Chapter 4

ETHICAL AND
SUSTAINABLE SOURCING/
STRATEGIC SOURCING
FOR SUCCESSFUL SUPPLY
CHAIN MANAGEMENT

Prepared by Mark A. Jacobs, PhD

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duplicated, or posted to a publicly accessible website, in whole or in part.
LEARNING OBJECTIVES

You should be able to –

•Understand and appreciate the trends in ethical and
sustainable sourcing.
•Define and describe the terms fair trade products, green
purchasing, social sustainability,
•supply base rationalization, VMI, supplier co-location, and
collaborative negotiations.
•Describe how ethical and sustainable sourcing strategies
are developed and implemented.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
2
LEARNING OBJECTIVES

You should be able to –

•Understand the use of environmental supplier
certifications.
•Define outsourcing and how it differs from purchasing.
•Discuss the importance of developing strategic alliances.
•Define benchmarking and discuss how it is used in
strategic sourcing.
•Understand the benefits of using 3PL suppliers.

©2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
3
CHAPTER OUTLINE

• Introduction
• Ethical and Sustainable Sourcing
• Developing Ethical and Sustainable Sourcing Strategies
• Supply Base Rationalization Programs
• Ethical and Sustainable Supplier Certification Programs
• Outsourcing Products & Services
• Early Supplier Involvement
• Strategic Alliance Development

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4
CHAPTER OUTLINE (Continued)

• Use of e-Procurement Systems

• Rewarding Supplier Performance
• Benchmarking Successful Sourcing Practices
• Using Third-Party Supply Chain Management Services
• Assessing & Improving the Firm’s Sourcing Function
• Strategic Factors in Sourcing
• Total Cost of Ownership
• Designing a Sourcing Portfolio: Tailored Sourcing

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5
Introduction

• Purchasing personnel can have a tremendous

impact on their companies’ costs and
reputations through use of ethical and
sustainable sourcing practices

• Increasing number of global competitors;

demands companies become more ethically
and environmentally focused

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6
Introduction

Sourcing - all of firm’s activities used to manage

external resources.
Strategic sourcing - managing the firm’s external
resources to support firm’s long term goals.
Drivers of Strategic Sourcing
▪ Reduce costs & delivery cycle times
▪ Improve quality & long-term financial performance
▪ Increase number of global competitors
▪ Increase customer focus
▪ Reduce high costs of globalization & materials,
▪ Deliver more innovative products more frequently &
cheaply than competitors
Ethical and Sustainable Sourcing
Defined
▪ Business Ethics is the application of ethical
principles to business
▪ Corporate Social Responsibility is the practice
of business ethics
▪ Ethical Sourcing is that which attempts to take into
account the public consequences of organizational
buying or bring about positive social change through
organizational buying behavior
Ethical and Sustainable Sourcing
Defined (Continued)

Ethical Policies should include –

▪ Determining where all purchased goods originated
and the manner in which they were made
▪ Knowledge of the suppliers’ workplace principles
▪ Inclusion of ethics as a performance rating
▪ Independent verification of vendor compliance
▪ Report of supplier compliance to stakeholders
▪ Provision of detailed ethical sourcing expectations to
suppliers
Ethical and Sustainable Sourcing
Defined (Continued)

▪ Ethical Trading Initiative (ETI) - an alliance of

organizations seeking to take responsibility for
improving working conditions and agreeing to
implement the ETI Base Code
▪ Fair trade product - manufactured or grown by a
disadvantaged producer in a developing country that
receives a fair price for their goods

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10
Ethical and Sustainable Sourcing
Defined (Continued)

Table 4.1 The Ethical Trading Initiative’s Base Code

Clauses Abbreviated Clauses Abbreviated Explanations
Explanations
1. Employment is freely No forced, bonded or 6. Working hours are not Working hours comply with
chosen involuntary prison labor. excessive national laws and benchmark
industry standards
2. Freedom of Workers have the right 7. No discrimination is No discrimination in hiring,
association and the to join trade unions and practiced compensation, access to training,
right to collective to bargain collectively promotion, termination or
bargaining are retirement
respected
3. Working conditions Accommodations shall 8. Regular employment is Work performed must be on the
are safe and hygienic be clean, safe and meet provided basis of recognized employment
the basic needs of relationships established through
workers national law and practice

4. Child labor shall not Persons under 18 shall 9. No harsh or inhumane Physical abuse or discipline, the
be used not be employed at night treatment is allowed threat of physical abuse, sexual or
or in hazardous other harassment or other forms of
conditions intimidation shall be prohibited
5. Living wages are Wages should be enough
paid to meet basic needs

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11
Ethical and Sustainable Sourcing
Defined (Continued)

Table 4.1 The Ethical Trading Initiative’s Base Code (continued)

Clauses Abbreviated Explanations
6. Working hours are Working hours comply with national laws and benchmark industry standards,
not excessive whichever affords greater protection. Workers shall not on a regular basis be
required to work in excess of 48 hours per week and shall be provided with at least
one day off for every 7 day period. Overtime shall be voluntary, shall not exceed
12 hours per week, and shall always be compensated at a premium rate.
7. No discrimination is There is no discrimination in hiring, compensation, access to training, promotion,
practiced termination or retirement based on race, caste, national origin, religion, age,
disability, gender, marital status, sexual orientation, union membership or political
affiliation.

8. Regular employment Work performed must be on the basis of recognized employment relationships
is provided established through national law and practice. Obligations to employees under
labor or social security laws shall not be avoided through the use of labor-only
contracting, sub-contracting, or through apprenticeship schemes.

9. No harsh or Physical abuse or discipline, the threat of physical abuse, sexual or other
inhumane treatment is harassment or other forms of intimidation shall be prohibited.
allowed

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12
Ethical and Sustainable Sourcing
Defined (Continued)

Sustainable Sourcing
▪ Green purchasing is aimed at ensuring products or
materials meet environmental objectives e.g. waste
reduction, reuse and recycling
▪ Sustainability is the ability to meet current needs of
the supply chain without hindering the ability to meet
future needs in terms of economic, environmental, and
social challenges
▪ Considers worker safety, wages, working conditions, human
rights
Ethical and Sustainable Sourcing
Defined (Continued)

Sustainable Sourcing should seek to –

▪ Grow revenues
▪ New sustainable product introduction
▪ Reduce costs
▪ Increase resource efficiencies
▪ Manage risk
▪ Link brand to social consciousness of consumer
▪ Build intangible assets
▪ Build social and environmental responsibility
Ethical and Sustainable Sourcing
Strategies (Continued)

Functional Products - MRO items & other commonly

low profit margins with relatively stable demands &
high levels of competition
Innovative Products - characterized by short product
life cycles, volatile demand, high profit margins, &
relatively less competition
Developing Ethical and Sustainable
Sourcing Strategies (Continued)

Framework for ethical and sustainable

sourcing strategy development –
Step 1 – Establish corporate ethical and sustainable sourcing
strategies
Step 2 – Train purchasing staff and implement policies
Step 3 – Prioritize items based upon ethical and sustainability
opportunities and ease of implementation
Step 4 – Develop performance measurement system
Step 5 – Monitor progress and make improvements. Increase use
of green and fair trade products
Step 6 – Expand focus to include other departments
Developing Ethical and Sustainable
Sourcing Strategies (Continued)

Ethical and Sustainable Framework

Step 1: Step 3:
Step 2: Train and
Establish Prioritize
implement
policies opportunities

Step 4: Develop Step 5: Monitor

Step 6: Expand
performance progress and
focus to other
measurement make
departments
systems improvements
Supply Base Rationalization
Programs
Supply base rationalization (AKA supply base
reduction or supply base optimization) is often
the initial supply chain management effort

Buyer-supplier partnerships are easier with a

rationalized supply base & result in –
▪ Reduced purchase prices
▪ Fewer supplier management problems
▪ Closer & more frequent interaction between buyer &
supplier
▪ Greater levels of quality & delivery reliability
Ethical and Sustainable Supplier
Certification Programs
Supplier certification programs are used to
identify strategic supplier alliance candidates

Firms use in-house formal certification programs,

& most require ISO 9000 / 14000 or similar
certifications as part of the certification process

Buyers can monitor quality assurance methods &

specify the type of acceptance sampling &
statistical process control methods used
Outsourcing Products and
Services
Outsourcing allows a firm to –
▪ Concentrate on core capabilities
▪ Reduce staffing levels
▪ Accelerate reengineering efforts
▪ Reduce management problems
▪ Improve manufacturing flexibility.

Risks associated with outsourcing, include –

▪ Loss of control
▪ Production decisions & intellectual property
▪ Increased reliance on suppliers
▪ Increased need for supplier management
Outsourcing Products and
Services (Continued)

In-sourcing (backsourcing) –
Reverting to in-house production when quality, delivery,
and services do not meet expectations

Co-sourcing (selective sourcing) –

The sharing of a process or function between internal
staff and an external provider & provides flexibility to
decide what areas to outsource, when, and for how
long.
Early Supplier Involvement

Early supplier involvement (ESI) highly effective

supply chain integrative techniques
- Key suppliers become more involved in the internal
operations of the firm, particularly with respect to
new product & process design, concurrent
engineering & design for manufacturability
techniques
Value engineering activities help the firm to reduce
cost, improve quality & reduce new product development
time
Early Supplier Involvement (Continued)

Vendor managed inventory (VMI) –

Suppliers manage buyer inventories to reduce inventory
carrying costs & avoid stockouts for buyer

From the buyer-firm’s perspective –

▪ Supplier tracks inventories
▪ Determines delivery schedules and order quantities
▪ Buyer can take ownership at stocking location
From the supplier’s perspective –
▪ Avoids ill-advised customer orders
▪ Supplier decides inventory set up & shipments
▪ Opportunity for supplier to educate customers about other
products
Early Supplier Involvement (Continued)

Electronic data interchange (EDI)

▪ Allows a supplier to profile demand & determine accurate
forecasts
▪ EDI also provides reorder point data to permit timely
deliveries
Supplier co-location or JIT II
▪ Supplier’s employee is embedded in buyer’s purchasing
department to forecast demand, monitor inventory & place
orders with access to sensitive files & records
Strategic Alliance Development

Alliance development, an extension of supplier

development refers to increasing a key or
strategic supplier’s capabilities.
Supplier alliances result in better market
penetration access to new technologies &
knowledge, & higher return on investment
Alliance development eventually extends to a
firm’s second-tier suppliers, as the firm’s key
suppliers begin to form their own alliances.
Strategic Alliance Development

Table 4.3 Maintaining a Successful Strategic Alliance Program

Steps Discussion
1. Determine the key strategic Can be based on business units, geographic areas,
parameters to organize industries, key alliance partners, or combinations of
around. these.
2. Facilitate the dissemination Alliance management and development information
of information. should be centrally controlled and available through
internal websites, pamphlets, and workshops.
3. Elevate the importance of Assign a director or vice-president of alliance programs,
the strategic alliance reporting to top management. Establish consistent
program. procedures for alliance programs throughout the
organization.
4. Provide continuous Management can increase the value and acceptance of
evaluation of alliance alliance programs when successes are made visible to
performance, visibility, and the firm’s lower level managers and employees. Alliance
support. management requires resources and on-going
reevaluation.
5. Reward suppliers as Rewards typically include increased business and other
performance merits. non-monetary awards.
Source: Adapted from Dyer, J., P. Kale, and H. Singh, “How to Make Strategic Alliances Work,” Sloan Management Review 42, no. 4 (2001): 37–43.

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27
Negotiating Win-Win Strategic
Alliance Agreements
Collaborative negotiations (aka integrative
negotiations) –
Both sides work together to maximize the outcome
or create a win-win result
▪ Requires open discussions and a free-flow of
information between parties

Distributive negotiations –
Refers to a process that leads to self-interested,
one-sided outcome
Negotiating Win-Win Strategic
Alliance Agreements (Continued)

Steps Description

Gain an understanding of both parties’ interests;

1. Build preparation
brainstorm value-maximizing solutions; identify objective
process
criteria to evaluate fairness of agreement.

2. Develop Review previous negotiations to catalogue standards,

negotiation practices, precedents, metrics, creative solutions used,
database and lessons learned.

3. Design Create an environment to work together to create a

negotiation launch shared vocabulary, build working relationships, and map
process out a shared decision-making process.

4. Institute feedback Create process to provide feedback to negotiating teams

mechanism and capture lessons learned.

(Table 4.4)
Use of e-Procurement Systems

Primary benefits of e-procurement include –

▪ Cost savings
▪ Frees-up time to concentrate on core business
e-procurement systems –
Concentrate large volumes of small purchases with
a few suppliers, using e- catalogues, available to the
organization’s users.
Reverse auctions –
Pre-qualified suppliers enter Web site & at pre-
designated time & date, try to underbid competitors,
monitoring bid prices until the session is over.
Rewarding Supplier Performance

Rewarding suppliers provides an incentive to surpass

performance goals

Punishment is a negative reward, may be to reduce

future business; or a bill-back amount equal to the
incremental costs resulting from a late delivery or poor
quality

Strategic supplier agreements can reward

suppliers by allowing –
▪ A share of the cost reductions
▪ More business and/or longer contracts
▪ Access to in-house training seminars & other resources
▪ Company & public recognition
Benchmarking Successful
Sourcing Practices
Benchmarking –
Measuring what other businesses do best and
matching their performance is an effective approach to
improving supply chain performance. Benchmarking
data regarding sourcing practices can be obtained in
any number of ways, both formal & informal.
Resources for learning about & implementing
sourcing practices –
▪ The Center for Advanced Purchasing Studies.
▪ Supply-Chain Council.
Using Third-Party Supply Chain
Management Services
Third-party logistics (3PL)
A growing industry that involves managing a
firm’s sourcing or materials &/or product distribution
responsibilities
▪ 3PL providers charge a fee for services for an estimated
savings of 10 to 20% of total logistics costs; benefits
include improved service, quality, & profits for their
clients.

Vendor-managed inventory (VMI) services –

One of the more popular roles of 3PL.
Lead logistics provider (LLP), aka 4PL –
A primary 3PL provider; one that oversees other
3PL’s
Assessing & Improving the Firm’s
Purchasing/ Sourcing Function
The purchasing/ sourcing function is one of
the most value-enhancing functions in any
organization
▪ It is preferable to periodically monitor the
purchasing/ sourcing function’s performance against
set standards, goals, and/or industry benchmarks.

▪ Surveys or audits can be administered as

self-assessments among purchasing staff as part of
the annual evaluation process.
Assessing & Improving the Firm’s
Purchasing/ Sourcing Function (Continued)

Assessment criteria include –

1. Participating in and leading 8. Further supplier
multifunctional teams integration
2. Participate in value 9. Contribute to new product
engineering efforts development
3. Finding/evaluating ethical and
10. Initiate supplier cost
sustainable suppliers
reduction programs
4. Optimize supply base
5. Managing local, regional and 11. Improvement of
global suppliers purchased product and
6. Early supplier involvement service quality
initiatives 12. Improve time to market
7. Creating strategic supplier 13. Maintain internal
alliances cooperative relationships
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35
Assessing & Improving the Firm’s
Purchasing/ Sourcing Function (Continued)

Skill set requirements of purchasing professionals

have been changing. Purchasing personnel must today
exhibit world-class skills such as –

1. Negotiating contracts Cost-controlling activities

include
2. Selecting suppliers
•Reducing supply base
3. Managing supplier
relationships •Negotiating global
agreements
4. Controlling costs
•Adopting new purchasing
technologies

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36
From
Chopra,
Chapter 15

37
Strategic Factors in Sourcing

1. Support for the business strategy

2. Improve firm focus
Total Cost of Ownership (1 of 4)
• Mistake to focus only on quoted price
• Total cost of ownership (TCO)
§ Includes all supply chain costs of sourcing from a
particular supplier
• Three “buckets”
§ Acquisition costs
§ Ownership costs
§ Post-ownership costs
Total Cost of Ownership (2 of 4)
Table 15-2 Factors Influencing Total Cost of Ownership
Performance Category Category Components Quantifiable?
Acquisition Costs Blank Blank
Supplier price Labor, material, and overhead Yes
Supplier terms Net payment terms, delivery frequency, Yes
minimum lot size, quantity discounts
Taxes and duties All tariffs and compliance costs Yes
Delivery costs All transportation costs from source to Yes
destination, packaging costs
Incoming quality costs Cost of inspection, defectives, and rework Yes
Management costs Cost of managing and planning the Difficult
purchase
Total Cost of Ownership (3 of 4)
Table 15-2 [Continued]
Performance Category Category Components Quantifiable?
Ownership Costs Blank Blank
Inventory costs Supplier inventory, including raw material, Yes
in process and finished goods, in-transit
inventory, finished goods inventory in
supply chain
Warehousing cost Warehousing and material handling costs Yes
to support additional inventory
Manufacturing costs Cost of manufacturing associated with the Yes
sourced part
Production quality costs Impact of sourced part on finished product Difficult
quality
Cycle time costs Impact of sourced part on production cycle Yes
time
Total Cost of Ownership (4 of 4)
Table 15-2 [Continued]
Performance Category Category Components Quantifiable?
Post-Ownership Costs Blank Blank
Reputation Reputation impact of quality problems No
Warranty and product Warranty and product liability costs Difficult
liability costs associated with sourced part
Environmental costs Environmental costs affected by sourced Difficult
part
Supplier capabilities Replenishment lead time, on-time To some extent
performance, flexibility, information
coordination capability, design coordination
capability, supplier viability
Designing a Sourcing Portfolio:
Tailored Sourcing (1 of 5)
• Options with regard to whom and where to source from
§ Produce in-house or outsource to a third party
§ Will the source be cost efficient or responsive
§ Onshoring, near-shoring, and offshoring
• Tailor supplier portfolio based on a variety of product and
market characteristics
Designing a Sourcing Portfolio:
Tailored Sourcing (2 of 5)
• Sources must focus on different capabilities
§ Cost
§ Responsiveness
• Volume-based tailored sourcing
• Product-based tailored sourcing
Designing a Sourcing Portfolio:
Tailored Sourcing (3 of 5)
Table 15.3 Factors Favoring Selection of a Responsive or
Low-Cost Source

Blank Responsive Source Low-Cost Source

Product life cycle Early phase Mature phase
Demand volatility High Low
Demand volume Low High
Product value High Low
Rate of product obsolescence High Low
Desired quality High Low to medium
Engineering/design support High Low
Designing a Sourcing Portfolio:
Tailored Sourcing (4 of 5)
Table 15.4 Factors Favoring Onshoring, Near-Shoring, or
Offshoring
Blank Onshore Near-Shore Offshore
Rate of innovation/product High Medium to High Low
variety
Demand volatility High Medium to High Low
Labor content Low Medium to High High
Volume or weight-to-value High High Low
ratio
Impact of supply chain High Medium to High Low
disruption
Inventory costs High Medium to High Low
Engineering/management High High Low
support
Designing a Sourcing Portfolio:
Tailored Sourcing (5 of 5)
Table 15.5 Differences Between Direct and Indirect
Materials
Blank Direct Materials Indirect Materials
Use Production Maintenance, repair, and
support operations
Accounting Cost of goods sold Selling, general, and
administrative expenses
(SG&A)
Impact on production Any delay will delay Less direct impact
production
Processing cost relative Low High
to value of transaction
Number of transactions Low High
Product Categorization

Figure 15-1 Product Categorization by Value and Criticality