company to rely on the established expertise and economies of scale of other

vendors rather than trying to become vertically integrated.

Backward vertical integration

• Refers to acquiring up streams suppliers for example, an end product manufacturer acquiring a suppliers

operations that supplies components part.

Forward vertical integration

• Refers to acquiring downstream customers for example, acquiring a distributor or other outbound logistics

providers.

Example:-

Attributes / Characteristics of a good supplier

Just in time

delivery

Sharing

information

Control and

support

Good in

communication

Involved supplier
in early discussion

Provide good

services

Right order

Type of Sourcing

Outsourcing
• Outsourcing involves transferring a portion of work or even an entire operation to outside providers or

supplier rather than completing it internally.

• Outsourcing has increased significantly in recent years as companies look for ways to improve efficiency

and reduce costs.

In-sourcing
• Usually means performing a business function internally.
• Many companies prefer in-sourcing because it lets them maintain control entire operation.
• The disadvantage the business will be adding new services, products and processes to its overall operation

that can effect to current resources, create new processes that need a different skill-net and even have
staff members leaving the company.

Co-sourcing
• Combines some of the benefits of both in-sourcing and outsourcing.
• Business agreement where the work is done by both internal staff and external workers.
• This help businesses lower the costs of their back office or administrative functions while still controlling

the critical parts of the client relationship.

Determine sourcing process

• A sourcing process is used to select the best product and service for a certain of expenditure.

• When selecting supplier through the sourcing process, the buyer will work in collaboration

with internal customer.

• The internal customer are buyer’s colleagues who are working in other department such as

finance or production.

• They are the ones who originally raised the need for the purchase and who will be actually

transacting with the selected suppliers.

“The sourcing has 4 distinctive phases”

i. Step 1: Specification development
• What are the needs of your internal customer i.e. the person who requires the product or service to be purchased?
• As a buyer, you challenge and ‘translate’ these needs in specifications that supplier can understand.
• The objective of buyers at the specification stage is twofold which are reducing total cost and safeguarding a competitive

market at the upcoming negotiation stage.

• Developing specifications in its turn is a 4 step processes:-

> Assess customer needs
> Assess what the market has to offer
> Develop specification
> Define winning criteria

ii. Step 2: Market Assessment
• Once the buyer has gotten a clear picture of business requirement, the next step needs to be done is to formally invite

the suppliers to quote for business.

• The formally approach the market via Request For Information (RFI) and Request For Quotation (RFQ).
• During the supplier determination procedure, it has 3 steps to select the possible supplier which are:-

> Preparing list of perspective supplier
> Determining all potential supplier
> Eliminating on various grounds until the number has been reduced to a workable few.

iii. Step 3: Negotiation
• At the negotiation stage, the buyer will analyze the offers and select the most promising suppliers to

negotiate with. Only then the negotiation will be carried out.

• During the meeting, the buyer’s goal is to clarify the terms of the offer and get additional value beyond

what has been offered, this might range from a lower price, a better quality product, improved payment
terms and etc.

• At the end of this process, buyer will conclude the deal with the best supplier.
• Most supplier build in a price concession in their first order. In order to obtain the concession, the buyer

must:-

> Built competition – to get the best results at the negotiation stage, the negotiator

should have at least two or more credible alternatives.

> Carefully analyze all quotation to get a feel for a selecting for stretching but credible

target.

iv. Step 4: Contract discussion
• The formal needs to be prepares by buyer with the supplier.
• In the contract, all of the agreed terms and conditions need to list out obviously without any changing

and amendment.

Types of Suppliers

a. Manufacturer
• A manufacturer is a person or a registered company which finished products form raw materials to

make a profits.

• The goods are later distributed to wholesalers and retailers who then sell to customer.
• In the manufacturing industry, products are made in large-scale so as to meet the irresistible demand

from consumers.

b. Distributor
• A distributor can be seen as the point of contact between the supplier and either a wholesaler or a

retailer.

• They serve as the intermediary that helps give retailer access to the products and services that they

want to sell.

• Their job is distributing products to those that want to sell them, whether they will then be sold to

consumers or to other businesses.

• Distributors might also be responsible for a specific geographic area, acting as the liaison for that area,

and requiring them to remain in that location.

• They are more likely to work with wholesaler or sometimes sell straight to retailers.

c. Broker/Sourcing agent

• A sourcing agent (also known as import agent, buying agent, or sourcing broker) is a regional

representative who performs outsourcing activities on behalf of the employer.

• They will reach out to variety of supplier and/or manufacturer, source the product you need and make a

commission out of the sale.

• If your business wants to import a ready-made product (or to have one made), a sourcing agent will

help you get the product into your hot little hand.

• Sourcing agent can help you navigate the processes from start to finish.

d. Local sourcing

• Refers to the sourcing of products or materials from manufacturers within your home country.

• Instead of reaching out to international supplies, you instead choose to buy from local manufacturers.

• If you are in demand of a quick turnaround, it might make sense to source from a local supplier who can

produce products and deliver within a certain time-frame, rather than have to take shipping times into
account.

e. Global sourcing

• Is the process of sourcing goods and services from the international market across geopolitical

boundaries.

• It aims to exploit global efficiencies such as lower cost skilled labor, cheaper raw materials and

other economic factors like tax breaks and low trade tariffs.

Single sourcing versus Multiple sourcing

a. Single sourcing
• Focus to one supplier only due to quantity discount or low shipping rates
• More economical due to low per unit handling and processing costs
• Easy to plan delivery on an orderly basis – JIT and blanket orders
• In times of material shortage, firm may have a greater assurance of supply

Reason favoring a single supplier:-
• To establish a good relationship
• Less quality variability
• Lower cost
• Transportation economies
• Proprietary product or process purchase
• Volume too small to split-easy to handle and manage

b. Multiple sourcing

• Firm who utilizes multiple supplier has greater assurance of uninterrupted supply in the event of

fire, flood or strikes which might disturb the operations of a single plant

• Multiple supplier stimulates competition among vendors in price, quality, delivery and service

• The decision to use multiple suppliers is influenced primarily by the amounts of raw material

required, the relative size of suppliers and their past performance

• Most buyers split orders between two or three suppliers depending on the amounts of raw

material required and the relative size of suppliers.

Reason favoring a multiple supplier:-

• Need capacity

• Spread the risk of supply interruption

• Create competition

• Gather information

• Dealing with specials of businesses

Supplier evaluation factors

• The decision to select supplier for office supplies or other noncritical materials is likely to be an easy one.

• However, the process of selecting a group of competent supplier for important materials, which can

potentially impact the firm’s competitive advantage, is complex one and should be based on multiple
criteria.

• Factors that firms should consider while selecting suppliers include:-

a. Process and product technologies

Suppliers should have competent process technologies to produce superior products at a reasonable cost to
enhance the buyer’s competitive edge.

b. Willingness to share technologies and information

Suppliers can assist in new product design and development through “Early Supplier Involvement (ESI)” to
ensure cost-effective design choice, develop alternative conceptual solutions, select the best components &
technologies and help in design assessment.

c. Quality

Product quality should be high and consistent since it can directly affect he quality of the finished goods.

d. Cost or price

The total cost analysis demonstrates how other costs beside unit price affect the purchase decision.

e. Reliability

Reliable quality level is the supplier financially stable? Is the suppliers delivery lead time reliable?.

f. Order system and cycle time

Delivery lead time should be short so that small lot sizes can be ordered on a frequent basis to reduce
inventory holding costs.

g. Capacity

The product and service supplied must always on regular basic. A vendor who has had supply issue will
influence your ability to meet the satisfaction of the customer due to the late shipment. Therefore, this is an
important factor when selecting vendor.

h. Communication capability
Facilities communication between parties.

i. Location
As it impacts delivery time, transportation and logistical cost.

j. Service
Supplier must be able to back up their product by providing good services when needed. Example of service
reserve capacity, internal operation, labor relations, warranties, vendor sources, plant visitations, financial
status and supplier goodwill.

h. Delivery time
You need to know that deliveries can be made where and when you want them. The number of deliveries per
week or month may also be one of the factors to consider for selection.

Supplier evaluation methods

a. The categorical method

• Basically, it is a procedure whereby the buyer relies on a historical record of supplier performance.

• Initially, a list of evaluation criteria is identified.

• The buyer then assign a grade to each supplier, for each criterion, based on past experience.

• A simple marking system of plus (+), minus (-), and neutral grades may be used.

• Evaluation lists are often provided to other department involved such as quality control, engineering,

production and receiving department.

• The buyer periodically assembles the ratings from these departments and uses them in conjunction

with his or her own.

• Vendor with composite high or low ratings are noted, and future supply decisions are influenced by

them.

• Although, this system is non-quantitative, it is mean of keeping systematic records of performance, it

is also inexpensive and requires a minimum of performance data.

Example:-

b. The weighted point method
• Evaluation criteria are based on weighted point where a number of evaluation factors can

be included, and their relative weights can be expressed in numerical terms so that a
composite performance index can be determined and supplier comparisons made.

• Each supplier in the supplier community is ranked according to one of the four following

categories:-

> AA = Group preferred supplier
> A = High performance supplier
> B = Performance supplier
> C = Low performance/conditional supplier

• Example criteria:-

> Quality of shipments – 40 points
> Accuracy of delivery promises – 30 points
> Frequency of cost-reduction suggestion – 20 points
> Price – 10 points

• Ranges:-

> 85 and above: excellent

> 70 to 84: acceptable

> 69 and below: unacceptable

Quality (40)

Delivery (30)

Cost-reduction (20)

Price (10)

Composite rating

Ranges

Vendor A

36

27

14

10

87

Excellent

Vendor B

32

15

4

8

59

Unacceptable

Vendor C

28

30

12

7

77

Acceptable

c. The cost ratio method

• Relates all identifiable purchasing costs to the value of the shipments received from

respective suppliers.

• The higher the ratio of costs to shipment, the lower the applicable rating for that supplier.

• What costs categories are used depends on the product involved.

• Example of costs categories: quality, delivery, service and price are the overall categories

and respective costs are accumulated for each.

• The quality, delivery and service cost ratios are combined with the quoted prices to

determine the vendor’s net cost.

Quality cost

ratio

Delivery cost

ratio

Service cost

ratio

Total cost
adjustment
Quoted price

Net adjusted cost

Vendor P

1

1

-3

-1

RM87.00

RM86.13

Vendor Q

2

2

+3

+7

RM83.25

RM89.08

Vendor R

3

1

+6

+10

RM85.10

RM93.61

Vendor S

2

1

+1

+4

RM85.00

RM88.40

d. The vendor management scorecard

• Creating or purchasing a vendor management scorecard is an essential component of

effective Supplier Relationship Management (SRM).

• A vendor management scorecard is a tool that is used to measure the performance and

effectiveness of vendors and suppliers that provide goods or services to the business.

• The vendor relationship process typically begins with the creation of an RFP/RFQ or another

document that vendors respond to in order for the business to objectively evaluate the
vendors capabilities and resources.

• When the best vendor for the task is selected, a contract negotiation process begins which

outlines all of the performance guidelines and expectations that a vendor will be legally
bound to adhere to.

• Once the terms of the contract have been agreed to by the buyer and seller, a binding

agreement is executed that summarizes the mutual expectations, particularly as it relates to
frequent monitoring and measurement of the vendors performance.

• Regular and frequent communications is necessary in order to ensure a successful vendor

management process.

e. ABC supplier analysis

• Method of supplier valuation that divides suppliers into categories based on total spend

over a period of time.

• This analysis allows managers to separate and manage the overall suppliers into three major

groups A, B and C.

• This allows different supplier management techniques to be applied to different segments

of the suppliers in order to increase revenue and decrease costs.