Supplier Evaluation in Procurement
Shortlisting suppliers helps in understanding the supply market and creating sourcing strategies. Sourcing strategies further help in generating solutions like outsourcing, long-term purchase arrangements, sub-contracting, spot purchases, competitive bidding, use of consortiums, make vs. buy analysis, vendor alliances, and backward integration.
Sourcing strategies may be different for different item categories, which may be required for the production process.
Table of Content
- 1 Supplier Evaluation in Procurement
- 2 Supplier Evaluation Process
- 3 Different Criteria for Supplier Evaluation
- 4 Supplier Selection in Procurement
- 5 Supplier Selection Methods
Supplier Evaluation Process
In the actual supplier evaluation process, when there is a need to select a single supplier for entering into a purchase agreement (both for the short-term and long-term), the starting point is the supplier analysis result and the latest supplier list. This list may or may not include all the suppliers who need to be included in the evaluation process depending on the procurement need.
The following steps are involved in supplier evaluation for a new specific procurement need:
- Review of the sourcing strategy applicable to the item to be procured
- Review of the existing supplier list
- A tailored supplier search to find eligible suppliers based on the item category
- Sending the Request for Information (RFI) to all the identified suppliers
- Evaluating RFI responses
- Sending the Request for Proposals (RFPs)
- Evaluating RFPs based on specified evaluation criteria
- Conducting contract negotiations
- Concluding the preferred supplier arrangement
RFP/RFQ is a structured document that normally contains the following mandatory sections:
- General information
- Instructions and timeline
- Bid package
- Supplier questionnaire
- Evaluation criteria
Different Criteria for Supplier Evaluation
Evaluation of RFPs or suppliers in general, for any procurement contract, is done through standard evaluation criteria. Different criteria for supplier evaluation:
- Management Quality
- Financial Strength
- Past Experience
- Technical Capability
- Operational Capability
- Delivery Performance
- Pricing and Cost Structure
- Quality Management
- Long-term Partnership Potential
- Regulatory and Environment Compliance
It is a well-known fact that companies with good management and leadership capabilities are cost-competitive and have long-term competitive advantages. When considering a supplier for a long-term partnership, it is essential that the management quality of the supplier is considered an important criterion.
In terms of the supplier’s management quality, some important aspects to be looked into are the vision, background, quality consciousness, customer service, employee turnover, strategic sourcing concepts, quality management approach, future growth plans, and social responsibility of the supplier.
Since this is a qualitative assessment, discussions with senior managers and visits to the supplier organization may be required.
The next important criterion is the financial stability of the supplier. It is important that the supplier is financially sound and can execute commitments over the long run.
The supplier’s financial strength is analyzed through financial analysis that could include typical methods like ratio and profitability analysis. Credit bureau reports from organizations like Dun & Bradstreet and credit-rating reports of the supplier should be reviewed.
The past experience of the supplier in executing similar contracts with other major customers is important to gauge the success with which the supplier can execute procurement contracts. A supplier who has decades of experience in executing similar contracts should obviously be given a higher rating than new suppliers.
Technical capability evaluates how strong the supplier could be in delivering products to the required specifications. This includes evaluating the supplier’s capabilities in design, engineering, and manufacturing.
The supplier is evaluated on the basis of technical know-how, design expertise, manufacturing infrastructure, employee skill level, etc. The purchasing organization should also take into consideration the supplier’s commitment to research and development.
This refers to methods, processes, and standards adopted by the supplier. Different processes and manufacturing standards could be deployed in delivering the procurement contract. The buying organization needs to ensure that the supplier adopts best practices, deploys the latest technology, and adheres to international standards.
This depends on factors, like lead time, process capability, service quality, warranty, and delivery performance. A supplier who can consistently deliver products in the shortest lead time with the highest quality level should be scored higher.
Pricing and Cost Structure
This refers to the price quoted by the supplier and the cost structure involved in that quoted price. The cost structure includes studying various costs, like direct material costs, labor costs, indirect costs, general overhead costs, and productivity parameters.
The cost structure should explain the rationale behind the price quoted by the supplier and the efficiency with which he can produce the item.
Suppliers with good-quality management systems are more reliable and can be trusted for quality assurance. With supply chain concepts like JIT and VMI, the supplier’s capability of producing items in adherence to quality standards and best practices in quality management has become important.
The buying organization goes beyond the usual certification requirements like ISO 9000 and other industry-related accreditations and looks for inbuilt quality management systems that are based on best practices.
An internationally recognized award like Malcolm Baldrige National Quality Award (MBNQA) is an example of how a supplier can prove that best-in-class quality systems.
Long-term Partnership Potential
Suppliers who have the capability to consistently meet the requirements over a long period of time are required for a long-term partnership. It is necessary to understand the supplier’s past experience and future growth vision.
It is also important to know the supplier’s current customers and the nature of the contract that he maintains with them. The supplier should be able to grow with the buying organization in accordance with market evolution.
Some questions that must be asked to identify the long-term partnership potential of a supplier are as follows:
- Is the supplier interested in a long-term commitment?
- Will he be interested in committing capacity and resources for this partnership?
- Can he participate and contribute to design and development?
- Is he willing to share information and maintain confidentiality?
- Is he committed to resolving problems in a mutually beneficial partnership?
Regulatory and Environment Compliance
Finally, mandatory certifications and the compliance status of the supplier should be verified. The verification is done in the context of industry-specific requirements and government regulations on environmental factors.
Each aforementioned criterion or standard has a certain sub-criterion along with sub-weights, which yield the supplier score for each of the above-weighted criteria. The final score is used for selecting the most suitable supplier. Supplier evaluation is often done through supplier site visits.
The buying organization may form a cross-functional team that is mandated to visit the supplier’s manufacturing plants and offices and meet the technical and managerial personnel of the supplier.
To have complete and first-hand information about the supplier, it is necessary that field visits are arranged before supplier selection. The buying organization’s cross-functional team may assess the supplier on all the criteria of supplier evaluation mentioned earlier.
The supplier site visits are arranged both as part of the pre-qualification phase meant for creating the approved vendor list and the supplier evaluation phase involved in supplier selection and contract negotiation. Such visits can also be conducted as part of the regular supplier performance evaluation process.
Site visits are conducted as a formal process requiring good preparation in advance. This might include the usage of checklists and other formal verification/knowledge-gathering tools that can ensure all relevant information is obtained. Apart from inspecting and auditing supplier facilities and information-gathering, site visits also help in building working relationships with the supplier.
Supplier Selection in Procurement
The total weighted score based on the rating of the supplier on all qualification criteria is used for the final supplier selection. The selected suppliers – maybe 3 to 4 – are called for negotiation during which further evaluation of supplier responses on various procurement contract parameters is done.
In the past, supplier selection was solely based on the price factor. However, with time, organizations experienced that considering price as the only criterion for supplier selection is not enough. This is because supplier selection is a complex process and depends on various factors related to the supplier market.
Before selecting a supplier, the buying organization needs to ask the following questions to understand the complex nature of the supplier selection process and select a suitable supplier:
- Does the market involve enough supplier competition that makes competitive bidding sufficient?
- Is the item to be procured produced by a single supplier?
- What is the buyer’s market position vis-à-vis the supplier’s?
- What is the degree of negotiation required for factors like quality service and cost?
- Should the item be sourced from a single supplier or should multiple sources be involved?
- Should the buyer explore other options like outsourcing, backward integration, supplier alliance, etc.?
Supplier Selection Methods
The selection of appropriate suppliers helps the organization make a strategic difference by attaining continuous improvement in customer satisfaction.
Considering the strategic importance of the supplier’s role in the functioning of the supply chain of an organization, researchers have developed different methods for supplier selection.
Linear Weighting Method
It is also known as the weighted point method. It is used for most of the typical purchases involving standard items, non-critical items, and routine procurement processes. It considers criteria that are weighted by the buyer at the time of supplier evaluation.
The weight for each criterion is then multiplied by the assigned performance score. The scores are totaled to get the final rating for each supplier.
Total Cost of Ownership (TCO) Method
In this method, instead of comparing price and other qualitative factors, suppliers are compared based on the total cost of ownership of the procured items. The total cost comprises the following components:
- Price (quoted by each supplier)
- Material management costs (number of suppliers involved, storage locations required, payment process involved, etc.)
- Quality-related costs (depends on incoming quality, need for inspection and quality control, etc.)
- Inventory costs (lead time involved, forecast accuracy required, levels of inventory required to be maintained, etc.)
- Delivery-related costs (transit distance, transport mode, volume shipped, etc.)
Other Quantitative Methods
These include some complex quantitative methods, which are not very frequently used. Among these methods comes the linear programming model which is a mathematical technique used for solving optimization problems, such as maximization and minimization problems of businesses.
Apart from this, there is a statistical method that tries to manage uncertainty regarding future inventory requirements. The expert system is another quantitative method that uses an expert knowledge base for supplier selection.