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Procurement and Inventory Management

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I have read and understood the rules on cheating, plagiarism and appropriate referencing as outlined in my handbook and I declare that the work contained in this assignment is my own, unless otherwise acknowledged. No substantial part of the work submitted here has also been submitted by me in other assessments for my degree course, and I acknowledge that if this has been done an appropriate reduction in the mark I might otherwise have received will be made Signed: SHUANG ZHOU

MODULE TITLE: MODULE CODE: MODULE DATE: NAME/NUMBER: GROUP:

Procurement and Inventory Management

1131812 H

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Table of contents
1. Question 13 1.1 Group the sourced components.3 1.2 Effect of their characteristics to the design of the sourcing processes4 1.2.1Characteristics of Items......................6 1.2.2Effect on sourcing process..7 1.3 Analysis of single and/or dual/multiple sourcing....8 1.4 Conclusion to Sourcing Process..8 2. Question 5..9 2.1 Key Performance Indicators & Inventory Management....9 2.2 KPI defined in Inventory Management..10 2.3 KPI in NordicPhone Company Supply Chain...12 2.4 KPI for LCD supply chain of NordicPhone13 2.5 Information exchange in the supply chain....14 Reference.16

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1. Question 1

Categories of Supply

1.1 Group the sourced components.


The Kraljic Matrix from Peter Kraljic was first introduced in a research article named "Purchasing must become Supply Management" in the journal Harvard Business Review (HBR). The Kraljic Matrix is often used to in procurement management. In Kralijics Matrix, there are two aspects to be considered to classify items. First one is profit impact, which refers to the strategic impact on the product value, cost of raw material and profit of item. The second one is supply risk, which includes the complexity of supply market, the pace of technological innovation, the replacement of raw material, the monopoly or shortage of market conditions and so on. ((Kraljic, P, 1983) According to the Kraljics Matrix, to group sourced components, first is to analyze their levels of profit impact and supply risk. Now begin the analysis. The case provided eight parts to be grouped, covers, plastics, print, electronics, circuit boards, power supply, LCD screens, and power cords. And some of them need the subvendors that supply raw materials. According to the price of iPhone components, the most expensive parts are the LCD screens and electronics. Here, the electronics include components like cam, antenna, sensor, memory, control system and so on. As data showed in the website (Ref.), the price of LCD is 23.09 and the price of electronics is around 39.96, as the total cost of an iPhone is about 112.89. Therefore, obviously, LCD and electronics are concluded into the Kraljics Matrix boxes with high price. Meanwhile, the cheapest components are considered as covers, plastics, and print. Supply risks include many aspects. The main aspects should be focused on are the supply capability, the selection of suppliers, the risk of information sharing and shipping risks. For the power equipment and covers, the material and technology for producing them are very normal and usual. Also there are not core techniques in designing these components. So these components can be regarded as the low supply risk products. And for LCD screens, electronics and circuit boards, they are the key elements to define the level of a telecommunication product. To ensure the sustainable quality and improve the performance for those products is very important. Hence, they are attributed to the high supply risk items. In general, the components can be grouped as following chart showed overleaf.

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High Impact on Financial Results / Strategic Value of relationship)

Leverage Items Power supply Power cords

Strategic Items LCD screens Electronics

Normal Items Covers Plastics Print Shop Low Low

Bottleneck Items Circuit boards

High Supply risk / Dependency on relationship

1.2 Effect of their characteristics to the design of the sourcing processes.


Generally, sourcing process includes following steps: selection of suppliers, contract making, product design, procurement and supplier evaluation. - Selection of Suppliers: To select a suitable supplier, first is to define the relationship. It is related to the level of resources sharing, investment alignment, price and volume and so on. It also determines the trust between both sides, like contractual trust, competence trust and goodwill trust. (Dawei Lu) There are different relationship between suppliers and customer, such as vertical integration, partnership relationships, long-term market relationships and short-term market relationships. To choose the relationship is based on the characteristic of items purchased. Thus, the methods of Kraljics Matrix and ABC classification are used in the procurement planning. - Contract Making: Contract making concerns the purchasing volume and price, the contractual coverage and so on. To a large extend it determines the profit both sides could get. A supplier that achieves break-even at below 70 per cent capacity utilisation can ultimately deliver at lower cost than one who breaks-even at 80 per cent utilisation (Kraljic, P, 1983, p.113) So there must exist differences when buyers give contracts with different break even per cent. - Product Design: Different relationship determines the level of design sharing. To support whole supply chain management, its better to have early design involvement

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with suppliers and establish joint design team. And to joint design can reduce the risks in supply chain, such as risk of redesign. - Procurement: Using Kraljics Model to classify all the items, and conduct a market analysis, then define the strategic position of items and finish the purchasing planning. (Laura Canez, 1997, p. 31-44) The Following figure is created by Laura Canez in 1997.

Figure - Kraljics Approach (Laura Canez, 1997, p. 31-44) - Supplier Evaluation: Its to assess the performance of suppliers. There are some evaluation criteria presented by Kraljic. Evaluation Criteria on Supplier Strength 1 2 3 4 5 6 7 8 9 10 Market size vs. supplier capacity Market growth vs. capacity growth Capacity utilisation or bottleneck risk Competitive structure ROI and/or ROC Cost and price structure Break-even stability Uniqueness of product and technological Entry barriers (capital and know how requirements) Logistics situation

Table Purchasing Portfolio Evaluation Criteria (Kraljic. P, 1983, p.113)

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1.2.1 -

Characteristics of Items

Leverage Items Products with optional suppliers in the market and which Can bring big profit. Usually, these products have the standardized quality criterions. Buyers take the initiative position. Low interdependence. Recommended procurement strategy: procurement bidding to selection supplier.

Strategic items Products which is crucial to buyers production processes Also bring high profit. With high supply risk: maybe due to the scarce of supply or difficult transportation. The balance of power for buyers and sellers. High interdependence. Recommended procurement strategy: a strategic alliance, close contact with suppliers, design together with suppliers, adopt vertical integration, focus on longterm value. Normal items Also called non-critical projects. Low financial impact. Abundant supply: easy procurement. The balance of power for buyers and sellers. Low interdependence. Recommended procurement strategy: by improving the production processes to reduce the investment on procurement of such items. Bottleneck items Supply by a particular vender or inconvenient transportation. Low financial impact. Sellers take the initiative position. General interdependence. Recommended procurement strategy: ensure the number of insurance contracts, vendors managed inventory, ensure safety stock (additional inventory), looking for potential suppliers.

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1.2.2

Effect on sourcing process

a. Power supply, Power cords (leverage items): Firstly, there are many suppliers for these two products. So its a competition for suppliers. For NordicPhone Company, these two components can be sourced globally, and both ship to the Denmark production center and Thailand production center. Secondly, these two production centers are located at Europe and Asia respectively. Therefore, dual sourcing or multiple sourcing could be applied here. The selection of suppliers for each production center is based on the principle of short distance. That is to say to source power supply and power cords near shore in order to reduce the cost of transportation and to ensure the timely supply as well. b. LCD Screens, Electronics (strategic items) These two kinds of items represent the core part of a telecommunication product. They are the highest value added parts. But due to the high risk of supplier capability, a stable and close contract is needed to build up a long-term relationship with suppliers. To establish a long-term relationship is also a good way to ensure the quality of products supplied. And in this case, suppliers can join into the whole production earlier, like participating the design of product. Only both sides, suppliers and manufacturers, trust each other to build a mutual credit atmosphere, a situation of win-win could be realized. c. Covers, Plastics, and Print Shop (normal items) All of them have a small value per unit and there are many alternative suppliers. Therefore, for these products, the management direction for procurement is to reduce their costs meanwhile maintains their quality. To select a nearby suppliers can much reduce the cost of transportation, and to reduce the cost of procurement and inventory, the integration of suppliers can be taken into consideration. d. Circuit Board (bottleneck items) For these kinds of bottleneck items, a secure continuous supply is mostly needed. Actually, the circuit board is not a bottleneck items in the telecommunication product chain in modern society. It is attributed to the bottleneck items just because of comparing with other components in this case. As we known, the circuit board is composed of the components of electronics. Thus, the suppliers of circuit board can be integrated with the suppliers of electronics components.

1.3 Analysis of single and/or dual/multiple sourcing.

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a. Single Sourcing: Single sourcing means procurement with the sole supplier. The supplier can provide the entire requirements of buyers. From the view of competitive situation, the purchaser is at an adverse position. Disadvantages for purchaser: May increase the cost of procurement. Bad position in the negotiating process. Reduce the cost of purchasing administration. Less time on re-negotiating prices but more time on developing partnership.

Advantages of single sourcing:

Hence, this kind of sourcing usually used in the emergent situations, such as timeless. b. Dual/ multiple Sourcing: Dual/multiple sourcing is to purchase from several suppliers. It means none of each supplier can provide the entire items. It is suitable for when there are many different kinds of materials need to purchase. But in this sourcing way, it may increase the cost of procurement, and even sometimes have negative impact on the accuracy of delivery. Therefore, it needs more precise procurement plan in this situation. There is an advantage of dual sourcing that its better for the quality of product due to the competition in different suppliers. Like the sourcing case of Mazda Seat, Mazda has two suppliers for providing seats. One is Delta Kogyo, and another one is Toyo Seat Company. There are 33% of the total seats volume are distributed to each supplier. And the remaining 33% is used as award to the supplier who has a better performance in the previous year. (Hines, 1995) Besides, multiple sourcing can reduce some unexpected risks in the supply chain, such as some disasters occurred in the suppliers plant.

1.4 Conclusion to Sourcing Process


In this case, single sourcing cannot sufficient to fit all groups of supply categories. Firstly, this company has an international production network. In this situation, single sourcing is not a good way to minimize the purchase cost. As showed in the case, the two main production centres are in the Denmark and Thailand respectively. One is in the Europe, and another one is in the Asia. Obviously, single sourcing is not the optimized method to select the location of suppliers. Secondly, through the components the case provided, they are not with the same characteristics, but they can be attributed to several categories. Beside the classification

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by Kraljics Matrix, there are some relations in the materials. For instance, the plastic is also the raw material of covers, and both the circuit board and LCD Screen can be assembled by the components of electronics. Therefore, some of the components suppliers can be integrated. And in this way, its more beneficial to improve the whole supply chain service level. Following is the sourcing process recommended to the NordicPhone Company.

Plastics & Covers In Europe

Denmark

Electronics Components Circuit Board In Europe Power Supply & Power Cords

Print Shop

LCD Screens In Sweden

Electronics Components Circuit Board In Asia

Thailand

Plastics & Covers In Asia

2. Question 5

Performance Measures of Inventory Management

2.1 Key Performance Indicators & Inventory Management


Enterprise Key Performance Indicators (KPI) is a management measuring method for the internal and output terminals to the business process by measuring and analysing the key parameters, which is to decompose the enterprise strategic goals for the operational working objectives. The KPI method follows the important 80/20 Rule that is 20% business contributes to 80% profit. The 80/20 Rule indicates the direction of performance assessment that key process and key results should be paid more attention to. Inventory Management is used to maintain the reserves at a reasonable level. It cares about how much and when to order, the accuracy of forecasting, demand analysis and supplier performance evaluation. It is key to balance the relationship between desired services and optimise costs. Excessive inventory brings problems like increased storage cost and capital sluggish with low liquidity. Insufficient inventory causes problems like decline in service level, impact of sales profit and corporate reputation. Therefore, the objective of inventory

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management is to keep the stock at a best level to control the funds employed by inventory to accelerate cash flow.

2.2 KPI defined in Inventory Management


a. Customer Service Customer satisfaction is the customer of feeling, after comparing the received service and his expectation. Customer satisfaction is a flowing indicator according to different customer because not all expectations are the same; the same thing enables one customer satisfied may not meet another customers requirement. Therefore, it is necessary to determine the customers satisfaction index scientifically and the degree of satisfaction level in order to further improve the quality management system. Customer satisfaction is important to evaluate the enterprise quality management system by tracking the performance.

Formula: Customer Service =

Number of Orders Delivered On Time Total Number of Orders

From the formula we can see that the higher Number of Orders Delivered On Time will have higher customer service (availability). To satisfy the customer service, the following three aspects should be done. Monitor service level regularly Choose a suitable measurement Set practical targets

Academically, there is a KANO Model to assist the customer satisfaction. KANO model defines three levels of customer needs: basic needs, expectations based needs and excitement based needs. These three requirements defined in the performance indicators are classified as the basic factors, performance factors and motivators. The basic demand refers to the features of product that customers think must have. The expectation of demand request product or service is good not just must product. Sometimes customers themselves are not very clear about what they expect, but they will satisfy with this level of service. And for the excitatory items, it needs to provide some service behaviour that completely beyond customers expectation. The following figure shows the Kanos idea.

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Figure - Kano chart (Kano,1996) b. Stock Value Stock value is the total inventory value. Usually, it is calculated in the end of every month. It includes the value of raw material, work in progress and finished goods. This indicator reflects the stock capability of a company. It should be combined with sales, stock turnover and other factors to analyse the operating status of a company. c. Stock Cover & Stock Turnover Stock Levels

Formula:

Stock Cover =

Free Stock Usage Rate

Stock Turnover =

Annual Use Free Stock

Stock Cover is an indicator to reflect how long the inventory can satisfy the current usage. And Stock Turnover is to reflect the liquidity of inventory level. It is an indicator for managers to judge whether the funds employed by inventory is rational. Both of these two factors are the key performance indicators in inventory management. And they are the description of stock levels. In addition, to improve inventory turnover is to accelerate cash flow so that improve the utilization of capital, contributing to a positive effect on the companys liquidity. The higher the inventory turnover ratio is, the faster the speed of inventory turnover is. Conversely, the slower turnover speed means the excessive inventory and the backlog phenomenon. There is no absolute standard for the evaluation of inventory turnover. It is usually compared with the other companies in the same industry or business area. In the inventory performance evaluation and analysis, inventory turnover is the most important

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content. Besides, this ratio also can reflect the speed of sales achieved. The higher ratio indicates the shorter time from funds invested to sales return. (Reynolds Dennis, 1999) d. Safety Stock & Review Level & Average Stock Stock Control Formula:

Safety Stock = CSF MAD SqRt(LT)

CSF: Customer Service Factors MAD: Mean Absolute Deviation LT: Lead Time

Review Level = Usage LT + Safety Stock

Average Stock = 1 2 Delivery Quantity + Safety Stock


Safety stock, also known as insurance stock, means the buffer inventory for higher demand than expected when the uncertainty (demand growth in the order time, the delay of arrivals, etc.) happens. When the safety stock is given, the average inventory can be described as the quantity of orders/delivery and safety stock. Safety stock is calculated based on the theory of Mathematical Statistics. The greater the safety stock is, the smaller possibility of shortage happens. But the excessive stock will lead to the emergence of remaining inventory. Therefore, firstly, safety stock is based on different category of items as well as the customers requirements. The quantitative calculation of the safety stock is contributed by the fixed customer demand, the change of demand, the fixed lead-time and the change of lean-time as well as the normal distribution analysis and the expected level of service to be obtained. (Wang, J.W.J, 2008) Review level is also named re-order level. It is a calculated figure based on lead-time and safety stock. To apply this indicator is to ensure a normal inventory volume. But its disadvantage is too relied on the amount of forecast sale in the lead-time. And Average stock is used to minimise the stock value. e. Inventory holding costs Inventory holding costs are consisted of many aspects, such as holding cost and re-order cost. Mainly, to ascertain the inventory holding costs of a company is based on the interest rate, the obsolescence rate, the storage cost and some relevant policy.

2.3 KPI in NordicPhone Company Supply Chain


For the inventory management, the most important key performance indicators are customer satisfaction and inventory turnover. Among the customer satisfaction, there are two aspects to be focused on. One is quality of products, and another one is the quantity of products.

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In NordicPhone Company, it has three different product lines. Firstly, an accuracy market research should be processed. It is not only based on the historical data, but also combined with the current demand in the different markets. Meanwhile, it is necessary to notice different demand of different product lines in different regions. Then it can be clear how much and what kind of products should be distributed into every distribution center. Second is about the quality of products. It is said that there are many problems with its operating system and the prices of some high tech component are above the average market level. Therefore, it is necessary to review the performance of the suppliers who provide these components. They need to negotiate with the suppliers about the quality of the components of operating system and implement to monitor suppliers activities regularly. Also looking for more potential competitive suppliers is needed. After all, to get a better partner is a long-term considered way for better development. In addition, for the prices level, it needs to figure out why the companys price level is higher than average market level. Thirdly, the company has B2C shop. The on-line sales are not as stable as distributors for B2B channels. But B2C system can provide accurate customer information that who buys the product, when and how much the customer purchase. This data can help the enterprise know more the market trend. For B2C shop, the key performance indicator is the delivery accuracy, including the type of product ordered and the accurate delivery time. For entire supply chain, the measurement of its performance can be divided into several processes, such as procurement, inventory, production, transportation, customer satisfaction and so on. Usually, the key performance indicators include inventory turnover, the life-cycle time of products, and inventory obsolescence rate. The products life cycle is the life of product in the market, referring to the whole process from when a new product starts to enter the market to be out of the market. Due to the time gap and different technology level, the life cycle of same product in different countries is different. It determines changes in international trade and investment. The inventory obsolescence refers to the defects in the stock, including crushed raw material and unqualified finished goods.

2.4 KPI for LCD supply chain of NordicPhone


It is said that NordicPhone Company has sourcing alliance with an LCD Manufacturer in Sweden. It proves the high level of design of LCD Screen. After ensuring the quality of a

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product, most important part to cover a high customer satisfaction is accurate forecasting in order to catch every peak demand. In the case, it is said that the media line phones produced a higher than average demand for 2 year, but due to the dramatically increase demand in Christmas time, leading to shortages in the availability of sufficient quantities of LCDs. From this information, it shows the insufficient inventory in LCDs during a special period but much more stock than demand during last two years. This is definitely caused by the inaccurate forecasting. NordicPhone Company should establish a special team to investigate this event. The team should re-evaluate the forecasting of media line products due to its abnormal demand trend. Forecasting is not just based on the analysis of historical demand, but also based on the understanding of market changing. Besides, seasonal forecasting is important. Seasonal demand is usually abnormal with normal days. Like in this case, during the Christmas time, the demand of media line phones reaches 5 times than average demand so that NordicPhone Company cannot satisfy the demand. In order to avoid this kind of failure in the future, the seasonal forecasting for major products should be calculated alone, combined the deseasonalised forecast and average forecast to get a more precise forecasting.

2.5 Information exchange in the supply chain


The information exchange between business partners along a supply chain is becoming more and more important and essential. The Supply chains serving the LCD production are significant part of the NordicPhone Company's international supply networks, which are in need of constant and reliable information exchange to maintain the undisrupted production. There are several information exchange methods, such as meeting, phone, instant messaging, email, fax, the EDI (Electronic Data Interchange), IT-based logistics system and Bookkeeping Systems. Among these methods, the face-to-face meeting is the most personal method for information exchanging. Then, the phone comes the second and the instant messaging is the third personal way for information exchanging. The rest methods as Fax, IT-based logistics system, EDI messages, and Bookkeeping systems are the most impersonal methods. (Vilko, J., Rumpu, A. & Koivuniemi, J.,2011) According to the provided information, the media line phones have over the last 2 year generated a much higher than average demand during the Christmas time in December,

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which reached up to 5 times than the expected sales. This situation caused shortages with the sufficient quantities of LCDs, which may cause the more obvious 'Forrester Effect' (or called "bullwhip" effect) that increases the instability of the suppliers' production, inventory management and marketing. The cause of the bullwhip effect is that supply chain is based on the orders instead of the customers demand. The information sharing or exchanging is a key countermeasure to Forrester Effect, making use of EDI and other IT-based logistic systems. Based on the customers' actual demand, according to appropriate correction with historical data and sharing information with suppliers timely, the NordicPhone Company can make a more precise production plan to reduce the 'bullwhip' effect. In modern society, many companies begin to implement CSCW (Computer Supported Collaborative Working) to improve their information exchange level. Thus, they need fewer meetings, meanwhile reduce the some administration costs. Also, to implement CSCW is a good solution to the Forrester Effect. CSCW supports any kinds of information, detailed documents, real-time records and so on. It is better for reflecting the changing of market and greatly reduces the preparation time for information exchange so that improve the efficiency and effectiveness. (Salhieh, SaEd M; Monplaisir, leslie; Singh, Nanua, 2001) In addition, to cope with the LCD issues in the case, VMI (Vendors Managed Inventory) strategy can be taken into consideration. VMI means allocate the inventory management job to suppliers. Consequently, suppliers can better join the analysis of real market and distribute products at right time when demand actually happens. Thus, it can avoid the situation like in the case, inventory at a higher volume than average demand but unsatisfied the seasonal demand in Christmas time.

References:

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Canez L., 1997, Outsourcing in the Manufacturing Industry dissertation for MSc in Engineering Business Management, Department of Engineering, Warwick University. Dr. Dawei Lu, Supply chain management, Lecture Notes for MSc in major of logistics and supply chain management, Warwick University. Hines P, 1995, Network Sourcing: A Hybrid Approach, International Journal of Purchasing and Materials Management, Spring 1995, pp. 18-24. Kano, N. ; Seraku, N; Takahashi, F.; Tsuji, S. , 1996, The best on quality. International Academy for Quality,7, pp. 165-186. Kraljic, P, Purchasing Must Become Supply Management, Harvard Business Review, 1983, pp. 109-117. Reynolds Dennis, April 1999, Inventory-turnover analysis: Its importance for on-site food service,vol 40, 2nd,pp54-58 Salhieh, SaEd M; Monplaisir, leslie; Singh, Nanua, 2001, A Flexible Planning Methodology to Support Global Product Development using CSCW Tools, Global Journal of Flexible Systems Management, pp:1-13. Vilko, J., Rumpu, A. & Koivuniemi, J. 2011. Risk management in supply chains: Information exchange, systemic motives and cognitive barriers. Technology Management in the Energy Smart World (PICMET), 2011 Proceedings of PICMET'11:, pp.19. Wang, J.W.J. et al., 2008. Supply Chain Safety Stock Quantity's Fractal Forecast and Study. Audio, Transactions of the IRE Professional Group on, pp.14. Website, http://iphone.91.com/content/2011-11-13/20111113191734196.shtml

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