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Strategic direction through purchasing portfolio management: a case study.

INTRODUCTION

Obviously, not all buyer-supplier relationships are to be managed in the same way. Research findings indicate that successful supply chain management requires the effective and efficient management of a portfolio of relationships (Bensaou 1999). Kraljic (1983) introduced the first, comprehensive portfolio approach for the use in purchasing and supply management. By categorizing products in a 2x2 matrix, sensible guidelines were given for managing supplier relationships. The Kraljic portfolio approach is generally considered as an important breakthrough in the development of theory in the field of purchasing and supply management (Syson 1992). In general, purchasing portfolio models aim at developing and implementing differentiated purchasing strategies. Recently, some new specific applications have been introduced, notably supplier involvement in product development (Wynstra 1998), supplier selection (de Boer 1998), supplier development (Handfield et al. 2000), Web-based procurement of MRO items (Croom 2000), specification processes (Nellore and Soderquist 2000), engineering-purchasing-supplier interaction (Nellore and Taylor 2000), facilitation of an internal process of change (Axelsson et al. 2000), and interorganizational competence development situations (Moller and Momme 2000).

Other authors have used Kraljic's basic ideas for the development of similar models, for instance ElliottShircore and Steele (1985), Syson (1992), van Weele (1994), Lilliecreutz and Ydreskog (1999), Bensaou (1999), Gelderman and van Weele (2000), Gelderman (2000), and to a certain extent Olsen and Eliram (1997a). Still, Kraljic's fundamental ideas and concepts dominate the discipline. However, there are some problems and unanswered questions.

The purpose of this article is to provide new perspectives on Kraljic's model, reporting on some important advancements in the use of a portfolio approach in purchasing and supply management. This article addresses a major problem area with respect to Kraljic's approach: the nature of the strategic recommendations. The results are based on a case study research, conducted at a large industrial company that is structured around a number of fairly autonomous business groups.

THE KRALJIC PURCHASING PORTFOLIO APPROACH

Kraljic (1983) introduced the first comprehensive portfolio approach for the determination of a set of differentiated purchasing strategies. Its general idea is to minimize supply risk and make the most of buying power (Kraljic 1983). This explains the choice of dimensions: accounting for risk on the one hand, and using buying power on the other hand. Kraljic's approach includes the construction of a portfolio matrix that classifies products on the basis of two dimensions: profit impact and supply risk ("low" and "high"). The result is a 2x2 matrix and a classification in four categories: bottleneck, non-critical, leverage, and strategic items. Each category requires a distinctive approach toward suppliers (see Figure 1).

Non-critical items require efficient processing, product standardization, order volume, and inventory optimization. Leverage items allow the buying company to exploit its full purchasing power, for instance through tendering, target pricing, and product substitution. Bottleneck items, on the other hand, cause a lot of problems and risks. Volume insurance should be realized by means of supplier control, security of inventories, and backup plans. A further analysis of the strategic items is recommended. By plotting the buying strengths against the strengths of the supply market, three basic power positions are identified and associated with three different supplier strategies: balance, exploit, and diversify.

Purchasing portfolio analysis has subsequently become the dominant approach to what the profession regards as operational professionalism (Cox 1997). Kraljic (1983) made a reasonable case for the usefulness of the portfolio approach by describing the experiences of some large industrial companies. Now, many years later, the purchasing portfolio approach is being used by several other large companies, for instance Shell, Alcatel, Philips, Akzo Nobel, Oce, and Siemens (van Weele 2000). In a survey of Dutch companies, Boodie (1997) found that nearly 50 percent of the responding purchasing managers indicated that they used Kraljic for formulating purchasing strategies. Of the large companies, with more than 5,000 employees, 85 percent reported to use the portfolio analysis.

RESEARCH QUESTIONS

In contrast with the growing popularity of portfolio techniques, there is a lack of empirical research providing insights and evidence on their actual use. Based on an extensive literature review, Olsen and Eliram (1997b) concluded that normative research is needed on how to manage different types of buyer-supplier relationships. Current research does not reveal how purchasing professionals handle the problem of positioning commodities and suppliers into the portfolio, how they actually develop purchasing strategies, and what results are derived from using portfolio techniques. Through this in-depth case study, which is to be followed by others, the authors try to overcome these shortcomings.

Kraljic's strategic recommendations for the four portfolio categories are usually summarized into simple concepts, like "efficient processing," "exploit power," "strategic partnership," and "volume insurance." At first sight, these seem to be quite logical, sound recommendations. However, if one takes a closer look at the nature of these strategic recommendations, one must conclude that they are rather generic by nature, providing only rough indications for the most appropriate supplier strategies. Moreover, they merely react and adapt to prevailing circumstances, taking the current power and dependence structure within the supply chain for granted. Purchasing professionals could always look for possibilities to move to other, strategically more attractive positions in the matrix. It is not clear if and how other positions in the matrix are to be pursued through the implementation of a recommended purchasing strategy (Gelderman 2000).

* What kind of specific commodity and supplier strategies are applied by purchasing professionals, using Kraljic's portfolio approach?

The general strategic recommendations, as provided by Kraljic, should be el aborated and tailored in view of company-specific circumstances and conditions. The Kraljic framework does not provide guidelines for moving commodities and/or suppliers around the different categories. in line with the foregoing, the prime questions underlying this research were:

* How are commodities and suppliers, in terms of their positions in the matrix, actually moved around the different portfolio segments?

* Under what conditions are the respective commodity and supplier strategies successful?

RESEARCH METHOD

The case study method was chosen for a number of reasons (Yin 1994). First, because of the apparently limited research on the actual use and possibilities of purchasing portfolio approaches. Publications are conceptual or anecdotal by nature. Second, case study research is preferable when the research questions focus mainly on "how" and "why" questions. The authors wanted to gain insights in the use and the possibilities of a portfolio approach, exploring and identifying the advanced practices of an experienced company. The questions in the research deal with exploratory issues, rather than frequencies or incidence. DSM, the actual case company, was invited to participate in the research because of its extensive experience with the portfolio approach in a large number of businesses.

The case study has been based upon a key informant method. Hence, a selected, limited number of executives and purchasing professionals were interviewed. The informants were chosen for their specialized knowledge of and experience with the use of portfolio models in real-life purchasing. Of course, the director of purchasing services was used as the prime key informant. The choice is justified by the fact that the authors wanted to interview an official with a clear overview of the entire purchasing operation. Other informants were chosen through a snowballing technique whereby the first informant nominated knowledgeable respondents, i.e., purchasing specialists and business unit managers. This, because the authors wanted to include and account for possible differences in experience and views, by confronting the decentral perspectives of the respective business unit managers to the likely more central perspective of the director of purchasing services. The interview guide can be found in the Appendix.

DSM: The Case Company

DSM is a large, integrated international group of companies that is active worldwide in the field of chemicals, biotechnical products, and plastics. The company is divided into 16 business groups that are subsequently subdivided into business units. DSM is a sizable customer with a $6 billion (USD) purchase expenditure that represents 70 percent of the firm's total revenue. An important objective is the achievement of purchasing synergy and leverage across business groups/units.

The company's prime products are intermediates and ingredients for the pharmaceutical and food industries, performance materials for the automotive and electronic industries, and polymers as well as industrial chemicals for a wide range of manufacturing industries. DSM operates in a number of global markets where price and cost are always key success factors. Pressure on prices and margins is omnipresent, which explains why chemical companies are always looking for opportunities to reduce cost, improve productivity, and improve the value proposition to customers. DSM pursues a strategy of "operational excellence" (cf. Treacy and Wiersema 1993).

Central to DSM's purchasing practice is its strong price/ performance orientation in its dealings with suppliers. Next, availability and a continuous, seamless supply of materials and services are important aspects in the relationship with its suppliers.

THE USE OF THE PORTFOLIO APPROACH

For DSM, the purchasing portfolio analysis is an important tool in developing purchasing strategies. It is aimed at staffing and guiding strategic discussions with business group management. The philosophy of DSM is that the Kraljic matrix should serve as a framework for an indepth discussion with representatives from the business groups involved. Preferably, cross-functional teams should decide on and substantiate their points of view with respect to the position of purchases in the matrix. Differences between actual and recommended practices are discussed as well. Views and plans are "challenged" as an internal warranty of quality.

For the purchasing portfolio analysis, a Kraljic-like approach is being used with comparable dimensions for the classification of products and product categories: (1) the strategic importance of the purchase and (2) the supply risk. The importance of a purchase is assessed in terms of the value added by product line, the percentage of purchased products as part of total cost, and the impact on the company's profitability. The "importance" dimension is therefore quite similar to Kraljic's original "profit impact." Supply risk is measured by supply scarcity, determined by factors such as state-of-the-art technology, complexity of the supply market, materials substitution, barriers to entry, logistics, and monopoly/oligopoly conditions.

There are no calculating rules to decide whether the importance of a purchase is "high" or "low." The same goes for the other dimension. The drawback of this method is that the validation of measures is limited. However, there is no belief in a quantitative approach for measuring values of the dimensions: "It is better to be roughly right, than exactly wrong." This does not imply that the assessment of positions in the matrix is a completely subjective matter. Points of view have to be substantiated by facts and figures with respect to underlying factors and variables. Management is forced into a critical evaluation of supply markets, suppliers, and purchase practices. These views are in line with Steele and Court (1996) who considered the lack of objective measurement as a beneficial characteristic. Long-term savings are connected to the use of the portfolio approach, be it that the "real" savings should be attributed to the development and implementation of purchasing and supply strategies. Within a period of four years, an estimated sum of $100 million (USD) can be accounted to a more integrated purchasing approach, taking advantage of the possibilities of leverage and synergy across business units/groups. The portfolio analysis is an important tool, especially for discussing, visualizing and illustrating the possibilities of professional purchasing and supply management. In the course of time, the purchasing portfolio approach has contributed to the awareness of purchasing possibilities and the professionalizing of purchasing within the business units/groups. To conclude, an important benefit of Kraljic's portfolio model is that the actual using and customizing lead to a better understanding of the strategic issues at hand.

CONNECTING CONDITIONS, GOALS, AND STRATEGIES

A main principle of DSM is that the non-critical and bottleneck cells should be as empty as possible. Obviously, leverage and strategic items are preferred to non-critical and bottleneck items. DSM is always looking for possibilities to move to other, better positions in the matrix, within the bounds of possibility. The in-depth interviews identified the most common strategic switches, from one category to another. The research revealed conditions leading to the choice of various purchasing strategies and new positions in the matrix.

Bottleneck Items

For the bottleneck items, DSM aims at increasing buying power and/or developing new opportunities, reducing the dependence on a supplier to an acceptable level (see Figure 2). An important issue concerns the question of whether standardization of requirements is possible or not. If standardization is not possible, then in the case of processed materials a capacity deal (1) is explored, concentrating purchases to an approved supplier. A better deal is made by concentrating regular supply to one supplier. A "better" bottleneck position is pursued by reducing supply risk on the one hand and obtaining a better negotiating position on the other hand. Other possibilities within the bottleneck quadrant are: keeping stocks, hedging, Internet buying, broadening the specifications, searching for alternative sources, risk analysis in combination with contingency planning, and so on. The device is: "Stay in the corner and make the best of it."

More rigorous is the switch from '"bottleneck" to "leverage." Especially MRO items are eligible for such a drastic move. Business groups/units have to agree on standardization and pooling (2) of their purchasing requirements.

Some purchased products are bottleneck items, due to a degree of overspecification. In a technical environment, there is a natural drive for overspecification, and technical specialists tend to settle only for "the best." Obviously, this results in financially unattractive deals. A related problem is the incompatability of equipment and MRO items, due to the fact that business units/groups work with their own specifications. This prevents the use of buying leverage by standardization and pooling of requirements. In these cases, DSM sets up a team of experts to investigate possibilities of standardization, following the principle of "fit-for-use." The idea is to make the end product less complex: the strategy is aimed at decomplexing (3a). What specifications are really necessary to fit the needs of the business groups/units involved? "Delete the waste of diversity" serves as the leading device. The team chooses the best-fitting standards, striving for more generic specifications. This allows for pooling (3b) of requirements across units/groups. There are more purchasing and supply possibilities in the case of a "decomplexed" product and, obviously, by pooling purchases the buying power is enhanced. To conclude, in a two-step process, buying leverage is established, provoking a switch from "bottleneck" to "leverage" in the portfolio matrix. This purchasing strategy is successfully applied for a number of products and services, such as maintenance services, electric engines, pumps, and valves.

The arrows (3a and 3b) in Figure 2 should be interpreted as follows: the starting points of the arrows correspond to the different positions of the business units/groups involved. These points come together in just one common end point, due to the joint buying effort.

Non-Critical Items

The main products in the non-critical category are office supplies and services. A key question with respect to these non-production oriented purchases is whether standardization and pooling are possible options or not (see Figure 3). The product category "travel expenses" is an example for which pooling (1) is a logical option. A framework agreement (master contract) with a preferred supplier is a contractual possibility. These arrangements are today replaced by e-procurement and an electronic catalog and ordering system. Nearly the entire purchasing procedure can be completed by an automated ordering and order handling process. E-procurement is only feasible when it is possible to standardize and pool the purchasing requirements, preferably those of several (if not all) business groups/units. For other commodities, pooling is not an option, for example when the product is in some respect unique to a specific business unit/group or when business units/groups make a reasonable case for not wanting to pool the ir purchases. These non-critical products, then, are purchased on a transactional basis (market exchange, non-relational elements). In those cases, the purchase card (2) is considered a useful tool for individual, nonstrategic commodities.

Leverage Items

At DSM, from time to time, commodities and suppliers change position from the "non-critical" to the "bottleneck" segment. This happens when standard items for some reason are substituted by customer-specific or supplier-specific alternatives. Hence, a business unit/group is locked into a specific supplier relationship, resulting in higher cost and a higher level of dependence. However unfortunate these movements in the portfolio can be, they sometimes have to be accepted. Due to DSM's decentralized corporate structure and the resulting autonomy of the business units, these counter-movements cannot always be avoided.

With regard to leverage items, DSM distinguishes between "strategic partnerships" and "partnerships of convenience" (see Figure 4). Detailed assessment of the supplier's profile indicates what kind of relationship is possible and desirable. The assessment implies the identification of key buying criteria and the performance of the supplier on these criteria. Price performance is always a key success factor, given the global markets in which DSM operates. Switching from the leverage to the strategic segment in the matrix might be sensible, when the supplier has the proper capabilities for co-design, in view of the main performance criteria. The move from "leverage" to "strategic" is feasible when only a limited number of suppliers appear to have the required capabilities and qualifications. Switching from the leverage to the strategic category might imply that DSM needs to spend time on supplier development to ensure that suppliers are able to meet DSM's specific requirements. However, before investing in suc h a relationship, DSM wants to verify whether sufficient trust in the supplier at different levels of the organization is present. Only then, strategic partnerships (1) are considered.

When a supplier does not qualify as a strategic partner, DSM will focus on efficiency and cost reductions. Leverage is sought in efficiency and supply chain optimization, not in design optimization. A partnership of convenience (2) at DSM is not considered as a "strategic partnership," but as a tactical solution to operational problems (quality, logistics, efficiency).

Partnership relationships with suppliers can be technology driven (joint venture, co-development, concurrent engineering) or driven by logistics (JIT management). Only the latter DSM qualifies as a partnership of convenience, because in this type of relationship the advantages resulting from design optimization are not considered. Hence, partnerships of convenience reside in the leverage segment.

Strategic Items

Successful strategic partnerships are rare. In the course of time, partnerships may become unsatisfactory. A position in the "strategic" segment means a high mutual dependence between the parties involved. Even in the case of a strategic partnership (1), DSM is always trying to restrict or reduce the dependence on the supplier involved (see Figure 5).

In some cases, the firm is locked in a partnership from sheer necessity, for instance because of an oligopolistic or monopolistic market situation. The development of new suppliers would solve this locked-in situation. This is not possible if the situation is caused by patents. Another non-desirable possibility is that the supplier does not really want to be involved in co-development. There is always a chance that a partnership evolves into an indolent, relaxed relationship. Strategic partners should be world-class suppliers--they are alert and high-performing, not only in a technical but also in an economical sense. This means that strategic partners should meet external benchmarks with a more than satisfactory price performance.

In the case of non-optimal "partnerships" with underachieving partners, a strategy of decomplexing and supplier development (2) might be pursued. By making the product less complex, alternative solutions are within reach. If necessary, new suppliers are developed. Essentially, DSM wants to make itself less dependent on underachieving, nondependable suppliers.

CONCLUSIONS

This research departed from the contention that, in contrast with an increased adoption of purchasing portfolio approaches by academics, little is known about their actual use. The most popular and widespread approach, i.e., Kraljic's purchasing portfolio, merely provides general guidelines for the development of purchasing and supplier strategies. The main objective of this research was to identify and describe the application of the purchasing portfolio approach by a well-experienced company. The findings suggest that the portfolio approach indeed is very helpful in positioning commodities in the different segments and in developing purchasing strategies.

For the case company, the authors have identified and described:

* The main movements within the matrix (goals and strategies)

* Circumstances accompanying these goals and strategies (conditions)

Kraljic's purchasing portfolio seems to be an effective tool for discussing, visualizing, and illustrating the possibilities of differentiated purchasing and supplier strategies. Next, it can be used as a powerful tool for coordinating purchasing and supplier strategies among various, fairly autonomous business units. For bottleneck and non-critical items, it facilitates the development of differentiated purchasing strategies, aimed at synergy and leverage across business units. For leverage and strategic items, it focuses on the assessment of the performance of suppliers, distinguishing strategic partners and partners of convenience. For these categories, the case company prefers positions at the central part in the matrix, avoiding too much supply risk. Moreover, there is a clear tendency to reduce the dependence on suppliers in different ways, such as broadening specifications, making products less complex, supplier development, and supply chain optimization ("partner of convenience")

Of course, the authors are aware of the limitations of this study. First, the findings are based on a single case study. Generalization of findings is obviously not possible. Second, the study is conducted in a large industrial company that operates in very competitive, global markets. Additional research in different types of companies could reveal other and similar advanced purchasing portfolio practices. The comparison with other companies could identify differences, to be explained by company-specific factors, such as company size, organizational structure, technology customers, network position, and organizational culture. The case study is concentrated on the corporate level, identifying purchasing goals and strategies across business units. Third, the results may be biased because the information was collected from a limited number of key respondents. To conclude, however, the authors feel that the study, albeit limited, has contributed to a better understanding of the possibilities of a portfolio appr oach in purchasing and supply management.

Appendix

INTERVIEW GUIDE FOR THE CASE STUDY

1. Background information on the company

Main activities

Principal products and markets

Organizational structure (business units)

Company's strategic focus

Annual sales

Number of employees

2. Background Information on purchasing

Annual purchase spend

Main purchasing categories

Purchase spend, divided according to purchasing categories

Centralized and/or decentralized purchasing

Development of the purchasing function

Position and perceived importance of purchasing

3. Purchasing and supply strategies

Main objectives of purchasing

Basic principles for purchasing practice

Buyer-supplier relationship strategies

Connection between purchasing and business strategy

Development of purchasing plans and strategies

4. Purchasing portfolio analysis

Main purposes and use

Occasions, frequency, situations, and timing

Kraljic-based or otherwise

Choice of dimensions

Factors per dimension

Labels for quadrants

Generic strategic recommendations per category

Measurement of dimensions/variables (establishing positions in the matrix)

Attributed results

5. Portfolio-based purchasing strategies

Basic principles for portfolio-based purchasing strategies

Procedures and additional tools for strategy development

Specific purchasing strategies for specific categories

Objectives of specific, portfolio-based strategies

Conditions and contingencies for strategies and categories
Figure 2

CONDITIONS, PURCHASING STRATEGIES, AND GOALS FOR BOTTLENECK ITEMS

current condition 1: condition 2: main
position standardization? overspecification? products


bottleneck not possible no processed
 materials
bottleneck possible no MRO items
bottleneck possible yes equipment,
 MRO items


current purchasing new
position strategy position
 (goals)

bottleneck capacity "better
 deal (1) bottleneck"
bottleneck pooling (2) leverage
bottleneck decomplex non-critical,
 (3a) and leverage
 pooling (3b)

Figure 3

CONDITIONS, PURCHASING STRATEGIES, AND GOALS FOR NON-CRITICAL ITEMS

current condition: main purchasing
position standardization products strategy
 and pooling?

non-critical possible office supplies, pooling (1)
 services
non-critical not possible office supplies, purchase
 services card (2)

current new
position position
 (goals)

non-critical leverage

non-critical "better"
 non-critical

Figure 4

CONDITIONS, PURCHASING STRATEGIES, AND GOALS FOR LEVERAGE ITEMS

current condition 1: condition 2: purchasing new
position capabilities price strategy position
 for co-design? performance? (goals)

leverage yes satisfactory strategic strategic
 partnership (1)
leverage no/n.a. satisfactory or partnership of everage
 not satisfactory convenience (2)

Figure 5

CONDITIONS, PURCHASING STRATEGIES, AND GOALS FOR STRATEGIC ITEMS

current condition 1: condition 2: purchasing new
position price performance in strategy position
 performance? co-design? (goals)

strategic satisfactory satisfactory strategic strategic
 services partnership (1)
strategic not not decomplex and leverage
 satisfactory satisfactory supplier
 development (2)


REFERENCES

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Bensaou, M. "Portfolios of Buyer-Supplier Relationships," Sloan Management Review, (40:4), 1999, pp. 35-44.

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Boodie, M.L.J. World Class Purchasing in the Netherlands is a Fiction, Berenschot Inkoopmanagement, Utrecht, the Netherlands (Dutch text), 1997.

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de Boer, L. Operations Research in Support of Purchasing -- Design of a Toolbox for Supplier Selection, Ph.D. thesis, University of Twente, Enschede, the Netherlands, 1998.

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Gelderman, C.J. and A.J. van Weele. "New Perspectives on Kraljic's Purchasing Portfolio Approach," Proceedings of the 9th International IPSERA Conference, London, Canada, 2000, pp. 291-298.

Handfield, R.B., D.R. Krause, T.V. Scannell, and R.M. Monczka. "Avoid the Pitfalls in Supplier Development," Sloan Management Review, (41:1), 2000, pp. 37-49.

Kraljic, P. "Purchasing Must Become Supply Management," Harvard Business Review, (61), September-October 1983, pp. 109-117.

Lilliecreutz, J. and L. Ydreskog. "Supplier Classification as an Enabler for a Differentiated Purchasing Strategy," Global Purchasing & Supply Chain Management, November 1999, pp. 66-74.

Moller M. and J. Momme. "Supplier Segmentation in Theory and Practice--Towards a Competence Perspective," Proceedings of the 9th International IPSERA Conference, London, Canada, 2000, pp. 508-519.

Nellore, R. and K. Soderquist. "Portfolio Approaches to Procurement--Analysing the Missing Link to Specifications," Long Range Planning, (33:2), 2000, pp. 245-267.

Nellore, R. and J.E. Taylor. "Using Portfolio Approaches to Manage Engineering-Purchasing-Supplier Interaction," Production and Inventory Management, (41:1), 2000, pp. 6-12.

Olsen, R.E and L.M. Ellram. "A Portfolio Approach to Supplier Relationships," Industrial Marketing Management, (26), 1997a, pp. 101-113.

Olsen, R.F. and L.M. Eliram. "Buyer-Supplier Relationships: Alternative Research Approaches," European Journal of Purchasing & Supply Management, (3:4), 1997b, pp. 221-231.

Steele, P.T. and B.H. Court. Profitable Purchasing Strategies: A Manager's Guide for Improving Organizational Competitiveness through the Skills of Purchasing, McGraw-Hill Book Company, London, 1996.

Syson, R. Imp rove Purchase Performance, Pitman Publishing, London, 1992.

Treacy, M. and F. Wiersema. "Customer Intimacy and Other Value Disciplines," Harvard Business Review, (71:1), 1993, pp. 84-93.

van Weele, A.J. Purchasing and Supply Chain Management: Analysis, Planning and Practice, Thomsom Learning, London, 1st and 2nd eds., 1994 and 2000.

Wynstra, J.Y.F. Purchasing Involvement in Product Development, Ph.D. thesis, Eindhoven Centre for Innovation Studies, Eindhoven University of Technology, the Netherlands, 1998.

Yin, R.K. Case Study Research: Design and Methods, 2nd ed., Sage Publications, Thousand Oaks, CA, 1994.

Cees J. Gelderman is assistant professor of marketing and purchasing management at the Open University of the Netherlands.

Arjan J. van Weele is the NEVI Chair in Purchasing and Supply Management both at Eindhoven University of Technology Faculty of Technology Management and Nyenrode University, Center for Supply Chain Management, the Netherlands.
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Author:Gelderman, Cees J.; van Weele, Arjan J.
Publication:Journal of Supply Chain Management
Date:Mar 22, 2002
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