Use traditional ABC analysis (using purchasing € value as the benchmark) to identify the top 20% suppliers. Please show calculations used in the answer.

FarmCo is a mid-sized manufacturer of farm equipment based in Austria. FarmCo has positioned itself as a premium manufacturer offering customized products and a 30-year spare parts warranty. The ability to provide excellent customer service is imperative to remaining competitive in its niche market segment. Products are made at three productions sites (Austria, Czech Republic, and Germany) by 1,100 employees resulting in an annual turnover of €180 million. Products are divided into two major market segments – grassland and tillage – and more than 80 product groups. The most important product group is the loading wagon accounting for more than 20% of company turnover. As one of the key measures of customer service, FarmCo counts the number of customer complaints. Recently, FarmCo has been getting more than usual complaints from
customers. Klaus Staberhofer, FarmCo chief executive officer, summoned Raimund Schüster, the supply chain manager, and Johann Steiner, vice president of finance, into his office. Klaus began, “I am getting an increasing number of complaints from our customers. What is the problem?” Raimund suspected that Klaus had called the meeting for this reason. He replied, “Weare having some problems with our suppliers that affect our production schedules and deliveries to customers, and at times, the quality of the final product.” “Tell me more,” demanded Klaus. “What is the problem? Is it related to the quality of components they are supplying us?” “Well, to a limited extent, it is material quality. There are other things that are more important, like lead times, distances, and ability to find alternative suppliers,” replied Raimund. Johann appeared to be a little impatient. “Why are you discussing these things with me? Do these affect financial outcomes?” Raimund replied, “These things are related to how we measure supplier performance, how we reward or penalize suppliers, and how we award contracts. We spend money managing suppliers. If we can identify which suppliers to focus on, then we will spend less money on supplier management. The money saved will be a direct addition to the company profit.”
Now Johann was interested. “I am listening. Keep going. Tell me what makes a supplier critical?” Raimund continued, “I think we need to talk to the purchasing managers to answer your question. Let me get back to you in two days.”

What Makes a Supplier Critical?

Two days later, all three met again, this time in Raimund’s office where he had many charts lying on his desk. Raimund began, “I started by asking our purchasing managers about the most important characteristics of suppliers. It all boils down to the following four: supplier reliability (SR), supplier manageability (SM), supplier importance (SI), and supplier dispensability (SD). SR, as the name suggests, is the reliability of the supplier in terms of lead times. SM is the ease of doing business with a supplier, which, in turn, makes the supplier more manageable. Supplier importance is the criticality of a supplier to our internal operations. Finally, supplier dispensability is the difficulty in finding a replacement supplier.” “Okay. So, now we can identify the critical suppliers. I am sure we have the data,” Klaus said. Raimund continued, “We have lots of raw data. However, converting it into usable
information is the challenging task.” Johann interjected, “I have an intern, Ingrid Legenstein, who is very good with numbers. Would you have a use for her skills?” “That would be very helpful, thank you,” said Raimund. Klaus summarized, “Okay, Raimund. As the first step, I want you to work with Ingrid tofind the data that can help us quantify SR, SM, SI, and SD.”

How to interpret data and transform it into usable information
Two weeks later, Klaus, Raimund, Johann, and Ingrid gathered in the main conference room. Raimund began by saying, “It has been challenging to convert the raw data into a usable format. Ingrid has spent the last two weeks diligently combing through the data, cleaning it up,
and making sense of it. I will let her show you what she’s found.” Ingrid was excited. This was her first presentation in a real business scenario. She was about to graduate and had been selected for this competitive internship position with FarmCo. She had worked hard on this assignment and felt that if she impressed the senior executives in the room, she could land a position with the company. “Thank you, Raimund,” Ingrid said. “As the first step to solving the problem, we needed to identify the data to measure SR, SM, SI, and SD. The higher the number of on-time deliveries for a supplier, the higher the reliability of that supplier. Therefore, for supplier reliability, I compiled the data on total deliveries and on-time deliveries. “The assumption behind supplier manageability is that the closer the geographical position of a supplier to our premises, the easier it is to do business with and manage them because of ease of meeting in person, similar working standards, lower language and cultural barriers, similar governmental regulations, currencies, time zones, shorter time to deliver missing parts, less exposure to natural risks, fewer traffic jams and many other similar reasons. Therefore, for supplier manageability, the most critical element is distance. So I compiled the data on geographical distance. To simplify things, we calculated the distance based on a route planning system to the headquarters for all suppliers and decided to use truck as the means of transport. This is acceptable since all suppliers are in Europe. “Measuring supplier importance was the most time-consuming and complex task. The aim was to get an idea of how important a single supplier is for an entire product group. To understand the importance of a supplier, we have to know exactly how many product variants in a product group use the parts from a given supplier. For the loading wagon category, we have 257 variations and 141 suppliers. In our supplier relationship management system, we only have data on suppliers for lead time and distance. In our material requirements planning system, we have the data on bill of materials for every product. There is no link between the two systems. I looked at the data on each supplier – at the level of parts purchased – in our supplier relationship management and material requirements planning (MRP) systems to identify the number of product variants for which that particular supplier supplied products. “Supplier dispensability was also difficult. I met with the managers of each of our 15
strategic planning groups and requested they identify the time it would take for them to replace a given supplier. The longer it takes to switch from a current supplier to a new one, the lower the dispensability of this supplier for loading wagon production. Switching time includes considerations, such as finding and assessing a supplier, the supplier obtaining necessary certifications, etc. Standard parts suppliers can easily be replaced, sometimes within three weeks. For specialized parts suppliers, the replacement time could take up to one year. “The following chart shows the data for five suppliers. I am ready for your questions.”

Supplier ID: 3002, total deliveries per year 1, total on time deliveries per year 0, km from headquarters 623 km, the number of product variants using parts from this supplier is 1, it would take up to 3 weeks to replace this supplier.

Supplier ID: 3003 has total deliveries per year of 782, 11 on time deliveries per year, it is 219 km away from headquarters, the number of product variants using parts from this supplier is 10, it would take up to 3 weeks to replace this supplier.

Supplier ID: 3006 has total deliveries per year of 28, 10 on time deliveries per year, it is 293 km away from headquarters, the number of product variants using parts from this supplier is 1, it would take up to 3 weeks to replace this supplier.

Supplier ID: 3011 has total deliveries per year of 53, 36 on time deliveries per year, it is 41 km away from headquarters, the number of product variants using parts from this supplier is 7, it would take from 6 weeks to 6 months to replace this supplier.

Supplier ID: 3012 has total deliveries per year of 423, 250 on time deliveries per year, it is 21 km away from headquarters, the number of product variants using parts from this supplier is 12, it would take from 6 weeks to 6 months to replace this supplier.

The room went silent for a few seconds. Klaus broke the silence by saying, “Great work, Ingrid. You are a rising star and will go places. I am pleased we hired you as an intern at FarmCo.” Johann and Raimund also praised her. Ingrid took a deep breath and smiled to herself. She was satisfied with her presentation and happy that the senior executives liked her work. Johann had a question. “A supplier may be critical on one measure but not on another. How do we meaningfully combine the data on all four measures to identify critical suppliers?” Raimund responded, “Ingrid and I have already begun working on the guidelines that managers in any product group can use to identify critical suppliers. We need some more time to refine it. How about we meet in one week and Ingrid and I will present the guidelines to you?”

How to use data for decision making

Everyone assembled in the main conference room. Ingrid ran the meeting. This time, she wasmore confident and eager to present the guidelines. Ingrid began the meeting by saying, “Raimund and I consulted with the purchasing manager for loading wagons and the 15strategic product group managers. Here are our guidelines:

o To estimate supplier reliability (or should I say, unreliability), we decided to calculate the ratio of the deliveries, not on-time divided to the total number of deliveries.

o To estimate supplier manageability, we applied the ratio of the distance from a given supplier to the longest distance from any supplier.

o To estimate supplier importance, we used the ratio of number of products for which a supplier supplies parts divided by the total number of products employed.

o Finally, to estimate supplier dispensability, one way is to group the suppliers into different categories and assign a score between 0 and 1 based on the time needed to replace a supplier. After consultation with purchasing managers, we came up with the following groups (and scores): up to 3 weeks (0.2), 3 to 6 weeks (0.4), 6 weeks to 6 months (0.6), 6 months to 1 year (0.8) and more than 12 months (1).

After we determined a score for each item, we can add up the scores to identify the most critical suppliers. I haven’t identified them yet, but if you give me one week, I will get back to you.” Johann was eager to understand the financial implications. “This is very interesting and so different from the usual activity-based costing (ABC) analysis based on purchasing value that we traditionally use for cash flow analysis. I am curious how the two approaches line upwith each other to rate our most critical suppliers.” Klaus also had an observation. “The first supplier on your list has just one delivery and that too was late. Do you think it will affect the rating of the supplier? How do you plan to address this?” Johann chuckled. “Some more tasks for you, Ingrid!” Everyone laughed. Ingrid said, “Sure. I will identify the critical suppliers based on the guidelines I presented and based on the ABC analysis. I will also think about how to address suppliers with few deliveries. How about if we meet again in one week?”

Answer rating: 100% (QA)

Certainly Lets start by calculating the ratios based on the guidelines Ingrid presented 1 Supplier R... View the full answer