Operation Management
Supplier Selection and Performance Measure of Inventory Management

Executive Summary

Procurement and inventory management has been touted as the main driver in any company competing in the market. Dynamic market environment have created demand uncertainties, any slight changes in downstream demand will have a whiplash effect on the whole supply chain. In this paper we will analyze two components of procurement and inventory management; decision making model in supplier selection and Key Performance Index to inventory control and supply chain management in general. A literature review of related theories to supplier selection will be presented followed by analyzing monetary and non-monetary criteria in developing a decision making model based on the case presented. Second part will discuss key performance indicator critical analysis on its relation to inventory control and supply chain management and its application in solving the problem presented in the case.

Supplier Selection

Theories Related to Supplier Selection

Increasing competitiveness among companies has resulted in lower profitability margin. Practitioners and academicians have identified purchasing as paradigm shift in business process where value can be added even before inventory are purchased, processed and distributed. Improving company profitability margin and EPS or earning per share has been the main focus in procurement. Supplier selection therefore is the main strategy and vital in a company as it contributes to the margin; selection of the best supplier meeting organization needs and delivery efficiency will definitely help in the long run.

Selection process now is no longer simple or just based on transactional basis; it has now evolved into a strategic process; where purchases are made based on selection criteria developed to meet organizational business models and building long term relationship. The selection process can be complicated and multidimensional.

Several factors have been identified by Merzer, Djavi & Saives (2001) to have influence on business purchases. 1) Composition of functional specialization members in the selection committee. 2) Degree of buyer seller relationship. 3) Role of intermediaries in the decision making process. 4) Impact of business environment in the selection process.

Criteria for supplier selection usually contradict one another, getting high quality product supplier will have higher unit cost price; lower priced products may come with higher defects rate for example (Pearson and Ellram 1995). As the market changes, supplier selection criteria will follow suit This situation needs the decision making process to weigh the criteria and trade off criteria according importance for achieving long term organizational goals and strike the right balance. Organizational and environment constraint needs to be analyzed. Internal constraint such as purchasing policy, storage capacity and production capacity all are factors to be weighted. External constraint such as governing body regulations needs to be adhered to.

Traditional models of supplier selection are i) total cost approach where selection criteria are converted to a cost component. Following which selection are made according to lowest cost supplier after adding and subtracting selection criteria in terms of cost prices(harding). ii) Multiple attribute utility theory (MAUT) gives decision makers multiple alternatives and what ifs situation to weigh their selection criteria(von). Multi objective programming mostly used in Just in Time production system; this programming takes into consideration multiple supplier and match it with organization purchase volume (Khurum and Faizul 2002).

Analytic Hierarchy Process (AHP) by Thomas Saaty (2008) is a comparison process of all criterions in supplier selection process. AHP first categorize supplier selection into hierarchy of criteria of which each will be analyzed individually. The criteria may monetary or non monetary, qualitative or quantitative and or tangible or intangible. Once the criteria have been decided, decision makers will evaluate the criteria by pairing criteria to supplier to compare relative importance. AHP provides numerical values towards decision making while allowing intangibles to be measured (Saaty 2006).

Problems facing the Product Operating System of Nordic Phone Company

Product operating system refers to underlying programs Nordic Phone Company uses to coordinate the functions of hardware and components in its product line. Problems or error in the operating system will result in dysfunctional phone. If such case happens too often; customer would lose confidence of its products.

Product operating system of Nordic Phone Company is sourced directly from suppliers, and issues arising from the sources as mentioned in the case are regular problems with the operating systems assuming it is related to downtime. In the case also mentioned that the products operating system is sourced at a slightly above market price; in this situation they would not have the competitive advantage if some of the components and operating system are soured above market price.

Supplier selection models will have to be reviewed in the company. A new decision making model will need to be applied to understand as to why product operating systems having regular problems and are sourced at above market value.

Monetary and Non-monetary Criteria to be considered in Supplier Selection

Criteria to be considered in supplier selection can be divided into monetary and non-monetary aspects. For non-monetary criteria; defect rate is critical to the quality products supplied, this can be measured by randomly test the product received (Vonderembse 1999). Suppliers must be rated on the ability to supply products according to specifications as agreed in contract. Nordic experiences persistent problems with its products operating systems, therefore this criteria should be the company’s upmost important criteria when selecting suppliers. Response time measure time taken from customer complaint till problems resolved by suppliers. This criterion to Nordic in solving its existing problem is important in the sense that quick responses from the supplier would save time and adapt better to supply shocks.

Timely delivery and lead time is another non-monetary criterion to consider. This is especially important for companies in lean manufacturing systems. Considerations to on time delivery to precise location are vital to the company’s wellbeing and continuous operation. Other criteria to assist in supplier selection by asking “does the supplier have the production and manufacturing capability to adapt to organizations ever changing demand from the market?” (Vonderembse 1999)

Nordic will have to consider the following criteria; Process capability, technology innovation and capacity of the supplier to ensure suppliers have the capability to meet its demand. Due to the large purchase; Nordic need to see that the supplier is able to fulfil the order and getting it right the first time. Relationship between organizations with suppliers; how is it now, reflections of past experiences and where will it be heading. Current supplier seems to be unable to meet Nordic’s specification and maybe it is time to reconsider its current supplier.

Monetary criteria would refer mostly to cost of the supplies. Pricing are the main focus here as the financial objectives would be to achieve higher margin and better profitability (Pearson and Ellram 1995). Nordic’s purchases are above market price, therefore selection of supplier would also largely depend on the pricing of the products offered followed by the non monetary criteria. Most of the time there will be conflict between monetary and non monetary criteria. Higher prices would reflect better quality items and vice versa. Organization seeking lower priced items may be in for higher defects, delivery timing and lead time for complaints to be resolved increased.

To successfully lower the cost incurred, Nordic must take into consideration all cost incurred including order cost, inventory holding cost, transportation cost for the product operating system. Given the higher purchase price of operating system, Nordic must evaluate the total cost incurred from the suppliers’ side to have a reflection of the situation and leverage on the advantage. Credit term given by supplier should also be included in the selection criteria; longer period of credit will improve company working capital and cash flow.

A Decision Making Model for Supplier Selection

Dynamic market environment calls for a strategic model that will incorporates into the changing demands and situational analysis into a decision making model. An ideal model must assist the decision making process fast and include multiple choices for evaluation while simple to execute. It is suggested based on AHP (Saaty 2006) that the following steps as a decision making model for supplier selection.

 

Step one prepare detailed process flow and identify where suppliers are needed in the products operating system supply chain system. Hypotheses are derived to find lower cost processes and production efficiency; for example, will standardized order reduce cost? Data on existing products operating system supply chain needed to identify products with similar functions, communicating with engineers to map efficiency and sourcing for suppliers (Bhushan and Rai 2004). Criteria for supplier selection will be established at this step.

Step two; compare each criterion through paring comparison. For example the cost of product operating system, with defect rate whether is it moderately to strongly prefer lower cost or strongly prefer lower cost compared to defect rate. Following pairing comparison, criteria importance will be established.

Step three; evaluate the pool of suppliers to narrow down numbers based on the criteria decided above. Decide suppliers to be awarded contracts using AHP model by pairing the suppliers to the criteria (Saaty 2006). It is a complicated process but AHP model evaluates provides Nordic with selection criteria to weigh qualitative and quantitatively of the criteria and pairing it to suppliers for optimal supplier selection.

Step four; progress report on the status of the supplier in delivering supply should be done periodically. KPI to identify supplier performance, implement continuous improvement.

Application of Theories to Product Operating System of Nordic Phone Company

Revaluation of the decision making model for supplier selection will be vital to solving the recurrence problem of product operating system and the above market value of some of the parts sourced. Since all product operating system and components are sourced, a structured procurement process will assist in getting best package out from the suppliers.

Adopting an existing model accustomed to Nordic Phone Company will streamline procurement process. Suggestion is that they adopt AHP model. This model would give comprehensive monetary and non-monetary criteria involved in supplier selection. Using paired comparisons and weight distribution over the criteria it will generate the most appropriate importance given the choices made by selection committee

Supplier selection criteria which will need to focus on would focus on non-monetary criteria as to avoid recurrence of problems. As for the product operating system, reliability would be the main focus. Receiving reliable operating system will reduce rework as there will be fewer problems arising. Follow-up services, ability of suppliers to response to the urgent request of operating system failures and availability of support team should also rank among the top importance.

Pricing of the total package of the operating system inclusive of support service, pricing for upgrades or additional programs in the operating systems should also be included in the supplier selection criteria. This criterion will enable Nordic to have flexibility to change and adapt to dynamic market demand. Implementation of such criteria will help Nordic to select suppliers with average cost compared to market.

Supplier relationship with Nordic such as track records of suppliers, previous experiences with the suppliers, financial stability, response speed and capability to delivery should all be considered as well. The criteria mentioned will be paired and weighted by the selection committee. Strong relationship with suppliers means better service quality provided by supplier; as such follow up services and response time towards improving downtime of the product operating system.

The decision will be based on supplier that has met the highest possible criteria without having Nordic to trade off important criteria weighted.

Performance Measure of Inventory Management

Key Performance Indicators Used in Inventory Control and Inventory Management in a Company

Inventory Management is describe as the continuity of supplies; to strike a balance between cost of supplies, storage and the continuous operation of the organization. Right policy will ensure minimal holding cost, continuous operation and right pricing. Therefore measuring the effectiveness of inventory management will ensure continuous improvement to be applied to the process.

Key Performance Index, a common indicator to performance management has in fact listed some criterions for efficient inventory management. Among the internal performance index weighted is inventory utilization; where inventory utilized over a period are gauged as management effectiveness. Inventory turnover measures the number of time inventory is changed in the period. Stock cover measures the number of days the inventory will lasts depending on the current usage patterns. Understanding these indicators and meeting the target set will improve inventory management efficiency and deviations from indicators reflect problems arising in the assembly processes.

On shelf availability indicator basically means the items will not run out of stock and is available for its internal or external customers. Inventory accuracy will be important to have similarities between the inventory you have and the inventory recorded in the computer should be similar; this indicator will help in retrieving important information in the assembly line. Order picking accuracy refers to the speed and accuracy of collecting inventory; reason being the faster and accurate retrievals of inventory means less time required, as we know time equals to costs (Tan, Kannan and Handfield 1998).

External KPI measurements are inventory completion; this refers to the completeness of the inventory including its packaging before delivery to its customers. Delivery accuracy refers to qualitative measures of delivery where time and accuracy are taken into consideration. Time taken will increase the cost as inventory would need to travel through longer transportation.

Cost to serve takes into account the total cost incurred to respond to a customer complaint; it is embedded with customer profitability after deducting the incurred cost to serve. It will provide organizations a truer picture of the customer cost and it encourage innovation to reduce the cost to serve (Spekman 1999). Downtime refers to the time that the product or service which is unavailable to the customer for a period of time.

Common indicator utilized for controlling inventories are inventory value indicator; measure the dollar value of inventory during a period of time, usually every month. It is detailed to each class of inventory to identify directly any significant changes in inventory value related to which class of inventory would need to be rectified. This inventory value indicator includes a separate value for surplus inventory, obsolete inventory and maybe used also as number of inventory instead of dollar value.

Number of inventories reviewed; which may be work in process or finished product. The lower the number of inventories reviewed would mean improvement of work processes resulting better indicator value while any unexpected or changes in some parameter would result in increased number of inventories reviewed. Six sigma model is an example of quality control KPI for inventory control.

Key Performance Indicators for Managing the Entire Supply Chain

Managing an entire supply chain for performance is no easy task especially involving global suppliers and delivery of finished goods. KPI for managing supply chain tend to focus more on the efficiency of the organization in moving the inventories from suppliers to finished goods and delivery to end customers. The efficiency of the supply chain in converting its cash payable to cash received as soon as possible. KPI would focus on monetary and inventory cycle indicator (Tan, Kannan and Handfield 1998). Other indicators would refer to mostly external indicators of excellence; such as delivery completion, delivery accuracy and cost to serve.

Among the indicators that can be used as measurements for entire supply chain in a company would be delivery accuracy. Delivery accuracy will have a chain reaction to an entire firm from receiving raw materials to finished product. Any disruption to delivery or deviation from the KPI set would see the processes involved coming to a halt or bottleneck at another. Working with global suppliers, timing delivery and delivery the right components will assists organization and supplier to long term relationship where both parties will help each other to grow (Mc Adam and McCormack 2001). Both important aspects are covered in delivery accuracy; time and quality, this two aspects meeting KPI benchmark set would ensure a smooth running operations.

If measurements in inventory indicators such as delivery accuracy fall, organization should immediately respond to rectify the situation. The shortfall of delivery accuracy will result in other indicators such as on time delivery will be affected. The root problem may be inaccurate inventory records, which will result in a chain reaction such as customer service could not generate accurate delivery date; which organization may not satisfy its customer demand, lost of customer. Organization knows the consequences of not able to meet its target indicators.

Customer Service Indicator an important measure for the supply chain management. It will help the organization to set achievable targets while monitoring service level regularly.

Essential KPIs for LCD Supply Chain

Nordic Phone Company faced serious quality issues regarding its LCD supplies. Given the grim situation of the supply chain in Nordic, it is best to adopt KPI as a measurement indicator for the suppliers to fulfil before receiving the supplies. One indicator that suits best for this situation is number of inventories reviewed.

Preventing the root cause of problem at source would be ideal rather than waiting for it to happen somewhere in the process or finished product. Adopting six sigma statistical test for reliability of the LCD supply by doing random checks on the units by batches before receiving them. For example; test results should be 1% or lower in defects rate; any significance level not met would result in rejecting the whole batch of components required for LCD supply chain. This way supplier will have to ensure meeting the quality standard before sending the supplies to Nordic. It is essential to tackle the cause at the supplier level as defects detected at a later stage will have implications on all other inventory management KPI’s in Nordic. Other KPI would be use to measure supplier delivery on time.

After receiving quality components and LCD screens required for the supply chain, Nordic need to make sure that the assembly process fits perfectly to reduce defects on the work in progress and finished goods. Indicators suitable to measure performance during assembly process are work in process days to determine the average days components take to be converted to finished products. For example; standard working days needed to complete a product line increases from 2.3 days to 2. 8 days, Nordic looking at this indicator must improve the processes to shorten the time taken to improve the LCD supply chain.

Number of Inventory reviewed would still be relevant to determine the number of defects in between the assembly process. For example; increase in number of units reviewed from current 1% to 1.5% indicates assembly process is the source of defects in LCD supply chain. Inventory accuracy indicator is vital to the LCD supply chain. As we know LCD supply chain is made of several components therefore real stock on hand and records in computer must tally. Achieving KPI in this area will streamline all other processes from receiving supplies to delivery of finished goods. Given the persistent problems in LCD supply chain, Nordic may want to have stock cover as an indicator to ensure smooth production. Stock cover indicator

Completed products will be delivered to customer according to order. Logistic performance will be vital to measure to indicate cost and delivery efficiency. Indicators such as on time deliveries are vital to meet customer satisfaction. Other indicator such as loading factor; for example full load would help to show proper planning and efficient delivery is in practice. Therefore LCD supply chain itself has many KPI to gauge its performance and most importantly quality control.

Forecasting demand may be used as KPI as well; indicated in the case, there will be five time increase in demand during the month of December for its media product line due to Christmas holiday season. Forecasting and actual demand should not exceed by 10% difference; any variations will put pressure on the supply chain. Forecasting LCD demand achieve its target indicator to fulfil customer demand during the holiday season.

Information Exchange in the LCD Supply Chain

Recognizing the consistent problem exist in its LCD supply chain, information exchanges between the LCD supply chains are vital to identify the root of the problem. First and foremost quality control measure needed at each and every workstation in between processes. The exchanges of information starts at the moment supplies are received. Random checks can be made and probability of defect components and LCD screens; only quality controlled items are allowed through to assembly points.

Each and every assembly station will practice quality control and maintain at the needed indicator would be ideal. Stock cover at all station may also be an indicator as to where the defects rates are high. Utilization of stock cover frequently indicates the where the problem lies in the assembly process. Kanban system or visual card system; functions to retrieve components and also to give instructions to produce more of the parts can be adopted by Nordic to efficiently communicate between workstation on inventory management. Feedbacks are also important as workstation receiving defective products will have to inform the previous lines of their findings. Valuing response from workstation regarding its quality and productivity is vital to solve any bottlenecks and improve work processes.

Distribution system of finished goods to warehouse and delivery to customers will also need to be assessed. Improper handling of fragile goods may cause defects to the supply chain. Nordic Phone Company material flow chart indicates that long distances transportation needed between production and distribution channel. Long transportation route and time needed made delivery mode to be mass transportation of finished goods. Inventory management here would require constant information exchange between production facility and distribution channel on demand, delivery time, customer service and feedback.

Conclusion

Establishing both monetary and non-monetary criteria and weighted decision making model such as AHP helps selectors to critically evaluate which criteria presents the most importance to organization purchase and qualifying suppliers during the selection process. Making decision is not an easy task especially given the multi dimension and considerations in the criteria; creating conflicting and selectors have to trade-offs some criteria depending on the importance. Key performance Indicator for inventory management presents interesting perspective to supply chain management. Inventory management is the key to lower working capital requirements and gives companies competitive advantage in the marketplace. Achieving KPI helps to achieve management goals while deviation from the indicator will help organizations to identify source of problem in the supply chain.

In the case of Nordic Phone Company, it is best for the company to adopt total quality management model. Detecting problems at source will help improve the bottom line and production efficiency. Overall, Nordic will have to reconsider the materials movement throughout its supply chain or invest in creating media product line in Thailand to meet the high demand during Christmas holiday season. Its decision making model especially in supplier selection would need to be revamp. Criteria must be evaluated first to determine the importance; followed by a qualifying process to select best supplier according to established criteria. Nordic Phone Company may adopt AHP decision making process to tap on the function of evaluating both monetary and non-monetary criteria, overlapping and contradicting criteria in its supplier selection criteria.

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