Page 105 - DMGT525_MATERIALS_MANAGEMENT

Materials Management

Notes  Willingness to change their products and services to meet your changing needs
 Quick response time in case of emergency, problem, or special request
Few models are capable of taking total costs into consideration total costs, but they are typically
very tricky to implement and time taking. Hence, the resources that are accessible to the firm’s
purchasing department will drive the firm’s model selection.
The three most common approaches are the categorical system, weighted-point average system and
the cost-based system. The categorical system is the most subjective technique since it does not
differentiate between the weights of the attributes considered. The weighted-point average
system overcomes this drawback by assigning weights to each attribute. The cost-based system
is the most objective of the three methods because it also considers non-performance costs.

7.2.2 Total Cost of Ownership Approach

The Total Cost of Ownership (TCO) approach is very similar to the cost ratio method. However,
it is more comprehensive because it considers all the costs associated with quality, delivery and
service. These costs include a number of non-value added activities such as service costs, receiving
costs, quality costs (inspection, rework, reject costs), failure costs, and administrative costs
including management time, maintenance, disposition and life-cycle costs. Lifecycle costs are
costs incurred throughout the life of a product or service. These costs may include maintenance,
downtime, repair, overhead, and idle time. In a study by Ellram, it was concluded that the price
of a piece of production equipment for a firm’s operations was only 35 percent of the total cost
of that piece of equipment over its life cycle. Despite the high percentage of the non-value added
costs, firms tend to either underestimate or completely ignore them.
TCO is a proactive and comprehensive system. Rather than focusing only on price, it examines
issues outside of the supplier’s cost structure. But using TCO presents the firm with new challenges.
The method is complex to implement and maintain. Thus, it consumes a great deal of time.

7.2.3 Weighted Point Method

In the weighted-point method, the relevant attributes are chosen and each are assigned a weight
depending on the importance to the overall performance. The firm reaches a consensus on
weight assignments to prevent or minimize subjectivity. The weight for each performance
category is then multiplied by the performance score that is assigned to it. Finally, these products
are totaled to determine a final rating for each supplier.

Firms often use the weighted point system because it is highly reliable and its implementation
costs are moderate. In addition, it combines qualitative and quantitative performance factors
into a common system. Because users can change the weights assigned to each performance
category, or change the performance categories themselves depending on the strategic priorities
of the firm, the system is flexible. The weighted-point method overcomes the subjectivity of the
categorical system, but it has some drawbacks. It requires the buyer to specify the value of one
performance measure relative to another, which is often difficult in practice.

7.2.4 Cost-based System

Using the cost-based system, a buyer is able to quantify the additional costs incurred if a supplier
fails to perform as expected. The total cost of doing business with the supplier can be calculated
by the Supplier Performance Index (SPI). This index is calculated for each item or commodity
provided by the supplier and has a base value of 1. It is represented by the following formula:
SPI = (Purchase Price + Non-performance Cost) / (Purchase Price). As derived from the equation,
the closer SPI is to 1, the better the supplier. Non-costs should include qualitative factors.

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