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Costs of poor quality includes costs associated with

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Unformatted text preview: Low Low High High Partial outsourcing is where only a part of a function is outsourced; the company outsourcing co ­ordinates the activities. In turnkey outsourcing, the entire function is outsourced to the supplier where the supplier handles all coordination of the function. By deciding on each of these six decisions, an entity can decide what kind of outsourcing they would like to achieve. Note that entities should never outsource their core competencies. After all, there should be no one doing it better than the entity so outsourcing it will be worse than if it was done in house. If this were not the case, then it would not be a core competency anymore! Management Accounting 2 – Semester 2 2010 23 Managing Supplier Relationships Outsourcing Process The outsourcing process can be split into three components: 1) Strategic Phase This phase involves selecting the activities to be outsourced and the appropriate supplier to outsource to through a series of assessments up to contract negotiation. In selecting a supplier, the amount of steps undertaken to find the right supplier will differ depending on if the entity is looking for a market relationship or a strategic partnership (discussed below). 2) Transition Phase This is the period of time where the contract is negotiated and activities are smoothly integrated into the supplier. Buyers should negotiate a contract that covers all possible risk areas such that if an event does arise, the buyer can do something about it that has been agreed upon. 3) Operational Phase This is the phase where we simply manage the relationship by monitoring performance and making any adjustments to the contract as necessary. In all three phases, we need to keep an eye out for hidden costs. These are costs such as the time and expense that management and employees had to give up in order to coordinate with the supplier, for which they could have otherwise used for productive activity. Hidden costs usually get less the longer you deal with the same supplier due to efficiencies. Types of Relationships between Buyer and Supplier The relationship between the buyer and the supplier can be determined by each one’s investment into the outsourcing operation. • • • • Strategic Partnership: High investment from both parties. Both parties here are putting a lot of investment into the partnership meaning that the risks are shared between both parties. Market Exchange: Low investment from both parties. In this type of relationship, the product that is being outsourced is most likely highly standardised and little expertise is required. Captive Buyer: High buyer investment but low supplier investment. The supplier has a strong bargaining position and buyers will incur high switching costs. Captive Seller: High seller investment but low buyer investment. The buyer has a strong bargaining position and sellers will incur high switching costs since the product being outsourced is usually highly complex. Supplier Transaction Costs Traditionally, the supplier who could supply a product or service at the lowest price to the buyer was considered to be the best supplier to be working with. However, a supplier can be cheap, but have very unreliable delivery and bad quality. To address this, we now look at the Total Cost of Ownership (TCO), which looks beyond just price. Management Accounting 2 – Semester 2 2010 24 Managing Supplier Relationships TCO splits costs into four types: • • • • Costs of Purchasing Includes costs associated with ordering, delivery and quality control of incoming goods. Costs of Holding Includes costs associated with storage, obsolescence and opportunity costs of inventory. Costs of Poor Quality Includes costs associated with rejection, re ­receiving, reworking, repackaging, scrapping, downtime and warranties Costs of Delivery Failure Includes costs associated with late delivery (lost sales/downtime) and early delivery (holding costs). TCO can be approached using the ABC method. This can be achieved by following these four steps: 1) 2) 3) 4) 5) Define all major activities; Allocate costs to these activities; Identify activity drivers; Calculate the cost per unit of activity driver; and Allocate costs to each supplier. Supplier activities can typically be further broken down into three levels: • • • Supplier Level ...
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