PROCUREMENT IN MANUFACTURING ORGANISATION: PORTFOLIO AND THE USE OF THE INTERNET

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1 PROCUREMENT IN MANUFACTURING ORGANISATION: PORTFOLIO AND THE USE OF THE INTERNET I Nyoman Pujawan Department of Industral Engneerng, Sepuluh Nopember Insttute of Technology, Surabaya Manchester Busness School, The Unversty of Manchester, UK ABSTRACT Procurement functon n manufacturng organsatons has played sgnfcantly more crtcal roles nowadays than n the past. The contrbuton of procurement functon s much determned by how well the procurement management system s desgned. A crtcal aspect of managng procurement functon n order to optmse ts contrbuton to the organsaton s procurement portfolo,.e., categorsaton of tems and then dfferentaton of procurement focus for dfferent categores. Ths paper wll dscuss procurement portfolo as a bass for procurement manager to optmse the contrbuton of hs/her functon n supportng the organsaton s objectves. The role of electronc procurement n each category of the portfolo wll also be dscussed. Keywords : procurement portfolo, manufacturng, electronc procurement. 1. INTRODUCTION Tradtonally, procurement has often been assocated wth clercal actvtes. People workng n a procurement functon spent most of ther tme admnsterng purchase requston from the unts or departments needng a product or servce, creatng purchase orders, delverng purchase orders to the supplers, admnsterng delvery schedule from the supplers, etc. When the tems or servce are purchased through a tenderng or bddng process, clercal actvtes such as draftng Request for Proposal (RFP) or Request for Quotaton (RFQ), admnsterng submtted proposal or quotaton, nvtng prospectve canddates, and conductng bddng process are among actvtes that are heavly assocated wth procurement functon. Those actvtes were often consdered to be less strategc, short-term cost orented, and hence, less effort was spent n dggng more strategc ssues of procurement actvtes. Wth the contnuous pressure n the market competton, people are startng to wden ther perspectve on what needs to be mproved n the supply chan. The fact that all manufacturng companes need heavy nvolvement of procurement functon and that the money spent by the procurement functon by large s domnant n the organsaton has gven manufacturng people crtcal understandng on how mportant and how strategc procurement functon s. When wder vewpont s taken nto account, procurement functon s not only crtcal to acheve cost advantage by obtanng low cost supply, but also contrbutes substantally to the other dmensons of the organsaton s compettve advantage. In addton to ts role to obtan cost advantage, procurement also supports the organsaton n mprovng responsveness, achevng better flexblty, and reducng rsks or mprovng relablty of the organsaton. As suggested by Ellram and Lu (2002), the fnancal mpact of purchasng and supply management goes well beyond cost reducton. It extends to such crtcal performance areas as busness growth, proftablty, cash flow, and asset utlzaton. 13

2 JURNAL TEKNIK INDUSTRI VOL. 5, NO. 1, JUNI 2003: Wth the above thngs n mnd, t s obvous that procurement people are held responsble for much wder responsblty nowadays. Understandng the strategc objectve of the company and deployng ths strategc objectve nto more specfc objectves, procedures, and standards n the procurement functon requres a vsonary manager. He or she should be able to brng hs or her staffs to support the organsaton strategc objectve. In other words, procurement manager should be able to algn the organsaton strategc objectves and the procurement objectves, procedures, and standards. Fgure 1 outlnes several strategc roles n whch the procurement functon s held accountable nowadays. In order to optmse the strategc role of procurement functon n a manufacturng context, t s mportant to put an approprate emphass or focus n lne wth the envronmental characterstcs facng the supply decsons. Classfcaton of tems based on ther envronmental condton and then the algnment of the focus of the procurement management for each of those categores or classfcatons s often known as procurement portfolo. Ths paper wll dscuss procurement portfolo to provde procurement manager wth a framework that can be used n optmsng the contrbuton of hs/her functon n supportng the organsaton s objectves. Strategc Roles of Procurement 1. Algn strategc role of the organsaton to procurement objectves 2. Actvely montorng procurement technology and adopt t when approprate 3. Develop procurement portfolo to approprately address dfferent supply characterstcs 4. Manage supply rsk 5. Develop healthy upstream competton 6. Mantan mportant nformaton from whch decson makng can be made more approprately 7. Facltate suppler nvolvement n new product development where approprate 8. Develop supply base where approprate Fgure 1. Outlnes of Strategc Roles of Procurement Functon 2. DEVELOPING PROCUREMENT PORTFOLIO Most organsaton normally deals wth thousands of tems to be purchased from supplers. Purchasng people are facng varous characterstcs of the tems and dfferent consumpton patterns. Characterstcs of tems may be assocated wth ther physcal volumes and propertes, desgn complexty, prce, etc. On the other hand, t s usual that a company manages varous dfferent demand patterns for the purchased tems. Some tems are requred at about the same quantty each week, some tems are needed n one week of each month, and many other tems are only needed several unts annually. Companes dealng wth fashon type products wll observe evolvng types of tems n ther database. Even manufacturng companes whch produce functonal tems lke lght bulbs, cereals, cgarettes, etc. are facng sgnfcantly dfferent consumpton pattern of the purchases. 14

3 Dfferences n the characterstcs of tems and n the pattern of consumpton are two out of many varables that make procurement actvtes dffcult. Other varables, such as the nature of market,.e., whether many capable supplers exst or the tems can only be suppled exclusvely by one suppler, the unt prce, the avalablty of local supplers, and the strategc mportance of the tem to the company are also mportant determnant n procurement decsons. Lterature on procurement portfolo suggested that n order to desgn an optmal procurement model, an organsaton should understand frst the characterstcs of tems to purchase, the demand pattern, maturty of the technology, and the avalablty of suppler. Wth respect to the type of relatonshp wth the suppler, Bensaou (1999) argued that no one type of relatonshp, not even the strategc partnershp, s nherently superor to the others. Ths means that each company should develop and manage approprately a portfolo of relatonshp. The types of relatonshp may be determned based on tem or product characterstcs, upstream market competton, and suppler condtons. For example, hghly standardsed tems wth stable or declnng demand, wth mature technology, and surrounded by many capable supplers whch the result n low swtchng costs would be approprately managed wth market exchange style of relatonshp. A market exchange relatonshp s charactersed by lmted nformaton exchange, lmted tme spent drectly wth suppler staffs, and vrtually no jont efforts between the buyer and suppler. On the other hand, complex tems whch requre hgh level of customsaton and large captal nvestment and can only be suppled by lmted number of supplers may be most sutably managed wth a strategc partnershp style. In a strategc partnershp model, both partes are wllng to share data/nformaton, extensvely nvolve n jont mprovement ntatves and n new product desgn. Handfeld et al. (2000) developed a commodty portfolo matrx based on volume of purchases and the degree of opportunty and rsk resultng n four classes of commodtes: non-crtcal, bottleneck, leverage, and crtcal strategc supples. The authors suggested that strategc supples are strategcally mportant and dffcult to substtute or to obtan from alternatve supplers and are usually purchased n large volume. A smlar portfolo was also used n Olsen and Ellram (1997) who dstngushed tems based on the degree of mportance and the dffculty of managng the purchase stuaton. Accordng to the authors, the degree of mportance s determned by three factors: competency, economc value, and mage. On the other hand, the dffculty of managng the purchase stuaton s determned by product characterstcs, supply market characterstcs, and envronment condtons. Fgure 2 presents a general portfolo based on the degree of crtcalty and the dffculty n obtanng the tem. The degree of crtcalty s determned by whether or not the tem s a core component of the fnal product. An tem has a hgh degree of crtcalty f unavalablty of the tem means that the producton process has to be stopped. Ths type of tem s normally requred n almost all of the fnal products and no substtute s avalable or possble. The degree of dffculty s reflected by the avalablty of capable supplers, flexblty n purchasng large or small quantty, and procurement lead tme, and delvery speed flexblty. An tem s consdered easy to obtan f many capable supplers are avalable wth hgh volume and speed flexblty. Items whch requre customsed and complex desgn s lkely to be uneasy to obtan because only lmted number of supplers s lkely to be capable of producng them. 15

4 JURNAL TEKNIK INDUSTRI VOL. 5, NO. 1, JUNI 2003: C r t c a l l y Hgh volume flexblty, low supply rsk, crtcal to the organsaton s success. Hgh volume flexblty, low supply rsk, not crtcal to the organsaton s success. Items are crtcal, maybe expensve, not many supplers are able to supply, rsk of supply shortage, competng wth other buyers. Low volume flexblty, there s a rsk of supply shortage, not so crtcal (not expensve and not part of the core process) D f f c u l t y t o O b t a n Fgure 2. Segmentaton of Purchases Based on Crtcalty and Dffculty to Obtan 3. ACHIEVING STRATEGIC COMPETITIVENESS BASED ON AN APPRO- PRIATE PORTFOLIO Creatng a classfcaton based on the above two dmensons s an mportant step n procurement management. However, the strategc mplcaton of ths classfcaton wll only be realsed when t s further translated nto dfferentated focus. Logcally, each cell, whch represents a unque set of characterstcs, wll have a dfferent focus from other cells. Fgure 3 outlnes the management focus that each cell should mantan. Cell 1 s a cluster of tems wth low degree of mportance and relatvely easy to obtan n the market. These tems are normally smple and standardsed, thus many supplers are capable of producng them. The technology requred to produce the tems s mature and n many cases, wth relatvely low complexty or unsophstcated. Many other buyers also normally need these tems. In manufacturng companes, commodtes tems such as bolt, nuts, and standardsed pant are examples of cell 1 tems. Most MRO (mantenance, repar, and operatons) tems also belong to ths classfcaton. Offce supples such as A4 papers are other examples. Snce tems are easly obtanable and the desgn are normally smple and standardsed, the buyer can focus on short-term purchasng nterest,.e., lookng at the prce, comparng them, and then select the best deal. Procurng these tems does not need to be done by evaluatng suppler technologcal capablty or ther fnancal poston. In other word, the buyer can desgn a very loose relatonshp and can move from one suppler to another whenever approprate and nvestment to mprove suppler capablty s hardly ever justfable n ths stuaton. As far as the procedure s concern, the buyer should strve to mnmse bureaucracy of the procurement process. Efforts should be spent to smplfy procurement process and the organsaton should delegate purchasng decsons to lower level of authorty. 16

5 C r t c a l t y Keep multple supplers. Look at other supply characterstcs, choce need not predomnantly be based on cost. The use of mult attrbute e-aucton s approprate. Focus on obtanng low cost supplers and smplfyng procurement processes. The use of e-aucton s approprate. Focus on mantanng effectve partnershps: ncrease suppler relablty and buyer s barganng power. Reduce long-term rsk. Use of on-lne nformaton exchange Focus on developng alternatve supplers. Invest n technology and knowledge to support suppler capacty and capablty. Develop purchasng consortum to justfy the nvestment. 4 D f f c u l t y t o O b t a n Fgure 3. Procurement Management Portfolo: Dfferences n Management Focus Cell 2 s a cluster of tems whch are not very crtcal but dffcult to obtan. They are non-core tems, sometmes the prce s not expensve, but only lmted supplers are avalable to supply wth a reasonable lead tme. Olsen and Ellram (1997) and Handfeld et al. (2000) referred to ths knd of tems as bottleneck. Low suppler avalablty may be due to the tems are economcally unattractve to produce or because the supplers are located far away so that t restrct speed flexblty. Qute often packagng tems for several manufacturng companes belong to ths classfcaton. Packagng tems are not core components and ther prce are normally not expensve, but qute often the manufacturer change or mprove the packagng desgns to mprove product appearance n the market and thus more appealng to the customers. Facng wth ths stuaton, a possble course of acton the management may need to take s to develop new supplers. If the suppler s developed exclusvely for the company, the volume of demand may not guarantee the economes of scale of ts producton. Thus, whereas approprate, ntatng what s called buyng consortum may be a vable opton. Suppler consortum s a group of buyng companes who am to obtan a better barganng power by poolng together ther demand. In ths framework, the buyng consortum s not prmarly developed to ncrease ther barganng power relatve to the suppler, but to ncrease the avalablty of the tems or to ncrease both volume and speed flexblty of the tems n queston. In contrast to cell 2, tems classfed to cell 3 are not dffcult to obtan and these tems are crtcal to the company. Companes that use standardsed tems as ther man components or materals wll often have cell 3 as domnant tems n ther purchases. Small to medum cake producers rarely use specalsed ngredents. Most of the ngredents, ncludng flour, sugar, and salt are standardsed tems that can be qute easly obtaned n the market. Because these tems are easy to obtan but the company normally 17

6 JURNAL TEKNIK INDUSTRI VOL. 5, NO. 1, JUNI 2003: requres n large volume, the focus n procurement management could vary. One company may need to keep more than one supplers and the buyng crtera need not be predomnantly based on cost. Other approprate crtera may be prortsed. The prce offered by one suppler maybe about the same, but one suppler s wllng to provde the buyer wth longer credt perod. Or, the quoted prce maybe the same, but one suppler s wllng to delver twce a day but other supplers are able to delver no more than once a day. In such a stuaton, the buyer should carefully choose what crtera to be used n selectng the suppler. Cell 4 s to accommodate strategc tems,.e., tems whch are hghly crtcal to the company and are not avalable as a commodty n the market. These tems requre specal capablty or sophstcated technology and thus, only lmted number of supplers s capable of producng/supplyng those tems. Lmted avalablty of supply ncreases the suppler s barganng power. Long-term rsk of supply could be hgh f the current suppler s not fnancally strong or f other buyers are competng wth the company to secure long-term supply avalablty. Due to these characterstcs, the company should spend substantal efforts to secure the supply and to mprove long-term suppler performance. Such a stuaton warrants the buyer to spend effort and money n ntatng long-term partnershp wth the suppler. Partnershp normally nvolves commtment to share rsks and benefts and to pursue collaboratve mprovement. The buyer may need to provde the suppler wth techncal, fnancal, and manageral supports whenever approprate. Suppler s often nvolved n the new product development process. Both partes are also wllng to share crtcal nformaton and conserve partner s trust by keepng all of the shared nformaton secure from other partes. Such a relatonshp requres trust, commtment, and relablty from both partes. Automotve companes are among the best examples showng suppler partnershp model. For example, as ponted out by Handfeld et al. (2000), BMW has sent mantenance engneers and procurement, logstcs, and qualty personnel to supplers sometmes for several weeks at a tme. 4. THE USE OF ELECTRONIC PROCUREMENT Recent development n supply chan management has been marked by a splendd applcaton of the Internet n purchasng actvtes. The tradtonal way of procurng goods or servces va manual and off lne actvtes such as sendng a Request for Quotaton (RFQ) by mal, conductng off lne bddng process, typng purchase order n a stand alone computer, sendng t by fax or regular mal, and then pay the blls by usng a separate payment system s gradually replaced by electroncs systems on the Internet. Those manual processes are not only tme consumng, but also costly. A purchase order had to move step by step through costly staffs, from the admnstratve staff fllng the purchase order, to the purchasng manager checkng and sgnng t, and then to the accountng department for budget approval. Fnally the purchase order should be sent va a regular mal or a fax by a mal clerk. Presutt Jr. (2003) ponted out that the cost for processng a purchase order s n the range of US$70 to 300. Wth the dramatc development of the Internet, many of the procurement actvtes can now be done electroncally. Johnson and Whang (2002) provded a comprehensve revew on the use of the Internet n busness, ncludng n procurement. 18

7 Software vendors have been persstently ncorporatng more and more capabltes on ther products so that the procurement processes can be done more easly wth less tme and headcounts whch ultmately promote hgher effcency and responsveness. PeopleSoft for example developed Suppler Relatonshp Management (SRM) software whch enables the user to seamlessly ntegrate the source to settle processes, from determnng the best suppler to recevng shpments, closng fnancal statements, and then contnually analysng supplers performance. Procur, another procurement software provder, offers a sourcng tool that enables the user to conduct on-lne negotaton wth dfferent negotaton strateges such as one to one, sealed bd, and dynamc prcng events. The tool s also equpped wth features to do mult-attrbute and mult lne bddng and to perform analyses on spendng, suppler performance, and other relevant analyss. Arba Spend Management provdes capabltes to obtan enterprse-wde vsblty and operatonal control. Ths applcaton enables the user to use fner crtera n selectng supplers. Oracle, wth ts Oracle Sourcng feature, allows users to ntegrate the procurement actvtes wth the back end applcatons. Many other procurement software/tools provders, such as Epcor and Covgna, are well equpped wth varous sophstcated capabltes. The role of thrd partes, such as ndependent electronc market exchanges, n boostng e-procurement practce has also been fantastc. Companes are now able to fnd a wde range of tems easly and quckly va vrtual markets. Wth the power of the Internet, varous tems can be easly bought electroncally va vrtual markets such as assetlne.com for constructon equpment and machnery, ronplanet.com for heavy equpment, steelaucton.com for steel products lke beams, rods, ngots, and ppes, chemcalnet.com for chemcal tems, theplastcsexchane.com for plastcs materals, and many others. Such vrtual markets are also developng progressvely n countres such as Chna (for example Chemchne.com, echnachem.com), Inda (such as Chemvalue.com, Indamarkets.com Indachemcalportal.com), Korea (cyberdsty.com), Mddle East (such as MEsteel.com), and Latn Amerca (ActMart.com). Those vrtual markets enable the buyng companes to more proactvely seek potental supplers, conduct bddng processes on-lne, and obtan up to date analyss on prce trends and other nformaton on market development from experts. Tradtonally, tems belong to cell 3 are approprate to purchase va a tenderng process. Unlke tem n cell 1, the large volume of purchases n ths category warrants the expensve and tme consumng tenderng process. Wth the advent of the Internet, tenderng process has become more popular n procurement, and tems n other category, especally n cell 1 are also canddates for tenderng. The use of the Internet as a meda for tenderng has made ths mode much cheaper and faster unlke the tradtonal tenderng process whch was normally very expensve and tme consumng. Buyers can do a tenderng process n ther own on-lne facltes, f there s any, but can also use thrd party provders such as the ones mentoned above. A popular means of selectng the cheapest offer from the competng supplers through the Internet s recently well known as electroncs reverse aucton or abbrevated as e-aucton (see for example, Emlan, 2000; Emlan and Stec, 2002; Smart and Harrson, 2003; Smeltzer and Carr, 2003). In ths case, the buyer nvtes several potental supplers to bd for prce electroncally and the one wth the lowest bd wll wn. E-procurement has not been extensvely appled for procurement of tems n categores 2 and 4. Although lmted number of manufacturng companes may have 19

8 JURNAL TEKNIK INDUSTRI VOL. 5, NO. 1, JUNI 2003: appled e-procurement for strategc tems, the nature of e-procurement would be dfferent from those n categores 1 and 3. Here, buyng companes are hardly ever possble to use e-aucton due to the lmted avalablty of potental supplers and due to specfc desgns are often needed for tems n cell 4. Electronc procurement n ths case should be able to ntegrate nternal busness processes of the two partes so that the buyer can easly montor suppler s stock and capacty avalablty and the suppler can also montor buyer s stock, demand, and producton plan/schedule. 5. CONCLUDING REMARK Ths paper dscusses procurement portfolo and the role of e-procurement n supportng the strategc role of procurement. In many organsatons, a large number of dfferent types of tems are usually purchased. Treatng all tems equally does not create an effectve procurement system. A portfolo s a model that procurement manager can use to dstngush tems based on ther characterstcs and then dfferentate procurement focus for each category n order to optmse the contrbuton of procurement functon to the company s strategc objectves. Furthermore, the use of electroncs procurement system should take nto account the above classfcaton. Electroncs reverse aucton whch s very popular recently and has been proven to provde very hgh rate on nvestment (ROI) s only sutable f many supplers are capable of supplyng the tems n queston. Understandng the characterstcs of tems, supply avalablty and the assocated rsks, the demand patterns, and the approprateness of each e-procurement system s crtcal to creatng an effectve procurement management system. REFERENCES Bensaou, M., Portfolo of Buyer Suppler Relatonshps, Sloan Management Revew, Summer, pp Ellram, L. R., and B. Lu, The Fnancal Impact of Supply Management, Supply Chan Management Revew, Nov/Dec. Emlan, M. L., Busness-to-Busness Onlne Auctons: Key Issues for Purchasng Process Management, Supply Chan Management: An Internatonal Journal, vol. 5 (4), pp Emlan, M. L., and D. J. Stec, Realzng savngs from onlne reverse auctons, Supply Chan Management: An Internatonal Journal, vol. 7(1), pp Handfeld, R. B., D. R. Krause, T. V. Scannel, and R. M. Monczka, Avod the Ptfall n Suppler Development, Sloan Management Revew, Wnter, pp Johnson, M. E., and S. Whang, E-busness and Supply Chan Management: An Overvew and Framework, Producton and Operatons Management, vol. 11 (4), pp

9 Olsen, R. F., and L. E. Ellram, A portfolo approach to suppler relatonshps, Industral Marketng Management, vol. 26 (2), pp Presutt Jr., W. D., Supply Management and e-procurement: Creatng Value Added n the Supply Chan, Industral Marketng Management, vol. 32, pp Smart, A., and A. Harrson, Reverse Auctons as a Support Mechansm n Flexble Supply Chans, Internatonal Journal of Logstcs: Research and Applcatons, vol. 5 (3), pp Smeltzer, L. R., and A. S. Carr, Electroncs Reverse Auctons: Promses, Rsks, and Condtons for Success, Industral Marketng Management, vol. 32, pp