Development of Supply Strategies

CHAPTER 4

Development of Supply Strategies

Editor

Joseph R. Carter, D.B.A., C.P.M.

NAPM Professor at Arizona State University and

Chair of the Supply Chain Management Department

INTRODUCTION

Competitive firms entering the 21st century cannot afford a purchasing process that treats all items, products, commodities, and services in the same way. The traditional purchasing paradigm is changing, and that bodes well for the profession and the economy. Blind reliance on numerical benchmarks such as purchase price variance and landed cost threatens to keep firms from acquiring distinctive competitive advantage in today's supply constrained marketplace. As more and more firms are discovering, positioning the purchasing process into a segmenting of different supply strategies, supply tactics, and supply management approaches is the only way to effectively link supply strategies with overall firm goals, product marketing strategies, and competitive efforts. This differentiation process is often referred to as "supply segmentation".

The supply segmentation technique provides a mechanism for discriminating between the various items and services that are purchased by a firm with the goal of developing specific strategies to meet the needs of the organization with respect to separate and logical categories of items. Supply segmentation is an excellent marketing tool for convincing senior management of the critical role that purchasing can and does play in the support of corporate level strategies and firm profitability.

This chapter will begin with a discussion of ''ABC'' analysis as applied to the purchase of goods and services and its limitations. A discussion of the supply segmentation approach to supply strategy development will follow, including development of a spend analysis and categorization of purchases. The chapter will end with a discussion of supply management goals and the supply management strategy development process.

ABC ANALYSIS

A variety of segmenting systems is available to help in purchasing planning and item control systems. A popular classification system is based on the dollar volume of purchases per item. Such a scheme is often referred to as ''ABC'' or ''Pareto'' analysis. ABC or Pareto analysis shows that a small percentage of the items purchased can be linked to a large percentage of the dollars spent by the firm. ABC analysis then classifies these purchased items/services in order of importance as either ''A,''

''B,'' or ''C'' items. It has been empirically demonstrated that ABC or Pareto analysis holds in a wide range of situations.

As an example, in purchasing, ABC analysis usually holds for item purchased, number of suppliers, inventories, and other measures. ABC analysis is often referred to as the 80-20 rule, where approximately 20% of the items/services purchased account for about 80% of the purchasing dollars spent. An example of ABC analysis that results in three classifications of items, A, B, and C, is presented in Table 4-1.

Naturally, these percentages can vary from organization to organization. Some companies even use more than three classification levels. Nonetheless, the concept of categorizing purchases is a very powerful and useful purchasing concept. It allows a prioritization of supply strategies and efforts in the areas of potentially highest returns. For example, a manufacturer, XYZ Company, with total annual purchases of $254,725,000 had the breakdown provided in Table 4-2.

The data presented in Table 4-2 can be categorized and prioritized as demonstrated in Table 4-3. A similar analysis of the firm's suppliers or inventories would be expected to show a similarly high portion of total value from a relatively small number of suppliers or items.

There are several ways in which a purchasing manager can use such a categorization scheme. For example, it is only sensible to expend more managerial resources and efforts on A and B items than on C items, as presented graphically in Figure 4-1.

LIMITATIONS OF ABC ANALYSIS

ABC analysis provides a tool for identifying those items that will make the largest impact on the firm's overall inventory cost performance when improved inventory control procedures are implemented. A perpetual inventory system, improvements in forecasting procedures, and a careful analysis of the order quantity and timing decisions for A items will provide a larger improvement in inventory cost performance than will similar efforts on the B and C items. But the ABC analysis primarily focuses on aspects of cost only. Therefore, ABC analysis is only a first step in improving inventory and thereby supply management performance.

ABC analysis helps focus management attentions on only one aspect of what is really important, that is, inventory costs. Unfortunately, to classify items into A, B, and C categories based on just one criterion is clearly to overlook other important criteria. Also, the guidance provided by ABC analysis relates only to the relative direct financial importance of certain items/services and does not extend to developing supply management tactics and strategies in dealing with complex markets and competitive suppliers.

It is because of these limitations and others that another technique, called ''supply segmentation,'' was developed. This tool has won wide acceptance and application in the development and implementation of supply strategies.

THE SPEND ANALYSIS

To begin constructing a supply segmentation portfolio, the firm must develop a ''spend'' analysis of all the goods and services that are purchased by the firm. Total purchases must be aggregated across divisions and/or strategic business units (SBUs) both for individual items/services and by individual suppliers. The spend analysis can be a laborious and tedious undertaking, but it is critical nonetheless. There are outside suppliers, such as Dun & Bradstreet, that will assist a firm in developing the spend analysis.

The concluding step is to graph each of these stock-keeping units (SKUs) and service categories on a chart in which the horizontal (X) axis represents the relative cost/value of the item or service