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Purchasing andSupply Management

Fourteenth Edition

P. Fraser Johnson, PhDLeenders Purchasing ManagementAssociation of Canada ChairAssociate Professor, OperationsManagementRichard Ivey School of BusinessThe University of Western Ontario

Michiel R. Leenders, DBA, PMACFellowProfessor of Purchasing ManagementEmeritusRichard Ivey School of BusinessThe University of Western Ontario

Anna E. Flynn, PhDFormerly Clinical Associate ProfessorSupply Chain ManagementThunderbird School of GlobalManagement

Formerly Associate ProfessorInstitute for Supply Management

Boston Burr Ridge, IL Dubuque, IA Madison, Wl New York San Francisco St. LouisBangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico CityMilan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto

Table of Contents

About the Authors v

Preface vii

Chapter 1Purchasing and Supply Management 1

Purchasing and Supply Management 3Supply Management Terminology 4Supply and Logistics 5

The Size of the Organization's Spend and FinancialSignificance 6Supply Contribution 8

The Operational versus Strategic Contribution ofSupply 8The Direct and Indirect Contribution of Supply 9

The Nature of the Organization 13Supply Qualifications and Associations 16Challenges Ahead 18

Supply Chain Management 18Measurement 19Risk Management 19Sustainability 19Growth and Influence 19Effective Contribution to Organizational Success 20

The Organization of This Text 20Conclusion 21Questions for Review and Discussion 21References 21Cases 22

1-1 Qmont Mining 221-2 Erica Carson 231-3 Southeastern University 24

Chapter 2Supply Strategy 26

Levels of Strategic Planning 27Major Challenges in Setting Supply Objectives andStrategies 29Strategic Planning in Supply Management 29

Risk Management 30Operational Risk: Supply Interruptions and Delays 30Financial Risk: Changes in Price 31Reputational Risk 31Managing Supply Risks 31The Corporate Context 32

Strategic Components 33What? 33Quality? 34How Much? 35Who? 36When? 36What Price? 36Where? 36How? 36Why? 37

Conclusion 37Questions for Review and Discussion 37References 38Cases 39

2-1 Spartan Heat Exchangers Inc. 392-2SaborInc. 402-3 Ford Motor Company: Aligned Business

Framework 42

Chapter 3Supply Organization 45

Objectives of Supply Management 47Organizational Structures for SupplyManagement 50

Small and Medium-Sized Organizations 50Large Organizations 51Centralized and Decentralized Supply Structures 52Hybrid Supply Structure 52Specialization within the Supply Function • 53Structure for Direct and Indirect Spend 56Managing Organizational Change in Supply 57

Organizing the Supply Group 58' The Chief Purchasing Officer (CPO) 58

Reporting Relationship 60

Table of Contents xi

Supply Activities and Responsibilities 61What Is Acquired 61Supply Chain Activities 61Type of Involvement 63Involvement in Corporate Activities 63Influence of the Industry Sector on SupplyActivities 63

Supply Teams 64Leading and Managing Teams 64Cross-Functional Supply Teams 64Other Types of Supply Teams 66

Consortia 67Conclusion 69Questions for Review and Discussion 69References 69Cases 70

3-1 Iowa Elevators 703-2 Roger Haskett 73

Chapter 4Supply Processes and Technology 76

The Supply Management Process 78Strategy and Goal Alignment 78Ensuring Process Compliance 79Information Flows 80Steps in the Supply Process 80

1. Recognition of Need 802. Description of Need 81

Purposes and Flow of a Requisition 81Types of Requisitions 82Early Supply and Supplier Involvement 83

3. Identification of Potential Sources 84Issue an RFx 84

4. Supplier Selection and Determinationof Terms 85

5. Preparation and Placement of thePurchase Order 85

6. Follow-up and Expediting 88Assess Costs and Benefits 89

7. Receipt and Inspection 90Eliminate or Reduce Inspection 90

8. Invoice Clearing and Payment 90Aligning Supply and Accounts Payable 91Cash Discounts and Late Invoices 92

9. Maintenance of Records andRelationships 92Linking Data to Decisions 93Manage Supplier Relationships 93

Improving Process Efficiency andEffectiveness 93

A Supply Process Flowchart 94Strategic Spend 95Nonstrategic Spend 95

Information Systems and the Supply Process 98Benefits of Information Systems Technology 99Technology Options 99Types of Information Systems 100Intranets and Extranets 102

Technology-Driven Efficiency andEffectiveness 102

Electronic Procurement Systems 103Electronic or Online Catalogs 105Electronic Data Interchange (EDI) 105E-Marketplaces 106Online Reverse Auctions 107Radio Frequency Identification (RFID) 109

Implications for Supply 109Policy and Procedure Manual 111Conclusion 111Questions for Review and Discussion 112References 112Cases 113

4-1 Bright Technology International 1134-2 Hemingway College 1154-3 Portland Bus Company 116

Chapter 5Make or Buy, Insourcing, andOutsourcing 120

Make or Buy 121Reasons for Make instead of Buy 123Reasons for Buying Outside 123The Gray Zone in Make or Buy 124

Subcontracting 125Insourcing and Outsourcing 126Insourcing 126

;Outsourcing 127Outsourcing Supply and Logistics 129

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Supply's Role in Insourcing and Outsourcing 129Conclusion 130Questions for Review and Discussion 130References 130Cases 131

5-1 B&L Inc. 1315-2 Rondot Automotive 1325-3 Alicia Wong 133

Chapter 6Need Identification andSpecification 135

Need Criteria in the Value Proposition 136/. Strategic Criteria 1362. Traditional Criteria 1373. Additional Current Criteria 138

Categories of Needs 140/. Resale 1412. Raw and Semiprocessed Materials 1413. Parts, Components, and Packaging 1414. Maintenance, Repair, and Operating

Supplies 1425. Capital 1426. Services 1457. Other 147

Repetitive or NonrepetitiveRequirements? 147Commercial Equivalents 148Early Supply and SupplierInvolvement 149Methods of Description 149

Brand 150"Or Equal" 150Specification 150Miscellaneous Methods of Description 152Combination of Descriptive Methods 153Sources of Specification Data 153

Standardization and Simplification 154Conclusion 155Questions for Review and Discussion 155References 156Cases 156

6-1 Moren Corporation (A) 1566-2 Moren Corporation (B) 1586-3 Carson Manor 160

Chapter 7Quality 165

Role of Quality in SupplyManagement 166Defining Quality 168

Quality 168Function 168Suitability 168Reliability 168Quality Dimensions 169"Best Buy" 169Determining the "Best Buy" 170

The Cost of Quality 170Prevention Costs 172Appraisal Costs 172Internal Failure Costs 172External Failure Costs 172Morale Costs 173An Overall Quality-Cost Perspective 173

Quality Management Tools andTechniques 173

Total Quality Management (TQM) 173Continuous Improvement 175Quality Function Deployment (QFD) 175Six Sigma 176Statistical Process Control (SPC) 177Sampling, Inspection, and Testing 180The Quality Assurance and Quality ControlGroup 184Assuring the Quality of PurchasedServices 185Supplier Certification 189

Quality Standards and AwardsPrograms 190

ISO 9000 Quality Standards 190ISO 14000 Environmental Standards 191The Malcolm Baldrige National (U.S.) QualityAward 192The Deming Prize 192

Conclusion 192Questions for Review and Discussion 193References 193Cases 194

7—1 The Power Line Poles 1947-2 Air Quality Systems, Inc. 196

Table of Contents xiii

Chapter 8Quantity and Inventory 198

Quantity and Timing Issues 199Quantity and Delivery 200Time-Based Strategies 200

Forecasting 201Forecasting Techniques 202Collaborative Planning, Forecasting, andReplenishment (CPFR) 203

Determining Order Quantities and InventoryLevels 203

Fixed-Quantity Models 203Fixed-Period Models 205Probabilistic Models and ServiceCoverage 205Buffer or Safety Stocks and Service Levels 206

Planning Requirements and Resources 208Material Requirements Planning (MRP) 208Capacity Requirements Planning (CRP) 209Manufacturing Resource Planning(MRP II) 209Enterprise Resource Planning (ERP)Systems 210Supply Implications of MRP 210

Functions and Forms of Inventories 211The Functions of Inventory 211The Forms of Inventory 213Inventory Function and FormFramework 213

Inventory Management 215Costs of Inventories 215ABC Classification 217Vendor- or Supplier-Managed Inventory(VMI/SMI) 219Lean Supply, Just-in-Time (JIT), and KanbanSystems 219Managing Supply Chain Inventories 223

Determing Quantity of Services 224Aggregating Demand 224Managing Consumption 224Dimensions of Services and QuantityDecisions 224

Conclusion 226Questions for Review and Discussion 226References 227

Cases 2278-1 Sedgman Steel 2278-2 Throsel-Teskey Drilling 228

Chapter 9Delivery 231

Logistics 232Role of Logistics in the Economy 233Role of Supply in Logistics 233

Transportation 233Transportation Regulation andDeregulation 234Supply's Involvement in Transportation 235

Transportation Modes and Carriers 235Road 236Rail and Intermodal 236Pipelines 236Air 236Water 237Radio Frequency Waves 237

Types of Carriers, Providers, and ServiceOptions 237

Types of Carriers 238Transportation Service Providers 238Specialized Service Options 238

Selection of Mode and Supplier 239"Best Value " Delivery Decisions 239Key Selection Criteria 240FOB Terms and Incoterms 241Rates and Pricing 242Documentation in Freight Shipments 243Expediting and Tracing Shipments 245Freight Audits 245

Delivery Options for Services 245Buyer Location versus Supplier Location 246On-premise versus Off-premise/Web-based ITDelivery 247

Transportation and Logistics Strategy 247Organization for Logistics 248Conclusion 249Questions for Review and Discussion 249References 249Cases 250

9-1 Penner Medical Products 2509-2 Andrew Morton 251

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Chapter 10Price 253

Relation of Cost to Price 254Meaning of Cost 255

How Suppliers Establish Price 256The Cost Approach 257The Market Approach 257

Government Influence on Pricing 257Legislation Affecting Price Determination 258

Types of Purchases 259Raw Materials/Sensitive Commodities 260Special Items 260Standard Production Items 260Small-Value Items 261Capital Goods 262Services 262Resale 262

The Use of Quotations and CompetitiveBidding 262

Steps in the Bidding Process 263Firm Bidding 264Determination of Most Advantageous Bid 264Collusive Bidding 265Public-Sector Bidding 265The Problem of Identical Prices 267

Discounts 268Cash Discounts 268Trade Discounts 269Multiple Discounts 270Quantity Discounts 270The Price-Discount Problem 2 70Quantity Discounts and Source Selection 272Cumulative or Volume Discounts 272 '

Contract Options for Pricing 273Firm-Fixed-Price (FFP) Contract 273Cost-Plus-Fixed-Fee (CPFF) Contract 273Cost-No-Fee (CNF) Contract 273Cost-Plus-Incentive-Fee (CPIF) Contract 273Provision for Price Changes 273Contract Cancellation 275

Forward Buying and Commodities 276Forward Buying versus Speculation 2 76Organizing for Forward Buying 277Control of Forward Buying 277The Commodity Exchanges 278

Limitations of the Exchanges 279Hedging 279Sources of Information Regarding Price Trends 280

Conclusion 281Questions for Review and Discussion 282References 282Cases 282

10-1 Cottrill Inc. 28210-2 Coral Drugs 28410-3 Price Forecasting Exercise 286

Chapter 11Cost Management 288

Strategic Cost Management 290Sources of Competitive Advantage 290Frameworks for Cost Management 290

Cost Management Tools and Techniques 293Total Cost of Ownership 293Target Pricing 299The Learning Curve or Manufacturing ProgressFunction 300Value Engineering and Value Analysis 301Activity-Based Costing 301

Negotiation 302Negotiation Strategy and Practice 303Framework for Planning and Preparing forNegotiation 304

Conclusion 306Questions for Review and Discussion 307References 307Cases 308

11-1 Deere Cost Management 30811-2 McMichael Inc. 30911-3 City ofGranston 310

Chapter 12Supplier Selection 313

The Supplier Selection Decision 314Decision Trees 315

Identifying Potential Sources 316Information Sources 317Standard Information Requests 321

Additional Supplier Selection Decisions 322Single versus Multiple Sourcing 322

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Manufacturer versus Distributor 324Geographical Location of Sources 325Supplier Size 326

Supplier Development/Reverse Marketing 326Evaluating Potential Sources 328

Level 1—Strategic 328Level 2—Traditional 333Level 3—Current Additional 335

Ranking Potential Suppliers 340Conclusion 340

Questions for Review and Discussion 341References 341Cases 342

12-1 Loren Inc. 34212-2 Russel Wisselink 34612-3 Kettering Industries Inc. 348

Chapter 13Supplier Evaluation and SupplierRelations 352

Measuring Supplier Performance 353Key Supplier Performance Indicators 353

Evaluation Methods 354Informal and Semiformal Evaluation andRating 354Executive Roundtable Discussions 354Formal Supplier Evaluation and Rating 355Weighted Point Evaluation Systems 356

Supplier Ranking 357Unacceptable Suppliers 357Acceptable Suppliers 358Preferred Suppliers 358Exceptional Suppliers 358

Supplier Relations 359Supplier Relations Context 360Supplier Goodwill 360The Purchaser-Supplier Satisfaction Matrix 361Supplier Relationship Management 364

Partnerships 365SEMATECH's Partnering Perspective 365Early Supplier/Supply Involvement (ESI) 366Partner Selection 367The Longer Time Perspective 367Co-location/In-plants 368Concerns about Partnerships 368

Strategic Alliances 369Conclusion 370Questions for Review and Discussion 370References 370Cases 371

13-1 APCEurope 37113-2 Plastic Cable Clips 3 7513-3 Delphi Corporation 378

Chapter 14Global Supply Management 383

The Importance of Global Supply 384Reasons for Global Purchasing 385Potential Problem A reas 390

Selecting and Managing OffshoreSuppliers 398

Global Sourcing Organizations 398Intermediaries 399Information Sources for Locating and EvaluatingOffshore Suppliers 400

Incoterms 401/Group E—Departure 402

Group F—Main Carriage Unpaid 402Group C—Main Carriage Paid by Seller 402Group D—Arrival 403

Tools for Global Supply 404Countertrade 404Foreign Trade Zones 407Bonded Warehouses 409Temporary Importation Bond (TIB) and DutyDrawbacks 409

Regional Trading Agreements 409North American Free Trade Agreement (NAFTA) 410The European Union (EU) 410ASEAN 410Mercosur 410Andean Community 411The World Trade Organization (WTO) 411

Emerging Markets 411Conclusion 412Questions for Review and Discussion 412References 413Cases 413

14-1 Trojan Technologies 41314-2 Marc Biron 415

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Chapter 15Legal and Ethics 417

Legal Authority of Buyer and Seller 418;,Legal Authority of the Buyer 419Personal Liability 420Authority of Suppliers' Representatives 421

The Uniform Commercial Code 422Purpose of a Uniform Commercial Code 422The Purchase Order Contract 423Acceptance of Offers 424Purchases Made Orally—Statute of Frauds 425Inspection 426Acceptance and Rejection of Goods 426'Warranties 428Title to Purchased Goods 429Protection against Price Fluctuations 429Cancellation of Orders and Breach ofContract 430

Common Law and the Purchase of Services 431Principles of the Law of Software Contracts 437E-Commerce and the Law 437

Electronic Signatures 438U.S. Uniform Electronic Transactions Act 439Antitrust and E-Marketplaces 439

Intellectual Property Laws 440Copyright Law 441Patents 441Trademarks 442Industrial Design 442Geographical Indication 443

Product Liability 443Alternative Dispute Resolution 444

Commercial Arbitration 444Mediation 445Internal Escalation 445

Regulatory>Requirements 445

The Sarbanes-Oxley Act 446Environmental Regulations 446

Eth'ics 447Perceptions 451Conflict of Interest 451Gifts and Gratuities 451Promotion of Positive Relationships withSuppliers 454Reciprocity 454

Corporate Social Responsibility (CSR) 455Conclusion 455Questions for Review and Discussion 456References 456Cases 457

75-7 Rocky Plains Brewing Ltd. 45715-2 Sinclair & Winston 459

Chapter 16Other Supply Responsibilities 463

Receiving 464Logistics and Warehousing 465Inbound and Outbound Transportation 466Production Planning 466Accounts Payable 466Investment Recovery 466

Categories of Material for Disposal 468Responsibility for Material Disposal 4 71Keys to Profitable Disposal 472Disposal Channels 472Disposal Procedures 4 74Selection of Disposal Partners 475

Conclusion 476Questions for Review and Discussion 477References 477Cases 478

16-1 Ross Wood 47816-2 Raleigh Plastics 4 79

Chapter 17Supply Function Evaluation andTrends 481

Organizing for Supply Research 483Full-Time or Part-Time Research Positions 483Cross-Functional Teams 484

Supply Research Opportunities 486Purchased Materials, Products, or Services 486Commodities 489Suppliers 490Assessing Research Results 493

Supply Planning Process 493Supply Budgets 493Performance Measurement Systems 494

The Value of Supply Metrics 494

Table of Contents xvii

The Challenges 495Measuring Supplier Performance 496Supply Management Performance Metrics 496

Establishing Metrics 498Efficiency Metrics 498Effectiveness Metrics 498Operating Reports 499Validating Results 500Appraising Team Performance 500Supply Performance Benchmarking 501

What Is Happening in Supply Management 502Emphasis on Total Quality Management andCustomer Satisfaction 502Corporate Social Responsibility andSustainability 503Globalization versus Local Sourcing 504Risk Management 505Safety and Security 505

Supply Processes and Technology 505Supply Organizations 506External and Internal Collaboration 506Metrics and Performance Measurement 507Innovation 507Public Procurement 507

Conclusion 507Questions for Review and Discussion 508References 508Cases 509

7 7-1 Randall Corporation 50917-2 Fairview School Board 51017-3 Tanton Foods 511

Indexes

Case Index 513Subject Index 514