The global sourcing decision and the international supplier
This chapter discusses about the global sourcing decision and the international supplier selection framework, which can be used in ArcelorMittal Steel Company for acquiring alternative sources for raw materials. The company can purchase the coal from different countries outside India, as there are many leading exporting countries. Before taking a decision for global purchasing, the company should check whether there is a need for global outsourcing decision to be made; if yes, the company should also make decision on international supplier selection. Here, in this chapter the implementation of a suggested global outsourcing decision and international supplier selection frameworks are discussed with relating to the literature review, which helps ArcelorMittal to make decision on the global sourcing and supplier selection.
From the literature review, it can be understood that the companies have changed a lot due to the global aspects; global supply chain is one of the main issues of a business today. The businesses are actively participating in the outsourcing activities in a large way, in order to survive and achieve profitability in this competitive business environment. Global sourcing has become a trend in today’s market and an essential element for the attainment of competitive position. Global sourcing is considered as a complex process and many of the companies are spending a lot of money for the process of global sourcing of raw materials and on other goods and services. Even though there are some of demerits for the global sourcing, majority of companies practice global sourcing as there are more of merits; like high quality, cheaper price, advanced technologies, less labour coat in the developing countries, better lead time, global competitiveness, good reputation, wide variety of suppliers, etc.
According to Brannemo, 2005, many companies are considering global sourcing activities as a complex process, but the companies lack supporting models for the sourcing decision process. Therefore there is very large need for the supporting models for the sourcing decision making process. The frameworks help the companies for making productive decision on the sourcing process. There are only few methodological approaches for the outsourcing decision making process in the literature review; Jennings (1997) and Quinn and Hilmer (1994) considers cost, core activities, relationship with the suppliers and the technologies as the main attribute for the sourcing decision, where as Welch and Nayak (1992) considers mainly the strategic and the technological factors for the outsourcing decision. Even though there are models developed for the sourcing decision, according to Ronan McIvor, the review of the literature reveals that there is no framework which integrates the key connecting elements of global sourcing decision making process and the impact of company supply base. Therefore in order to overcome these problems, Ronan McIvor, considers three main aspects in his outsourcing decision making framework, they are; value chain perspective, focus on the core activities and the impact of the supply base on the outsourcing decision process; which has been discussed in the review of literature.
The framework model developed by McIvor has a strategic approach, which has been built for the outsourcing decision. The model mainly consists of four stages in a sequential order and the description of each stage is discussed below (Ronan McIvor, 2000):
Stage 1: Define the core activities of the business
Core activities are the main central activities which are needed for the successful serving of the company’s customers in each market. The core activities and non-core activities should be identified in this stage, as the process is considered to be complex; necessary care should be taken in order to ensure that the true benefits are assessed and the long term strategies are considered. The process of identifying the core activities can be done by the top level management along with the participation of teams from the lower level, the teams formed should cover a large section of members; functionally, hierarchically and divisionally. The main role of the teams is to find out the important determinants of the competitive advantage in their markets, industries, etc in which the company competes or planning to compete. In general, the framework wants the company to outsource the main non-core activities.
Stage 2: Evaluate the relevant Value chain activities
After identifying the core activities of the company in the first stage, next stage is to analyse the company’s competencies on these identified core activities against the external sources. In order to analyse there are mainly two stages analysis; evaluate value chain activities and the total cost analysis for the core activities. In the evaluate value chain activity stage, each core activity should be benchmarked with the capability of the competitors of that particular activity, which helps the company to know its relative performance for its each activity, while in the next stage of total cost analysis for the core activities, the company identifies and measures the cost for outsourcing and performing in-house. Once the company carries out this analysis, it helps the company to know where it can give focus on the resource and activities, to help them achieve outstanding performance and provide a unique customer perceived value. If the company does not have any special capabilities, it is better to outsource the activities to the external supplier, having lower cost base. Depending on the need and particular circumstances, the organisation’s value chain can be analysed or evaluated on the basis of activity or its sub-activity level.
In order to gain competitiveness the companies are positioning themselves in the specific parts of the value chain, therefore there is a high need for the evaluation of the company’s capabilities against the suppliers and the other competitors in the market; this can done with the benchmarking approach. In an outsourcing decision, understanding the capabilities of the competitors is as important as knowing their share in the market. Even though the process of benchmarking is time consuming and expensive, it helps the company to search the best processes or skills and provide them the external information, which helps in validating the company performance.
Stage 3: Total cost analysis of the core activities.
In this particular stage, the company measures the cost which will incur if a sourcing activity is performed internally or externally. It includes not only the purchasing price, but also all the cost from the acquisition which is carried out in the entire supply chain, therefore in this stage all the cost associated with the outsourcing decision are identified. There are mainly two types of cost; cost estimation for performing internally and cost estimation associated with the supplier, which has been identified in the previous stage. In order to collect the data, the company needs to breakdown its functional cost accounting data into the individual cost of the performing activities; this activity-based cost management system is more suitable if using value chain approach in the outsourcing decision. This method helps in finding out the cost of individual activities and task separately and also shows ones competitiveness in cost in relation to its competitors. These advantages make the Activity-Based Cost a strategic management tool (Thompson and Strickland, 1996).
The suppliers cost can be measured by having a good relationship with the suppliers, the cost involved for performing each activity can be collected from the suppliers. If the buyer and supplier have correct information about the cost incurred, then it will be possible to fix the margins more accurately. The company can use the information from this stage, in order to take appropriate decision, if there is any difference between the performance of the internal and external providers of an activity. According to McIvor (2000), once the company completes benchmarking its core activities, the company happens to face any one of the two scenarios;
Scenario One: The company is more efficient, than any other available external suppliers; if this occurs there are two options:
Perform internally: It is suggested to continue and maintain this activity in-house and it considered an ideal for having competitive advantage on the company’s core activities.
Strategic sourcing: There are chances that the company outsource the activities to the best competent external source, as the company considers that it will not be able to sustain its competencies in the activity in the coming future. Some companies prefer outsourcing the activities rather than performing internally, in order to become more flexible to the market changes and respond very quickly to the customers change.
Scenario Two: External sources are more competent than the internal sources: In this situation, the company has again two options:
Invest in order to perform internally: This focus on investing in the essential resources for bridging the difference between the company and the external providers. If the company does not have any resources and lag in the capabilities when compared to the external providers, then there is no meaning in investing in the resources, which helps the company to match its capabilities against the external provider.
Strategic outsource: The Company outsource its core activities, in which it has no competitive advantage, and in this case, it should move towards the next stage four; Relationship analysis.
Stage 4: Relationship Analysis:
A strategic partnership relation or alliance with the suppliers helps a firm to learn and exploit the capabilities of the supplier. The relationship with the suppliers is one the main issues which has to be addressed before outsourcing the core activities of a company. If a company plans to outsource its core activity, then it is better to develop and maintain a partnership relationship with its external suppliers. In order to achieve and maximise a competitive advantage, the company can develop and maintain a better buyer-supplier relationship. Even though the companies try to develop and maintain relationship with their key suppliers, this will exist only till the suppliers maintain its leadership in the advance technology and quality. The future threat towards the customers should also be considered, as there are chances that the suppliers acquire the knowledge and skills from the customer organisation and compete against them in future. The company can follow invest to perform internally strategy, if there are no suppliers available and if the company has suppliers available, then it can develop relationship with the suppliers and focus on the resources which are of high value added.
The outsourcing decision framework consists of mainly four stages, which have been briefly described above. The steel company, ArcelorMittal can implement this framework for their outsourcing decision making process, the framework integrates three key strands; value chain, the supply base impact and the core competency thinking. The framework also helps in benchmarking the capabilities of the company with the external sources, thus helping the company to validate its performance. Here in the case of ArcelorMittal Indian project, there may arise the need for the outsourcing of the raw material; coal, as there is a sharp decline in the production of coal in India, therefore the company can make outsourcing decision by using the framework developed by McIvor, which gives a solution for the company whether to source the raw materials internally or external. There are many competitors in the Indian Steel industry like Tata Iron and Steels Company Ltd., Steel Authority of India Ltd., Jindal Vijayanagar Steel Ltd., etc, therefore in order to achieve a competitive position in the Indian market place the company needs to benchmark its operations with its competitors and work accordingly The framework developed by McIvor for the outsourcing decision making, allows the benchmarking approach against the competitors.
After the Outsourcing decision making process, the company will decide upon whether to outsource or perform internally, once the company is done with the outsourcing decision process, one of the main issue to be faced by the company is on the supplier selection. From review of literature, it can be analysed that many researchers has found out the supplier selection decision making process as a complex one. According to Ferhan Cebi and Demet Bayraktar, 2003, a firm can purchase products at reduced price and maintain competitiveness through selecting a right type of supplier. There are many models and techniques which are developed for the selection of suppliers, many of them are for the selection of domestic suppliers. One of the commonly used supplier selection approach; after analysing and evaluating seventy-eight approaches and article; according to William Ho, Xiaowei Xu and Prasanta K. Dey (2009), it is the AHP-GP approach and the most commonly used criteria for the supplier selection are quality, delivery and cost. A firm to decide on the selection of domestic suppliers, it can use the integrated approach of Analytic Hierarchy Process and Goal Programming (AHP-GP), but for the international supplier selection there are only techniques and models.
After deciding to outsource, the next step for the company is to select its international supplier. According to Hokey Min, even though many supplier selection models are developed, the models lack certain factors which are to be considered for international supplier selection. Due to the complexity in the international supplier selection process, one of the commonly used approaches for solving the complexity is the Multiple Attribute Utility Theory (MAUT). Hokey Min (1993) develops an international supplier selection hierarchy applying the concept of MAUT, which helps the decision maker to simplify the structure of the complex problem and evaluate the quantitative and qualitative factors considering the elements of risk and uncertainty. The hierarchy for the international supplier selection developed by Hokey Min is discussed below (Hockey Min, 1993):
According to Edward and Newman (1982) and DeWispelare and Sage (1981), the steps involved for the application of MAUT are:
Identify the main objectives and goals of the decision to be made and also the scope of the problem.
Appropriate sets of finite attributes are to be defined; which affects the decision outcome, it should be presented in a hierarchical model.
The information about the concerning attributes from the decision makers are to be discussed and the significance of the attribute should be determined.
The functional relationship with the attributes and the utility score should be decided and if the relationship is uncertain, using probability distribution expected utility score is to be determined.
Calculate the overall utility score for each decision alternative and rank the entire alternative in terms of its overall scores.
Carry out sensitivity analysis.
The systematic approach of MAUT helps to breakdown the complexity of a problem under multiple-criteria, making the approach more appropriate for the international supplier selection. According to Miller (1956), many of the decision makers are not able to handle more than seven or nine factors at a time. Therefore, with the help Multi-level decision Hierarchy there is need for breaking down the complex problem into small sub-problems. International supplier selection is important as it includes many inter-related decisions, based on the financing, purchasing, negotiation and on the quality of the product at the source. A wrong decision made on the selection of international suppliers leads to low product quality, delays in delivery of the material, exchange rate fluctuation, etc; therefore it should be considered as an easy task.
The figure shows the structure of the supplier selection in a hierarchy level, at the top it is the ultimate goal and in the second level it shows the selection criteria; which are considered as important for the selection of international suppliers. The main criteria used in the international supplier selection hierarchy by Hokey Min include; financial terms, service performance, quality assurance, buyer-supplier partnership, trade restrictions, perceived risk and trade restrictions. In the third level the criteria’s are breakdown into many factors, which are considered to affect the selection of suppliers. And in the fourth and last level there are the alternative suppliers available. The main multiple criteria and the attribute are discussed below:
Criteria One: Financial Terms:
Financial term is one of the most important criteria to be considered for the selection of international suppliers, as it constitutes the total international purchasing cost. The attribute under the financial terms include; cost, payment terms and freight terms.
Cost: Cost is one of the main attribute, which has to be considered for the supplier selection. The company should reduce the cost in order to gain profit and competitiveness in the market, therefore the firm should select a supply base which is of low cost, from where the firm can reduce its purchasing price, logistic cost, filing cost, import duties, cost incurred for investigating the suppliers performance and their financial position, etc
Payment terms: There are many types of payment terms, usually before the commencement of work the advance payment should be made by issuing the letter of credit or any other types of payment. Therefore the firm should negotiate on the terms of payment, which are more favourable for the firm than issuing letter of credit.
Freight terms: Due to the large distribution network and channel in the international sourcing, the terms and conditions of freight by the suppliers should be checked carefully, as the insurance cost and logistic expenses used to be very high for international sourcing.
Criteria Two: Quality Assurance:
Quality is one of the main reasons why many of the firms perform international sourcing; therefore it is necessary to check that the suppliers are strict in their quality assurance. According to Laske (1992), it is better that a quality investigation team from the buyer firm visit the suppliers firm for the assessment of the supplier’s quality commitment and capability.
Criteria Three: Perceived Risk:
There are many types of international risk which should be considered for the supplier selection decision process. Some of the international risks associated with the supplier selection are political risk, currency fluctuations, unstable exchange rates, control in local prices, disputes among the labour, etc; there are chances for these risks to increase the hidden cost for the international purchasing. Different countries have different types of government policies for importing and exporting, some of the policies can affect the ability of a firm’s production control and distribution planning; therefore these risk factors should be considered in the process of international supplier selection.
Criteria Four: Service performance:
The services provided by the external suppliers are also considered, for the international supplier selection process, the attributes include; on time delivery and technical assistant:
On-time delivery: One of the main issues in external sourcing is the delay in the delivery time. According to the survey conducted by Shipley (1991), the main problems in the international sourcing is the delay in transport and lead time, which adversely affects the firms practicing Just-In-Time principles in their production process. In order to select the appropriate supplier, the firm should check the length of the supply chain and investigate the supplier’s commitment towards on-time delivery services.
Technical Assistance: Due to the technological advancement, the product developed by the suppliers are of more sophisticated, therefore ability of the suppliers to provide the technical assistance for the products should be considered for international supplier selection process.
Criteria Five: Buyer-Supplier Partnership:
According to Ellaram (1990) and Leenders (1993), many purchasing organisations has developed strategic partnership and alliances with their supplier organisation, based on short term and long term contracts, negotiations and through mutual support. In order to maintain a long term contract with the suppliers, two attributes should be considered; Financial stability and Negotiability:
Financial Stability: Financial stability of the suppliers is very necessary for the partnership; an unstable financial position of the suppliers will adversely affects its long term relationship with the buyer organisation.
Negotiability: Negotiation is very important in the business in order to maintain good relationship with the suppliers and for conflict resolution. Without performing negotiation, it is difficult to build a relationship with the suppliers, as there are chances for conflicts between the buyer and the supplier. If the suppliers are not flexible in the negotiation process, this would affect the long term relationship of the suppliers. Therefore the flexibility of suppliers in the negotiation process should be considered for the international supplier selection process.
Criteria Six: Cultural and communication Barrier:
The culture, languages, ethics and customs are different in different countries; therefore there are chances for communication and cultural barriers between the buyer and the foreign supplier. In order to ensure effective communication with the supplier the buyer firm should consider the attributes like, Electronic Data Interchange (EDI), cultural and language similarities and ethical standards, these attributes also helps in conducting effective negotiation as well. In some of the less developed countries, they have poor communication technology and therefore the firm should take careful decision while dealing with these countries.
Criteria Seven: Trade Restrictions:
The government is more involved in the international trade, when compared to the domestic, in order to protect its domestic industries. Some of the trade restrictions include tariffs, customs duties and countertrade.
Tariffs and custom duties: Import duties should be given to the government for importing goods and services from other foreign countries; this is done in order to protect the domestic industries. Due to these tariffs and import duties, there can be an increase in the purchasing price for the firm; therefore these additional charges should be taken into account while dealing with an international supplier.
Countertrade: Countertrade is the agreement made by the purchasing firm to buy specified amount of goods or services from the supplier’s country, in order to satisfy the offset requirements. According Forker (1992), due to the benefits such as, having no currency exchange and developing market for the products in the less developed countries; made countertrade more popular in worldwide practice.
In the case of ArcelorMittal Steel Company’s Indian project, the company can implement Hokey Min’s (1993) framework for the selection of international suppliers. This framework can be applied by identifying the alternative international suppliers for coal at the beginning and relative weights can be determined on the basis of decision maker’s preference and importance on the attributes. With the assistance of a computer program of MAUT the company can use a PC based Logical Decision, which helps to breakdown the complex problem into simple hierarchical structure allowing the decision maker to provide his rating. Logical decision helps to determine weights for the attributes, taking into account that equally preferred alternative suppliers must have equal overall utilities. The weights calculated helps to establish the utility function; therefore the overall utility score for each of the alternative can be computed and ranked in respect to the overall utility scores obtained. The suppliers are ranked according to the each criterion and overall criteria for selecting the most desirable suppliers. Once this initial solution is obtained, sensitivity analysis should be carried out in order to check the difference in the overall utility of alternative, if a change occurs in the weight of each criterion or attribute. The focus will be given towards the sensitivity of criteria, which reflects the collective measure of criteria or attributes.
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