SUPPLY CHAIN AND

LOGISTICS MANAGEMENT
Assignment No 2
Date: 22nd March 2010

SOURCING
BINOY KM
• 431

KAILAS SREE CHANDRAN

• 432

KRISHNA KUMAR R
• 433
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INTRODUCTION
Sourcing is the set of business processes required to purchase goods and services.
Managers must first decide the tasks that will be outsourced and those that will be performed
within the firm. For each task, the manager must decide whether to source from single supplier
or a portfolio of supplier. If a portfolio of multiple suppliers is to be carried, the role of each
supplier in the portfolio must be clarified. The next step is to identify the set of criterion that
will be used to select supplier and measure their performance. Managers than suppliers and
negotiate contracts with them. Contracts should be structured to imrove supply chain
performance and minimize information distortion from one stage to the next. Contracts also
clearly define the role of each supply source. Once suppliers and contracts are in place,
procurement processes that facilitate the placement and delivery of orders play a major role.
Sourcing decisions are crucial for a firm because they affect all other inventory decisions and
the level of efficiency and responsiveness the supply chain can achieve.

PROCUREMENT
Traditionally, the main activities of a purchasing manager were to beat up potential suppliers
on price and then buy products from the lowest cost supplier that could be found. That is still
an important activity, but there are other activities that are becoming equally important.
Because of this, the purchasing activity is now seen as part of a broader function called
procurement. The procurement function can be broken into five main activity categories:

1. Purchasing
2. Consumption Management
3. Vendor Selection
4. Contract Negotiation
5. Contract Management

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SUPPLY CHAIN OPERATIONS

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1. Purchasing
These activities are the routine activities related to issuing purchase orders for needed
products. There are two types of products that a company buys: (1) direct or strategic
materials that are needed to produce the products that the company sells to its customers;
and (2) indirect or MRO (maintenance, repair, and operations) products that a company
consumes as part of daily operations.
The mechanics of purchasing both types of products are largely the same. Purchasing
decisions are made, purchase orders are issued, vendors are contacted, and orders are
placed. There is a lot of data communicated in this process between the buyer and the
supplier—items and quantities ordered, prices, delivery dates, delivery addresses, billing
addresses, and payment terms. One of the greatest challenges of the purchasing activity is
to see to it that this data communication happens in a timely manner and without error.
Much of this activity is very predictable and follows well-defined routines.

2. Consumption Management
Effective procurement begins with an understanding of how much of what categories of
products are being bought across the entire company as well as by each operating unit.
There must be an understanding of how much of what kinds of products are bought from
whom and at what prices.
Expected levels of consumption for different products at the various locations of a company
should be set and then compared against actual consumption on a regular basis. When
consumption is significantly above or below expectations, this should be brought to the
attention of the appropriate parties so possible causes can be investigated and appropriate
actions taken. Consumption above expectations is either a problem to be corrected or it
reflects inaccurate expectations that need to be reset. Consumption below expectations
may point to an opportunity that should be exploited or it also may simply reflect
inaccurate expectations to begin with.

3. Vendor Selection
There must be an ongoing process to define the procurement capabilities needed to
support the company’s business plan and its operating model. This definition will provide

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insight into the relative importance of vendor capabilities. The value of these capabilities
have to be considered in addition to simply the price of a vendor’s product. The value of
product quality, service levels, just in time delivery, and technical support can only be
estimated in light of what is called for by the business plan and the company’s operating
model.
Once there is an understanding of the current purchasing situation and an appreciation of
what a company needs to support its business plan and operating model, a search can be
made for suppliers who have both the products and the service capabilities needed. As a
general rule, a company seeks to narrow down the number of suppliers it does business
with. This way it can leverage its purchasing power with a few suppliers and get better
prices in return for purchasing higher volumes of product.
4. Contract Negotiation
As particular business needs arise, contracts must be negotiated with individual vendors on
the preferred vendor list. This is where the specific items, prices, and service levels are
worked out. The simplest negotiations are for contracts to purchase indirect products
where suppliers are selected on the basis of lowest price. The most complex negotiations
are for contracts to purchase direct materials that must meet exacting quality requirements
and where high service levels and technical support are needed.
Increasingly, though, even negotiations for the purchase of indirect items such as office
supplies and janitorial products are becoming more complicated because they fall within a
company’s overall business plan to gain greater efficiencies in purchasing and inventory
management. Suppliers of both direct and indirect products need a common set of
capabilities. Gaining greater purchasing efficiencies requires that suppliers of these
products have the capabilities to set up electronic connections for purposes of receiving
orders, sending delivery notifications, sending invoices, and receiving payments. Better
inventory management requires that inventory levels be reduced, which often means
suppliers need to make more frequent and smaller deliveries and orders must be filled
accurately and completely.

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All these requirements need to be negotiated in addition to the basic issues of products and
prices. The negotiations must make tradeoffs between the unit price of a product and all
the other value added services that are required. These other services can either be paid for
by a higher margin in the unit price, or by separate payments, or by some combination of
the two. Performance targets must be specified and penalties and other fees defined when
performance targets are not met.

5. Contract Management
Once contracts are in place, vendor performance against these contracts must be measured
and managed. Because companies are narrowing down their base of suppliers, the
performance of each supplier that is chosen becomes more important. A particular supplier
may be the only source of a whole category of products that a company needs and if it is
not meeting its contractual obligations, the activities that depend on those products will
suffer.
A company needs the ability to track the performance of its suppliers and hold them
accountable to meet the service levels they agreed to in their contract. Just as with
consumption management, people in a company need to routinely collect data about the
performance of suppliers. Any supplier that consistently falls below requirements should be
made aware of their shortcomings and asked to correct them.
Often the suppliers themselves should be given responsibility for tracking their own
performance. They should be able to proactively take action to keep their performance up
to contracted levels. An example of this is the concept of vendor managed inventory
(VMI).VMI calls
for the vendor to monitor the inventory levels of its product within a customer’s business.
The vendor is responsible for watching usage rates and calculating EOQs. The vendor
proactively ships products to the customer locations that need them and invoices the
customer for those shipments under terms defined in the contract.

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CREDIT AND COLLECTIONS

Procurement is the sourcing process a company uses to get the goods and services it needs.
Credit and collections is the sourcing process that a company uses to get its money. The
credit operation screens potential customers to make sure the company only does business
with customers who will be able to pay their bills. The collections operation is what actually
brings in the money that the company has earned.
Approving a sale is like making a loan for the sale amount for a length of time defined by the
payment terms. Good credit management tries to fulfill customer demand for products and
also minimize the amount of money tied up in receivables. This is analogous to the way
good inventory management strives to meet customer demand and also minimize the
amount of money tied up in inventory.
The supply chains that a company participates in are often selected on the basis of credit
decisions. Much of the trust and cooperation that is possible between companies who do
business together is based upon good credit ratings and timely payments of invoices. Credit
decisions affect who a company will sell to and also the terms of the sale. The credit and
collections function can be broken into three main categories of activity:
1. Set Credit Policy
2. Implement Credit and Collections Practices
3. Manage Credit Risk

1. Set Credit Policy

Credit policy is set by senior managers in a company such as the controller, chief financial
officer, treasurer, and chief executive officer. The first step in this process is to review the
performance of the company’s receivables. Every company has defined a set of
measurements that they use to analyze their receivables, such as: day’s sales outstanding
(DSO); percent of receivables past customer payment terms; and bad debt write-off amount
as percent of sales. What are the trends? Where are there problems?
Once management has an understanding of the company’s receivables situation and the
trends affecting that situation, they can take the next step which is to set or change risk
acceptance criteria to respond to the state of the company’s receivables. These criteria

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should change over time as economic and market conditions evolve. These criteria define
the kinds of credit risks that the company will take with different kinds of customers and the
payment terms that will be offered.
2. Implement Credit and Collections Practices
These activities involve putting in place and operating the procedures that will carry out and
enforce the credit policies of the company. The first major activity in this category is to work
with the company sales people to approve sales to specific customers. As noted earlier,
making a sale is like making a loan for the amount of the sale. Customers often buy from a
company because that company extends them larger lines of credit and longer payment
terms than its competitors. Credit analysis goes a long way to assure that this loan is only
made to customers who will pay it off promptly as called for by the terms of the sale.
After a sale is made, people in the credit area work with customers to provide various kinds
of service. They work with customers to process product returns and issue credit memos for
returned products. They work with customers to resolve disputes and clear up questions
by providing copies of contracts, purchase orders, and invoices.
The third major activity that is performed is collections. This is a process that starts with the
ongoing maintenance of each customer’s accounts payable status. Customers that have
past due accounts are contacted and payments are requested. Sometimes new payment
terms and schedules are negotiated.
The collections activity also includes the work necessary to receive and process customer
payments that can come in a variety of different forms. Some customers will wish to pay by
electronic funds transfer (EFT).Others will use bank drafts and revolving lines of credit or
purchasing cards. If customers are in other countries there are still other ways that payment
can be made, such as international letters of credit.

3. Manage Credit Risk

The credit function works to help the company take intelligent risks that support its
business plan. What may be a bad credit decision from one perspective may be a good
business decision from another perspective. If a company wants to gain market share in a
certain area it may make credit decisions that help it to do so. Credit people work with

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other people in the business to find innovative ways to lower the risk of selling to new kinds
of customers.
Managing risk can be accomplished by creating credit programs that are tailored to the
needs of customers in certain market segments such as high technology companies, start-
up companies, construction contractors, or customers in foreign countries. Payment terms
that are attractive to customers in these market segments can be devised. Credit risks can
be lowered by the use of credit insurance, liens on customer assets, and government loan
guarantees for exports.
For important customers and particularly large individual sales, people in the credit area
work with others in the company to structure special deals just for a single customer. This
increases the value that the company can provide to such a customer and can be a
significant part of securing important new business.

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