Chapter 9 Sourcing – Optimizing the Supply Chain



Starting from the time a quote is taken through when material is rolled into production, managing supplier quality, cost, and delivery is imperative in running a successful business.

There are five key supply management goals:


1.Meeting the business objectives with a focused sourcing strategy

2.To buy at the best price while meeting the required specifications

3.Ensuring that the right material is at the right place at the right time, with factory-fresh quality

4.To receive a material forecast to manage inventory in line with strategic objectives and budget

5.To continuously develop the sourcing team to meet existing and future requirements.


The goals are accomplished by maintaining a list of available, qualified suppliers; selecting suppliers and negotiating contracts; establishing key performance indicators; acting as an interface between the business and its suppliers; and providing training. Also, the supply management team is expected to know the market for their commodities, understand the laws in the countries where business is done, understand and improve lead times, and maintain ethical behavior.

Competitive pressures make supply management increasingly dependent on supplier performance, which means that quality and service can often be more important than cost. Therefore, cost is not always the only key factor in choosing a supplier.


Mission of Sourcing

The mission of sourcing is to develop a plan for every part (PFEP) or service that is consistent with operations strategies of low production costs, on-time deliveries, high-quality products and services, and flexibility.

Sourcing has become increasingly important because:


All organizations have suppliers, which creates operational dependencies

The impact of material costs on the P&L can be more than 60 to 70 percent of revenue

Supplier deliveries must be exact in timing, quantity, quality, and cost

Globalization has created a growing competition for scarce resources along with longer supply chains.

Therefore, sourcing organizations must continually evolve and have strong relationships with their suppliers.

There are three parts to a sourcing strategy: cost management, new product introduction, and strategic sourcing and supplier development.


Cost Management

When Taiichi Ohno started his journey on the Toyota Production System (TPS), Toyota’s suppliers were not enthusiastic about the manufacturing system he developed. The prevailing production philosophy at the time was one of highly efficient equipment manufacturing producing large lots, with any surpluses stored in a warehouse because it was assumed that they would always be absorbed by the marketplace.

The oil crisis of the 1970s changed this dramatically, as suppliers were suddenly unable to dispose of their inventories. As Ohno stated, “It’s funny how people don’t get serious about something until they are confronted by the necessity.”

A tool commonly used to help sourcing organizations develop an understanding of the cost of an item is a quote sheet. Here, research from the sourcing team includes: current practices, stakeholder requirements, industry and market information, potential suppliers, and competitive analysis and definition (or strategy) of what the team is hoping to accomplish by this action. Criteria for supplier selection include:


Product price

Quality of material


After-sales service

Supplier location

Inventory availability

Financial stability

Technical capability

Product range

Another highly effective method of managing overall cost is to apply a total acquisition cost* (TAC) model. TAC is a tool to evaluate the total cost of procuring a product or service from a supplier. It is an easy concept to understand, yet quite tedious to actually do (see below).

TAC was developed to provide transparency for the procurement process, define the true cost of sourcing material, assist with supplier selection, and help with modeling and simulations. In addition, it helps with measuring the cost per unit of acquiring material as well as cost as a percentage of sales in order to level out volume and mix changes.

Finally, this methodology is also useful in identifying the first steps of potential areas for improvement at both the plant and supplier level. By utilizing TAC, we not only measure the piece price but also capture all costs—logistics, warehousing, trade, packaging, factory floor, obsolescence cost, and inventory-carrying costs. We find the true costs of acquiring material into production.


Sales and Marketing Costs

One of sourcing’s primary responsibilities is to be involved with the new product development process. This is necessary to manage the following:


The cost of direct and indirect materials and services

Service levels, quality, and cost

Uniformity throughout the business

Strategic planning for a coordinated global strategy.

Factors to consider in evaluating sourcing or product decisions are cost, sales, and margin. The following are just some of the costs related to delivering a product to the marketplace.


Managing Ongoing Supplier Relationships

Monitoring, measuring, and communicating supplier performance is essential to the success of the business. Key elements of managing supplier capability are as follows:


Supplier service agreements—service levels, lead times, capacity commitment, flexibility, lead time to change, means of collaborative planning, and performance measures

All strategic suppliers and those with known resource constraints reviewed as part of the monthly planning cycle

Generate visibility on requirements out through the planning horizon

Assess changing requirements and review whether they are within the parameters of the existing service agreement

Develop a formal supplier review process with key suppliers

Capability and flexibility review


Impact/risk to the factory supply plan.

Ways to improve supplier effectiveness are to form partnerships with long-term contracts; manage supplier base determined by quality, cost, and delivery; develop opportunities for both parties to learn more about each; solicit suppliers to provide input to product design; provide full access to the supply plan and schedules; and build a continuous flow of data to the supplier about changes to specifications or operational requirements.

In addition:


Collaborate to improve cycle times and reduce costs

Reduce and eliminate receiving inspections

Cultivate joint training programs for mutual understanding of challenges.

Finally, common barriers to good sourcing/supplier relationships include poor communication and feedback, poor quality and/or delivery, supplier complacency, misguided supplier improvement objectives, poor perception by suppliers of customer credibility, misconceptions of purchasing power, and mutual mistrust.


Final Thoughts on Sourcing

One person’s finished good is someone else’s raw good. It’s all about cost management, strategic sourcing, and new product introduction.

It’s that simple. Relationships can flourish between customer and supplier and shouldn’t be made contentious by solely fixing on price. Supply management is all about managing the process for the success of the business.

Case Study 9.1

Supplier Development and Cost Management

In 1995, it was decided that we were switching to 4 hours of inventory inside the plant. We operated a 22-day closed-loop cycle that ran across the North American continent from east to west, including Mexico and Canada, that supported a build rate of 1,000 Corollas and 600 Tacoma’s per day.


Project Description

Multiple Daily Shipments from Suppliers to Plant



New United Motors in Fremont, California, was established in 1984 as a joint venture between Toyota and General Motors. We produced 1,000 Geo Prizms/Toyota Corollas, as well as 600 Toyota Tacoma pickup trucks per day.

With growing political and monetary pressures in the early 1990s, Toyota committed to increasing the purchase of North American–sourced parts for its worldwide production.

North American part suppliers were predominantly located in the Midwest, Southeast, and Texas border regions.

Philosophically, the plant was operated with the fundamental principles of Toyota Production System: Just-in-Time (JIT) and Heijunka (level production/level flow and pull systems were fully utilized). The term FRS stands for final requirements schedule.

The plant supply chain was designed around a 22-day closed-loop cycle from supplier to plant and back, which also contained returnable containers and imported second-tier material.

Other observations to note:


Toyota had little experience in Japan with long-distant logistics, so a supply chain had to be designed to accommodate the production line being 2,000 miles away

Plant inventories were to be kept at a minimum (1 day); however, it was viewed that they were excessively overflowing at line side, and line workers had to worry about parts being supplied correctly

Suppliers were experiencing troubles from large Kanban fluctuations and quite often had to prepare material shipments early due to variability in the transportation process.

While each function worked to optimize their process, there was no macro view of TAC.


Project Goals Were

1.Recurrent daily processes

Equal interval of arrivals at manufacturing

Cyclical transportation operations

2.Shorten lead times

Shorten/eliminate sleep or stagnation times

Small lot shipments

3.Provide flexibility to respond to changes in volumes

Maintain JIT level of service

Provide maintenance with little impact on preceding processes.



Orders for daily material requirements were divided into four-hour increments and transmitted to suppliers and logistics providers on a daily basis based on agreed-upon lead times

Quality checks and piece counts were eliminated at the plant. These were moved to the supplier dock and performed by the logistics providers at the time of milk-run pickups*

Material was verified and consolidated for rail shipments based on four-hour increments

Container contents and supplier verification data were transmitted to the plant for actions

Suppliers and logistics providers were paid upon arrival of material at the plant

Plant inventories were reduced from 16 to 4 hours for North American suppliers. In addition, the entire network’s TACs were reduced by 5 percent.

The plant got to a 4-hour inventory—half a shift.