OPS 395 Week 1 Procurement Within the Supply Chain Example

Sixty-Two Cents of Every Sales Dollar: The Role of Procurement in a Wisconsin Laundry Equipment Maker's Supply Chain

[Student Name]

University of Phoenix

OPS/395: Purchasing and Procurement

Week 1 Assignment

[Instructor Name]

[Date]

Fox Valley Washer Works, its spend, suppliers and figures are composites written for a model paper.

Fox Valley Washer Works is a composite manufacturer in Fond du Lac, Wisconsin, that builds commercial washer-extractors, tumble dryers and ironers for laundromats, hotels, hospitals and on-premises laundries. It employs about 520 people and had sales of about $180 million last year. Its purchasing department of nine people places about 14,000 purchase orders a year. The owners see purchasing as a clerical function that keeps parts arriving. This paper examines procurement's place in Fox Valley's supply chain, analyzes what it spends and argues for a more strategic role.

Procurement, Purchasing and Supply Management

Purchasing usually means the transactional work of buying: requisitions, purchase orders, expediting and payment. Procurement is broader, including identifying needs, selecting suppliers, negotiating and managing contracts. Supply management extends further still, treating the supply base as a source of cost advantage, quality, innovation and risk to be managed over time. Chen et al. (2004) studied manufacturing firms and found that strategic purchasing, in which purchasing participates in strategic planning and takes a long-term view, was associated with closer supplier relationships and better firm performance. Fox Valley's purchasing department sits at the transactional end of that range.

The Procure-to-Pay Process

At Fox Valley, the process runs as follows. Production planning or a department creates a requisition. A buyer checks for an existing supplier and price, requests quotes if none exist, and issues a purchase order. The supplier ships; receiving inspects and records the receipt. Accounts payable matches the invoice to the purchase order and receipt, a three-way match, and pays on terms. Exceptions, such as price differences, short shipments or missing receipts, return to the buyer to resolve. About 18 percent of invoices fail the three-way match, consuming much of the buyers' time.

Spend Analysis

The team extracted twelve months of accounts payable data, about $112 million spent with 1,140 suppliers, and categorized it.

Direct materials, about $86 million: stainless steel sheet and coil, $21 million; electric motors and drives, $17 million; electronic controls and touchscreens, $14 million; castings and bearings, $11 million; wire, harnesses and fasteners, $9 million; other components, $14 million.

Indirect purchases, about $15 million: maintenance, repair and operating supplies, tooling, information technology and office supplies.

Services, about $11 million: freight, temporary labor, engineering services and facilities.

Concentration is high: 40 suppliers account for about 80 percent of spending, while about 700 suppliers each received less than $10,000. Indirect spending is scattered: maintenance supplies were bought from 64 different suppliers, often at different prices for the same items.

Seven hundred suppliers shared about two percent of the spend and most of the paperwork.

Where the Money Goes Within Direct Materials

The direct material categories differ in character. Stainless steel is a commodity whose price follows global nickel and chromium markets; Fox Valley cannot control the price but can control how much it buys from whom and on what pricing formula. Motors and drives come from a handful of large manufacturers, two of which supply most of Fox Valley's needs, and switching would require redesign and testing. Electronic controls are the most technical category: the touchscreen controllers are customized to Fox Valley's software, and only one supplier currently makes them. Each category therefore needs a different approach, which is the subject of next week's strategic sourcing analysis.

Why Purchasing Matters to Profit

Purchases of $112 million equal about 62 percent of sales. With an operating margin of 6 percent, Fox Valley earns about $10.8 million in operating profit. A 5 percent reduction in purchase costs, about $5.6 million, would raise operating profit to about $16.4 million, a 52 percent increase. To achieve the same profit increase from sales at a 6 percent margin, the company would need about $93 million more in sales, a 52 percent rise. Even if extra sales carried a higher contribution margin, say 25 percent, the company would need about $22 million more sales, a 12 percent rise. Purchasing savings are not the only path to profit, but they are a large and often neglected one.

Problems in Current Practice

Three problems stand out. First, buyers spend most of their time on transactions and exceptions, leaving little time to analyze categories or develop suppliers. Second, sourcing decisions are made one order at a time, so Fox Valley buys stainless steel from four mills at different prices and terms without combining volume. Third, procurement is not involved in product design; engineers specify parts and suppliers, and purchasing learns of new components when the first requisition arrives.

Research on Strategic Purchasing

Carr and Pearson (1999) found that when purchasing was managed strategically, firms were more likely to have long-term relationships with key suppliers, and those relationships were associated with better financial performance for the buying firm. Gadde and Snehota (2000) argued that companies should not treat all suppliers alike: high-involvement relationships are costly and should be reserved for suppliers whose contribution justifies the effort, while low-involvement relationships suit standard purchases. Both points apply to Fox Valley, which treats every supplier the same way.

How the Function Should Evolve

Fox Valley should organize procurement around categories: one category manager each for metals, motors and controls, other direct components and indirect purchases and services. Category managers would analyze spend, develop sourcing strategies and manage key suppliers, while two buyers handle transactions with help from catalog purchasing for maintenance supplies. Procurement would join new product development reviews from the concept stage. And the function would be measured on total cost, supplier quality and delivery and savings achieved, not just orders placed.

Conclusion

At Fox Valley, purchases equal about 62 percent of sales, concentrated in a few direct material categories and scattered across hundreds of small suppliers. A purchasing department focused on transactions leaves savings, quality and innovation on the table. Research links strategic purchasing to closer supplier relationships and better performance. Organizing by category, joining product development and measuring total cost would move procurement from clerical support to a source of competitive advantage, which the coming weeks develop through strategic sourcing.

References

Carr, A. S., & Pearson, J. N. (1999). Strategically managed buyer-supplier relationships and performance outcomes. Journal of Operations Management, 17(5), 497-519. https://doi.org/10.1016/S0272-6963(99)00007-8

Chen, I. J., Paulraj, A., & Lado, A. A. (2004). Strategic purchasing, supply management, and firm performance. Journal of Operations Management, 22(5), 505-523. https://doi.org/10.1016/j.jom.2004.06.002

Gadde, L.-E., & Snehota, I. (2000). Making the most of supplier relationships. Industrial Marketing Management, 29(4), 305-316. https://doi.org/10.1016/S0019-8501(00)00109-7