Procurement and
Manufacturing
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Overview of procurement and manufacturing
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The quality imperative
Procurement
Manufacturing
Lean and six sigma
Logistical interfaces
4-2
The 8 Dimensions of Product Quality
• Performance
– How well the product performs in
comparison to how it was
designed to perform
• Reliability
– Likelihood that the product will
perform throughout its expected
life
• Durability
– The actual life expectancy of the
product
• Conformance
– Does the product meet its
specifications as designed
• Features
– What different functions or tasks
can the product perform
• Aesthetics
– Is the styling, color, workmanship
pleasing to the customer
• Serviceability
– What is the ease of fixing or
repairing the product if it fails
• Perceived Quality
– Based on customer’s experience
before, during and after they
purchase a product
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Performance
• How well the product performs in comparison to
how it was designed to perform.
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Reliability
• Likelihood that the product will perform throughout
its expected life.
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Durability
• The actual life expectancy of the product.
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Conformance
• Does the product meet its specifications.
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Features
• What different functions or tasks the product
perform.
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Aesthetics
• Is the styling, color, workmanship pleasing to the
customer.
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Serviceability
• What is the ease of fixing or repairing the product if
it fails.
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Perceived Quality
• Based on customer’s experience before, during and
after they purchase a product.
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Total Quality Management
• Total quality management (TQM) is a
philosophy focused on meeting customer
expectations with respect to all needs,
across all company functions, and
recognizing all customers, both internal and
external
• TQM’s basic conceptual elements are:
– Top Management commitment and support
– Maintaining a customer focus in product, service
and process performance
– Integrated operations within and between
organizations
– A commitment to continuous improvement
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Management standards have been established
by the ISO in both quality and environment
• The International Organization for
Standards (ISO) was formed after World
War II
• ISO 9000—International Quality Standard
– First one established in 1994
– Currently transitioning to ISO 9000:2008
• ISO 14000—International Environmental
Standard
– First one established in 1998
– Current one is ISO 14001:2004
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ISO certified suppliers are frequently preferred
by procurement departments
• They have to conform to an externally defined
set of standards for quality and delivery of
service
• They are usually more open to sharing supply
chain information
• They welcome building relationships with their
customers
• They have formal processes in place for continual improvement of
their products, services, and processes
• They are easier for procurement folks to initially qualify and
periodically audit
– Certification is done by an external register agency
– Firms have to be re-certified every three years
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Procurement is now a strategic activity of the firm
• Several factors have elevated the
importance of procurement to the
firm
– Purchased goods and services are
among the largest cost elements for
most firms
– The growing emphasis of
outsourcing has expanded the
supply base of organizations
• This added complexity requires more
management attention on the
organizational interfaces with suppliers
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Purchasing perspective
• Purchasing was historically perceived as just a buying
function for manufacturing and repair materials and
supplies
– Purchasing agent tried to get lowest price possible for acceptable
quality
– Transactional focus led to getting the best possible “deal” today
• Did not focus on future transactions
– No concept of Supply Chain
• Purchasing seldom looked beyond the first-tier supplier
– Purchasing simply responded to demands of production group
4-16
Procurement perspective
• Procurement is an organizational capability that ensures
the firm is positioned to implement its strategies with
support from its supply base
– Procurement looks up and down the entire supply chain for
impacts and opportunities
• Goods and service account for 55 cents of every sales dollars
– Focuses on building relationships with suppliers and downstream
customers
– Involvement with outsourcing includes more than just purchasing
raw materials and parts
• Also includes finding alternate sources for manufactured products or
services to help manage demand
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Procurement focuses on several issues
related to the firms’ supply base
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Ensuring continuous supply
Minimizing inventory investment
Quality improvement of supply
Supplier development
– Supplier selection
– Building supplier relationships
– Supplier continuous improvement
• Lowest total cost of ownership
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Figure 4.1 Major Categories for the Components of Total Cost
of Ownership
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Procurement strategies
• Volume consolidation
– Reducing total number of suppliers while
minimizing risk
• Supplier operational integration
– Building partnerships
– Sharing information and knowledge
– Identifying linked processes and shared
opportunities for improvement
• Value management extends beyond
buyer-seller operations
– Involving the supplier early in product design
– Reducing complexity
– Value engineering
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Savings potential from volume consolidation
• Purchases average 55% of every sales dollar
• Cost savings estimated between 5% to 15% of
purchases
• Potential savings is $5.5 million annually for a
company with revenues of $100 million
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Supplier operational integration
• Primary objective of operational integration is to cut waste,
reduce cost, and develop a relationship that allows both
buyer and seller to achieve mutual improvements
• Integration can take many forms
– Buyer providing detailed sales information to supplier
– Buyers and suppliers working together to redesign linked
processes
– Eliminating duplicated activities performed by both the buyer and
supplier
• Can provide incremental savings of 5% to 25% over the
benefits of volume consolidation
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Value management through early supplier involvement in
product design
Figure 4.2 Flexibility and Cost of Design Changes
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Purchase requirement segmentation
• Pareto Principle is a small percentage of
items account for a large percentage of
the dollars spent
– For example, “A” items in ABC inventory
• Purchasing processes should be tailored
to the value and/or criticality of the
materials needed
• Segmented approach is used to prioritize
resources for purchasing
– The most procurement effort goes to the most
critical supplies/suppliers
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E-Commerce and procurement
• Electronic Data Interchange (EDI) is the
electronic transmission of data between a firm
and its suppliers
– Shares information and knowledge such as order
entry, planning/scheduling, tracking, delivery, billing
and payment
• Internet-based communications offer several
opportunities for making product information
available while overcoming compatibility issues
between computer systems
– Electronic catalogs allow rapid access to product
info, specifications, pricing and ordering
– Buying exchanges allow sellers or buyers of specific
goods or services to find each other on a common
web site
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Manufacturing Perspective
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Brand Power
Volume
Variety
Constraints
Leadtime
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Brand Power
• The measure of customer preference based on
reputation, product quality and supply chain
capabilities
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Volume
• Volume is traditionally treated according to the
principle of economy of scale
– Average cost to produce product declines as manufacturing
volume increases
– Particularly important when high fixed costs are present
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Variety
• Variety involves frequent product runs and high
repetition of small lot sizes
– Processes that can rapidly switch production from one product
to another while retaining efficiency are said to have economy
of scope
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Constraints
• Constraints interact with volume and variety to create
realistic manufacturing plans
– Capacity is how much can you produce in a given unit of time
– Equipment considers how flexible it is
• Is one particular piece a bottleneck?
– Setup/Changeover considers how quickly can you change from
one variety of product to another
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Leadtime
• The measure of elapsed time between release of a work
order to the shop floor and completion of all work on the
product to achieve ready-to-ship status
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The four common manufacturing processes
• Job shop creates a custom product for each customer
• Batch process manufactures a small quantity of an item in
a single production run
• Line flow process has standard products with a limited
number of variations moving on an assembly line through
stages of production
• Continuous process is used to manufacture such items as
gasoline, laundry detergent and chemicals
• Modifications of the above can create new options
– Mass customization produces a unique product quickly and at a
low cost using a high volume production process
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Manufacturing strategies should match your
market requirements
• Make to Stock (MTS) features economies of scale, large
volumes, long production runs, low variety, and distribution
channels
• Assemble to Order (ATO) is when base components are
made, stocked to forecast, but products are not assembled
until customer order is received
– Manufacturing postponement practiced here
• Make to Order (MTO) relies on relatively small quantities,
but more complexity
– Requires much interaction with customer to work out design and
specification
– Usually shipped direct to customer
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The choice of strategy determines which
performance cycles the customer experiences
Figure 4.3 Manufacturing Strategy and Performance Cycles
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Total cost of manufacturing
• Total cost of manufacturing (TCM) includes:
– Procurement and production activities
– Inventory and warehousing activities
– Transportation activities
• TCM generally expressed as cost per unit
• Procurement and production costs go down
as volume goes up
• Inventory and warehousing costs go up as
volume goes up
• Transportation costs go down as volume goes
up, but level off at high volumes
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TCM per unit ranging across strategic
alternatives
/MTS
Figure 4.4 Total Cost of Manufacturing
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Lean systems
• Lean is a philosophy of
manufacturing that
emphasizes the
minimization of the amount
of all resources (including
time) used in the operation
of a company
• Defining principle is the
elimination of “waste”
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Primary objectives of lean systems are to
 Produce only the products that
customers want
 Produce products only as quickly as
customers want them
 Produce products with perfect quality
 Produce in the minimum possible
lead times
 Produce products with features that
customers want and no others
 Produce with no waste of labor,
materials or equipment
 Produce with methods that reinforce
the occupational development of
workers
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Six sigma quality concepts
• Six sigma approach is to
identify sources of variability
and then systematically reduce
them
• The six sigma goal is to
achieve a process standard
deviation that is six times
smaller than the range of
outputs allowed by the
product’s design specification
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Example of a six sigma quality level
Three sigma quality level
• Produces defect free product
99.74 percent of the time
• 66,807 defects per million parts
produced
Six sigma quality level
• Produces defect free product
99.99966 percent of the time
• 3.4 defects per million parts
produced
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Logistical interfaces
• Resources must be procured, positioned, and
coordinated as needed to support the
manufacturing strategy selected
• Four approaches to achieve this are:
– Just-in-time (JIT)
– Materials requirements planning (MRP)
– Design for logistics
– Performance based logistics
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Just-in-time (JIT) interfaces
• Just-in-time only produces to a customer
order (ATO, MTO)
• Purchased materials and components arrive
at the manufacturing or assembly point just
at the time they are required for the
transformation process
• Raw material and work in process
inventories are minimized
• Demand for materials depends on the
finalized production schedule
• Lot sizes are as low as one unit
• Close cooperation with suppliers is
essential!
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Materials requirements planning (MRP) interfaces
• For more complex manufacturing
where large numbers of components
or assemblies are used to produce a
final product
• Procurement has a key role in insuring
all the components are obtained on
time to make an end item
– Key information requirement is the bill of
materials (BOM)
• Planning sometimes spans multiple
manufacturing locations (e.g. Boeing
Dreamliner)
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Design for logistics interfaces
• Design for logistics includes the
requirements and framework for
logistical support in the early
phases of product development
• Considers
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What we are going to make
How we are going to make it
What logistics capabilities do we need
How we are going to integrate our
suppliers into the process
– Any subassembly manufacture by
suppliers
– The need for outsourcing of some
parts or assemblies
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Performance based logistics interface
• Initiated by US Department of
Defense to purchase
performance outcomes instead
of individual transactions
defined by product
specifications
• Government specifies desired
outcomes and lets suppliers
determine the best way to meet
those requirements
• Currently limited to government
purchasing but business
organizations are expected to
adopt the practice
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