Total Cost Supplier Selection Model: A Case Study

INTRODUCTION Defining purchasing's "total cost" role in the supplier selection process has become increasingly important as consumer expectations for both product quality and service change at increasing rates. Implementing an effective supplier selection model at the operating level presents a number of challenges to the model's development team and to the organization for which the model is being designed. Supplier cost model designers must balance the factors of simplicity and accuracy when predicting supplier-related costs, while the implementing firm must be prepared to change functional measurements in support of total cost decisions. This article discusses the General Electric Wiring Devices organization's (GEWD) total cost approach for selecting suppliers, without the delays usually associated with gathering and processing information for most sophisticated evaluation models. TOTAL COST While many traditional methods focus on "laid in" cost expressed in dollars per unit, a reasonable calculation of total cost must also include opportunity costs and costs associated with risk. Opportunity costs and risk concerns, while often difficult to translate into dollars, are important factors relative to supplier selection and long-term viability. The supplier selection model discussed in this article seeks a balance between the simplicity of a subjective model and the accuracy of a cost-directed model. TRADEOFFS BETWEEN ACCURACY AND SIMPLICITY The literature dealing with supplier selection and performance evaluation systems stresses profile analysis, using both cost indexes and weighted matrices. For example, one company was successful in combining its extended purchase price with specific "nonperformance costs," yielding a performance index for rating supplier performance.|1~ Others prefer the use of weighted point matrices. One author describes the weighted point method as an effective compromise between qualitative and quantitative elements of the supplier selection decision.|2~ Another discusses a weighted point method that evaluates supplier performance and also determines the order quantity mix between suppliers.|3~ A more recent school of thought utilizes a Monte Carlo simulation technique to quantify the degree of uncertainty involved in developing suppliers' ratings.|4~ Generally speaking, weighted point methods are among the most commonly used techniques for comparing suppliers,|5~ and while their simplicity facilitates ease of use, such models by themselves often misrepresent actual supplier costs. Table I shows a simplified weighted point decision matrix in which suppliers A and B are compared, based on five weighted criteria. Each supplier receives a one-to-ten score for each criterion, and scores are multiplied by predetermined importance weights to fill the "Total" columns. TABULAR DATA OMITTED Summing each "Total" column produces a total score for each supplier, and the highest scoring supplier is awarded all or most of the corresponding business. In this example, supplier B wins the contract based on a 71 point advantage over supplier A. The traditional weighted point model used in this illustration relies on two key assumptions to justify its usefulness as an effective decision aid: (1) importance weights must accurately represent each selection criterion's proportion of actual purchased cost, and (2) methods for rating suppliers in each category must be consistent across all suppliers in the evaluation. While attempts have been made to address both consistency|6~ and uncertainty|7~ in the scoring process, experience has shown that most techniques for assigning importance weights rely on subjective inputs from one or more individuals and lack the objectivity needed to model true supplier-related costs. On the accuracy side of the simplicity-accuracy spectrum lie various versions of the cost-based system, most of which usually require periodic updating and maintenance to keep up with changing suppliers and costs. …