Supplier Selection & Evaluation

Supplier Selection & Evaluation

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Preparing a Prospective Supplier List

You can search for the potential vendors by looking at several information sources: Past experiences Interviewing with the salesperson of the

supplier Catalogs published by the vendors Trade Directories

Classifies suppliers according to the products they make

Includes names of company personnel, financial status, and location of sales offices

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Information sources…

Trade Journals or Business Magazines These are oriented towards specific industries

Fairs and Trade shows Specific to industry. Ex: Computer, textile, etc.

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Types of Suppliers

In the search for suppliers, all available types (that is, distributors, manufacturers, and foreign sources) should be considered.

The number of suppliers to be used should also be considered.

Trade-offs between price, delivery, and service and community relations and goodwill must be weighed when selecting various types of vendors.

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Local vs. National Suppliers

There are inherent natural advantages to buying from local suppliers whenever possible.

Among the most significant are the following:1. There is usually a freight savings when the distance

between firms is relatively short.

2. Local vendors tend to share the same political and tax concerns as the purchaser.

3. Close proximity permits many possibilities for communication and service; shorter lead times, and exchanges.

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Local vs. National Suppliers…

There are also considerations that favor national suppliers:1. National concerns may offer lower prices because of

their ability to produce in mass quantities for large numbers of customers.

2. Technical assistance may be better from large firms that provide extensive research and development support.

3. Continuity of supply may be more certain with larger-volume producers, which exercise considerable raw material purchasing power and maintain large in-process and raw materials inventories.

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Distributor vs. Direct

The buyer will often have to choose between buying through a distributor or direct from a manufacturer.

Both options have their advantages and disadvantages.

The manufacturer often offers lower prices than the distributor; this difference usually depends on the volume of business.

Manufacturers generally prefer large-quantity orders.

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Distributor vs. Direct…

Manufacturers often find small-quantity purchases unprofitable, considering the expenses involved, and charge a premium price to compensate.

Thus, a distributor may offer lower prices on purchases of smaller quantities.

Since distributors are generally local firms, they are often able to provide better service than manufacturers.

For instance, distributors are able to ship quickly and handle rush orders as well as visit the buyer's facility frequently and provide personal services.

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Distributor vs. Direct…

Another factor in the decision concerns inventory levels.

Buying direct usually means buying in large quantities, and the purchaser must hold these quantities in inventory.

In contrast, the distributor maintains a local inventory, and the buyer can utilize it, making smaller, more frequent buys.

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Foreign Sources

The increasing industrialization of third-world countries, coupled with lower labor costs, has made foreign purchasing increasingly attractive in recent years.

The quality problems formerly associated with foreign goods have in many instances been transformed into quality standards that challenge domestic firms.

However, the drawbacks of foreign sources sometimes negate the cost savings.

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Foreign Sources…

The first problem is long lead times.

In addition to the actual travel time of the goods, time is spent in customs.

A large volume of paperwork is necessary to import goods, and there is a lack of service.

When a source has no domestic facilities, there are few avenues of recourse if the supplier makes a mistake.

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Foreign Sources…

Another problem is currency fluctuation.

With such long lead times, the price agreed upon may rise or fall between purchase and payment simply because the foreign currency exchange rate fluctuates against the buyer country’s currency.

These problems can be dealt with in many ways, and the supplier will often handIe most of the import details.

Information about foreign sources can be obtained from embassies or trade offices operated by various countries in major cities.

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Looking at Suppliers in Developing Countries Often, you will be investigating suppliers in low-cost,

developing countries.

Countries tend to develop in a structured way.

First, a major multinational will move into a developing country and set up a factory.

This factory will be mainly an assembly plant and will do very little local purchasing.

The components will be imported.

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Country Development

Next, and with varying degrees of speed, supporting suppliers will grow up around the multinational and replace the imports.

Eventually local employees will leave the multinational and start their own competing companies.

At this point, the country has what Michael Porter calls a "cluster," and the potential for world-class competitive industries.

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Buying from Developing Countries…

When a major multinational moves into a less-developed country, there is good chance that the multinational may be able to offer lower prices quickly.

If you are buying from the company already, you should know and explore these possibilities.

Later, when the supporting industry starts to develop, it becomes attractive to buyers of the supporting products.

You should start checking early and be prepared to move to be the supporting company's customer.

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Single vs. Multiple Sourcing

Because of quantity discounts or low shipping rates, it may be more economical to concentrate purchases with a single supplier.

JIT and blanket orders lead to single sourcing.

In other instances the total amount needed may be too small to justify splitting the order among suppliers because it would increase per-unit handling and processing costs.

Other purchases that encourage the use of a single supplier are those of parts made by processes employing expensive tools or dies.

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Single vs. Multiple Sourcing…

In most cases, however, the buyer who utilizes multiple suppliers has greater assurance of uninterrupted supply in the event of fire, flood, or strikes, which might disrupt the operations of a single plant.

Multiple sourcing also stimulates competition among vendors in price, quality, delivery, and service.

Therefore, many buyers use multiple sources for most of the items purchased.

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How many suppliers?

The decision to use multiple sources prompts questions about how many suppliers to use and on what basis to allocate the business.

Although these questions cannot be answered universally, these decisions are influenced primarily by the amounts required, the relative size of the suppliers, and their past performances.

Most buyers split orders between two or three suppliers.

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Supplier Evaluation Factors

After potential suppliers have been determined and located, a qualitative evaluation and elimination process is used.

This process compares suppliers in terms of their ability to provide the desired quality, quantity, price, and service.

In purchasing parlance, quantity has a somewhat specialized meaning, referring not only to the total amount required but also to the schedule according to which the goods must be received.

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Supplier Evaluation Factors…

Thus, a supplier who might be able to supply the desired quantity during the specified period, but could not supply this quantity on specified dates, would not be a satisfactory supplier.

In purchasing, price is meaningless when considered in isolation from other factors.

A price is good only if the item supplied has the desired quality and quantity and is accompanied by sufficient useful services.

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Location

The geographical location of the supplier is an important consideration in evaluating service.

Shipments from distant suppliers are subject to more and greater risks of interruption by accidents, strikes, and acts of nature.

The possibility of using substitute modes of transportation is also lessened as distance increases.

Companies may overcome some of their geographical disadvantages by providing pool car shipments, branch warehouses, and make-and-hold services.

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Managing the Disadvantages of Location “Pool car shipment" refers to the practice of collecting a

number of small orders from a given geographical region and combining them into one shipment, thereby economizing on freight by obtaining the full-car rate rather than the much higher less-than-carload (LCL) rate.

Pool car shipments may be used in conjunction with “branch warehouses” that act as distributing points for shipments originating at the home plant.

In “make-and-hold” service, the seller produces in anticipation of a buyer's needs and stores the merchandise.

The seller is then ready to ship immediately upon word from the buyer, minimizing total order time.

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Reserve Capacity

The reserve facilities of a supplier are another consideration in evaluating service.

This issue is of special importance during business booms.

A supplier with an adequate reserve of productive facilities can respond to increased customer requirements.

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Technological capabilities

The stage of a supplier's technological development and its ability to keep up with current methods are other considerations affecting service.

Technological capabilities give the buyer access to outreach research.

Buyers rely on vendors to suggest design and material changes as new concepts are perfected.

The buying firm often relies on the provision of such service as an extension of its own research and development facilities.

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Inspection

The inspection methods and quality control procedures used by the prospective supplier are also considered.

A supplier who is careless about inspecting finished goods will ship items that must eventually be rejected and returned as unsatisfactory for their purpose.

If such a supplier is also careless in controlling production quality, the problem is aggravated, because some imperfections may not be discovered until the item has been incorporated into the finished product.

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Labor Relations

Another source of interference with the continuity of production in a supplier's plant may be the workers themselves.

If relations of the supplier with its workers are poor, there may be strikes or slowdowns in production.

The possibility of such delays can sometimes be projected by determining the morale of the workforce, and reviewing the labor policies as expressed by general management.

The history of strikes and the length of the union contract also reflects the labor management climate.

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Warranties

Service also includes the kind and form of warranties that accompany a supplier's products.

Relevant considerations include a vendor's ability to provide installation wherever necessary and to provide replacement parts as needed.

The supplier should assure the buyer that the product delivered will be maintained throughout its normal life.

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Vendor Sources

Vendor relations also influence a supplier's service rating.

A good supplier has well-developed sources of raw materials and components that will ensure continuity of production during periods of fluctuating business conditions.

The volume of raw materials carried in inventory and the relationship between direct and distributor sources affect this evaluation.

To the degree that the supplier has well-developed sources of supply, the firm will be able to produce effectively during business booms.

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Plant visitations

Buyers perceive risk when deciding upon a choice among alternative market offerings.

The uncertainty about the consequences of any given selection heightens the anxiety or stress.

Hawes and Barnhouse examined how purchasing executives handle personal risk.

They found nine important tactics in use for handling perceived personal risk.

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Visit the supplier

The foremost tactic mentioned consisted in "Visit the operations of the potential vendor, to observe its viability firsthand."

In addition to reducing buyer stress, visits to the plants of suppliers are an important means of initial evaluation and periodic examination of existing vendors.

It is often desirable for a representative of the production or engineering departments to accompany the buyer on such visits, especially if the products are highly technical.

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Financial Status of Supplier

The financial status of the supplier directly affects its ability to serve and should be carefully evaluated.

One way to perform this evaluation is through the analysis of credit reports.

Credit reports contain information about suppliers' financial standings.

These reports also provide information on the experience, management, and facilities of the potential vendor.

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Financial Status of the Supplier…

A related supplementary procedure is independent analysis of the vendor's financial statements.

The purchasing official can obtain information regarding the vendor's financial stability, pricing policies, and general operating efficiency by applying the tools of ratio analysis to the vendor's balance sheet and income statements.

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Financial Status …Popular Ratios

The current ratio relates current assets to current liabilities.

The usual rule-of-thumb acceptable ratio is two to one.

Because current assets and liabilities are those that can be turned into cash within a short period of time (a year or less), this ratio measures the financial ability of the firm to continue in the short run.

However, because in recent years companies have often maintained current ratios less than two to one to avoid idle and unproductive assets, this ratio should not be overemphasized.

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Financial Status …Popular Ratios…

The acid test ratio is a variant of the current ratio in that it relates current assets, excluding inventories, to current liabilities.

Inventories are omitted from current assets because they are often difficult to liquidate.

An acceptable ratio here is one to one.

Like the current ratio, it is a reflection of a company's short-term functioning ability.

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The sales-receivable ratio represents sales divided by accounts receivable.

It indicates whether customers are paying their bills promptly or whether too much of the vendor's assets are tied up in receivables.

This ratio is related to the seller's standard terms of payment.

For example, if the terms are 90 days, not much more than this amount of total sales should be in receivables.

A firm with annual sales of $6 million and 90-day terms should not have much more than $1.5 million in accounts receivable.

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Net profit to sales is an overall measure of the firm's profitability after all expenses have been deducted.

The size of the profits gives an indication of the possibility of successful price negotiations.

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Cash flow is obtained by adding net profit after taxes to depreciation charges, which are allocations against profits that do not reflect actual cash outflow.

It measures the amount of dollars the firm is receiving.

Cash flow assists profit evaluation because it is a measure of how much cash a company is likely to require for meeting short-term expenses.

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The inventory turnover ratio is the cost of goods sold divided by the average inventory.

It indicates the degree of efficiency in inventory management and the freshness and sale-ability of the inventory.

If the ratio is low, the firm is either over-inventoried or undersold.

A high turnover ratio is usually preferable to a low one.

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Supplier Goodwill

Developing supplier goodwill is a vital part of purchasing personnel's strategic planning.

Goodwill benefits the organization in emergencies and helps ensure adequate levels of supply during periods of shortages.

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Quality Management

Quality is the last, but the most important, factor on the evaluation list.

Without good quality, the lowest-cost supplier in the world will not be acceptable.

The ISO series (ISO 9001, 9002, 9003) of quality standards is becoming more and more a requirement worldwide.

However, it is a quality systems and documentation specification, not a quality requirement.

A company produces a set of operating specifications that guarantee consistency in its processes and its production.

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ISO Quality Standards

If the operating specifications meet ISO requirements and the company passes an audit showing it follows the specifications, it can obtain an ISO certification.

This reduces, but does not eliminate, the need to survey a quality system.

There are two problems to consider.

First, the specification guarantees consistency, not quality.

The specification could state that a defined level of quality that you regard as mediocre (moderate quality) would be acceptable.

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ISO Quality Standards…Problems If the potential supplier follows the operating specification

consistently, they will produce to that quality level consistently.

It may not be good enough for you.

Second, once granted an ISO certification, the supplier may not follow the specification consistently.

There can be years between auditors' visits.

For these reasons, even an ISO-qualified supplier needs some quality auditing.

You should check the quality level produced.

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Acceptable Quality Level, (AQL)

You should ask what a supplier's outgoing quality level is.

What you are really looking for here is the attitude toward shipping faulty parts.

There are still suppliers who ship to acceptable quality levels, or AQLs.

An AQL of 0.4, for example, means that a lot with 4,000 parts per million (0.4 percent) faulty parts has a 95 percent chance of being shipped.

This AQL is measured by sample inspection, and there are sample plans that allow a lot with known rejects in it to ship.

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Supplier Evaluation Methods

The measure of a supplier's value is expressed in its performance record.

In recent years buyers have emphasized the setting of objective standards and procedures for evaluating and comparing existing suppliers.

The least precise evaluation technique is the categorical method.

It relies heavily on the experience and ability of the individual buyer.

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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 assigns 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 departments involved, such as quality control, engineering, production, and receiving.

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The Categorical Method…

Vendors with composite high or low ratings are noted, and future supply decisions are influenced by them.

Although this system is non-quantitative, it is a means of keeping systematic records of performance.

It is also inexpensive and requires a minimum of performance data.

However, the process relies heavily on the memory and judgment of the individuals providing the ratings, and the ratings may become routinely performed without much critical thought.

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The Weighted Point Method

Weighted-point method quantifies the evaluation criteria.

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.

For example, following evaluation criteria have been chosen: quality of shipments, accuracy of delivery, and price.

Assuming that quality and delivery are the most significant, a point rating system such as the following might be used: quality, 40 points; delivery, 40 points, and price, 20

points.

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Weighted Point Method…

% Perf. (A) % Perf. (B) %Perf. (C) (A+B+C)Vendor Quality %40 Delivery %40 Price %20 Total Score A 90 36 70 28 60 12 76 B 80 32 60 24 80 16 72 C 70 28 80 32 90 18 78

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Weighted Point Method…

The advantage of the weighted-point plan is that a number of evaluation factors can be used with relative weights corresponding to the needs of the firm, thereby minimizing subjective evaluation.

If this individually assigned plan is used in conjunction with the categorical method, suppliers can be evaluated on a quantifiable basis and many of the intangible aspects of service can still be considered.

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The Cost-Ratio Method

The cost-ratio method relates all identifiable purchasing costs to the value of the shipments received from the respective suppliers.

The higher the ratio of costs to shipments, the lower the rating for that supplier.

What cost categories are used depends on the products involved.

Quality, delivery, service, and price are the overall categories, and respective costs are accumulated for each.

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The Cost-Ratio Method…

For example, costs associated with quality normally include

the costs of unusual visits to a vendor's plants,

unusual inspection costs of incoming shipments, and

all costs associated with defective products, including rejected parts and the resulting manufacturing losses.

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The Cost-Ratio Method…Quality Cost Ratio

Vendor__________________________ January, 20__

Visit to vendor plant 200Sample approval 300Incoming inspection 75Manufacturing losses 0Reworking costs 0Value of rejected parts 425Other 9

Total costs 1,000Total value of purchases 100,000Quality cost ratio:

(total cost / purchases) %1