PURCHASING MANAGEMENT

Introduction
2

PurchasingObtaining merchandise, capital equipment; raw materials, services, or maintenance, repair, and operating (MRO) supplies in exchange for money or its equivalent.

Objectives
Purchasing, Procurement, Material and Supply Management: The terminologies are interchangeable Obj: Minimize Cost in the Procurement Function Supply chain management

Obj: Minimize costs and times across the supply chain

Trends in Purchasing Management

Purchasing Trends:
Information Management through ERP System JIT Purchasing Long term relationships Supplier management- improve performance through

Supplier

evaluation (determining supplier capabilities) Supplier certification (third party or internal certification to assure product quality and service requirements)
Strategic

partnerships- successful and trusting relationships with top-performing suppliers

4

Procurement Procedure

Recognize need. Send Purchase requisition Warehouse/ Purchase dept. Send Item/ Items from Warehouse to requestor Investigate and select supplier for RFPs and RFQs. Send RFQ & RFP Receive Supplier Quotation / Bid Perform Supplier Evaluation and selection Prepare and issue purchase order, follow-up.

The Purchasing Process

7

Manual Purchasing-Older system, prone to

duplication of effort and error
Step 1-Material Requisition/Purchase Requisition- stating product, quantity, and delivery due date are clearly defined. Step 2- The Request for Quotation (RFQ)- Buyer identifies suppliers & issues a request for quotation (RFQ).

Step 3- The Purchase Order (PO)- The purchase order is the buyers offer & becomes a binding contract when accepted by supplier.

The Purchasing Process- Cont.

8

Electronic Procurement (e-Procurement)

Step 1- Material user inputs a materials requisition- relevant information such as quantity and date needed. Step 2- Materials requisition submitted to buyer- at purchasing department (hardcopy or electronically). Step 3- Buyer assigns qualified suppliers to bid- Product description, closing date, & conditions are given. Step 4- Buyer reviews closed bids & selects a supplier

Advantages for the e-Procurement System.

Time

savings Cost savings Accuracy Real time Mobility Tractability Management Benefits to the suppliers
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Purchasing Role in an Organization

Purchasing Functions: To assure availability of the products and services:

at

right time, at right quantity, at right quality, at right price, From the right vendor.

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Purchasing Role in an Organization

Purchasing Functions: To assure availability of the products and services:

at right time, at right quantity,

at right quality,
at right price, from the right vendor.

Question : What will be the impact on the organization if purchasing function are not performed properly?

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Issues and their impact on departments

Issues & Problems Late/ early deliveries Purchasing Manufacturing Inventory Distribution Sales

Higher or lower quantity

Below standard / Quality Material

Higher price
Not the right Vendor

Issues and their impact

13

Issues & Problems Late/ early deliveries

Time

Cost

Image of the Company

Sales

Efficiency

Higher or lower quantity

Below standard / Quality Material Higher price

Not the right Vendor

The other Roles of Purchasing

Maintain the flow of goods/ services to serve the organization and its supply chains, at the desired customer service levels on a continuous basis Minimize the investment in inventory to free up capital for other projects Maintain the required quality levels of purchased goods and services Search for and develop capable suppliers Achieve good working relationships with other functional areas of the organization Maintain working relations with suppliers. Control vendor performance. Maintain supplier database.

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The Role of Purchasing in an organization

Purchasing contributes to these objectives by:

Actively seeking better materials and reliable suppliers, Work closely with strategic suppliers to improve quality materials, and Involving suppliers and purchasing personnel in new product design and development efforts.

Purchasing in Value Chain

Support activities

Primary activities

Inbound logistics Operations Outbound logistics Marketing and Sales Service Corporate infrastructure Human resources management Technology Development Procurement

Materials receiving, storing, and distribution to manufacturing premises Transforming inputs into finished products. Storing and distributing products Promotions and sales force Service to maintain or enhance product value Support of entire value chain, e.g. general management planning, financing, accounting, legal services, government affairs, and QM Recruiting, hiring, training, and development Improving product and manufacturing process Purchasing input

Role of Purchasing
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Clerical ? Tactical ? Strategic ?

What is the role of Purchasing in an Organization ?

Analyze the Case

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Before
Annual

Budget for Purchasing Purchasing Practices Savings Purchasing Practices Cost Saving Factors

After
Annual

Evolution of Purchasing and Supply Management

Pre 1939 1940-49 1950-69 1970-89 1990-1999

2000-Future

Clerical

World War II

Managerial emphasis

Purchasing strategy

Integration into corporate strategy Integration with supply networks and information technology

Inbound logistic and outbound logistic

Purchasing as an administration function

Why Purchasing : The Number Makes Difference

Cost Drivers

Manufacturing Cost

30 55

SG & A Cost R & D. Corporate Allocation Material Cost

5
4.5

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A R&D Pretax Profit Profit Improvement 5% Reduction in Material Content 5% Reduction in Manufacturing Cost 5% Increase in Sales

$1.00 ($.50) ($.30) $.20

$1.00 ($0.475) ($.30) $.225 Increase 12.5%

$1.00 ($.50) ($.285) $.215 Increase 7.5% ($.1) ($.05) $0.065 Increase 30%

$1.05 ($.525) ($.315) $.21 Increase 5% ($.105) ($.0525) $0.0525 Increase 5%

($.1) ($.05) $0.05

($.1) ($.05) $0.075 Increase 50%

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A RD&E Pretax Profit Profit Improvement 5% Reduction in Material Content 5% Reduction in Manufacturing Cost 5% Increase in Sales

$1.00 ($.50) ($.30) $.20

$1.00 ($0.475) ($.30) $.225 Increase 12.5%

$1.00 ($.50) ($.285) $.215 Increase 7.5% ($.1) ($.05) $0.065 Increase 30%

$1.05 ($.525) ($.315) $.21 Increase 5% ($.105) ($.0525) $0.0525 Increase 5%

($.1) ($.05) $0.05

($.1) ($.05) $0.075 Increase 50%

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A RD&E Pretax Profit Profit Improvement ($10) ($ 5) $5 $100 ($50) ($30) $20 $1 Decrease to Material Content $100 ($49) ($30) $21 Increase 5% ($10) ($ 5) $6 Increase 20% $1 Increase in Sales $101 ($50.5) ($30.3) $20.2 Increase 1% ($10.1) ($ 5.05) $ 5.05 Increase 1%

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A RD&E Pretax Profit Profit Improvement ($10) ($ 5) $5 $100 ($50) ($30) $20 $1 Decrease to Material Content $100 ($49) ($30) $21 Increase 5% ($10) ($ 5) $6 Increase 20% $1 Increase in Sales $101 ($50.5) ($30.3) $20.2 Increase 1% ($10.1) ($ 5.05) $ 5.05 Increase 1%

Types of Buyers
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Merchant Buyerswholesalers and retailers who purchase for resale.

Industrial Buyerspurchase raw materials for conversion, services, capital equipment, & MRO supplies.

Decision Making In Purchasing

Make or buy? Keep inventory and how much? What price to pay? Where, when and what size to place orders? How long is the lead time and when to expect orders What is the best alternative? What transportation mode to choose? Long or short term suppliers? Should we cancel ord Who will form the negotiation team and what is the strategy in negotiation? Should we use bidding or reverse auction?

Purchasing Decisions
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Decision
Make or buy? Keep inventory and how much? What price to pay? Where, when and what size to place orders? How long is the lead time and when to expect orders? What is the best alternative?

Strategic

Planning

Operational

What transportation mode to choose?

Long or short term suppliers? Should we cancel orders? Who will form the negotiation team and what is the strategy in negotiation?

Should we use bidding or reverse auction?

The Reverse Auction

Regular auctions: In a regular auction, purchasers are allowed to place a bid on an item, which is the amount they are willing to pay in order to buy the item. The person who places the highest bid usually ends up with the item. Reverse Auction: With a reverse auction, however, the opposite is true. More specifically, the buyer advertises a need for an item or service. Sellers then place bids for the amount they expect to be paid in order to perform such a service or provide such an item. Generally, the seller who places the lowest bid will win the job or sell the item.

Small Value Purchase Orders

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Processing costs can be substantial.

Requisitions Processing Purchase Order Processing Invoice Processing Payment Processing

Small Value Purchase Orders

34

Processing costs can be substantial. Small value purchases should be minimized through: Procurement Credit Card/Corporate Purchasing card Blank Check Purchase Orders Blanket or Open-End Purchase Orders Stockless Buying or System Contracting Petty Cash Standardization Accumulating Small Orders to Create a Large Order Using a Fixed Order Interval

Sourcing Decisions: The Make-or-Buy Decision

35

Outsourcing -buying materials and components

from suppliers instead of making them in-house. The trend has moved toward outsourcing.

Backward integration refers to acquiring

sources of supply

Forward integration refers to acquiring

customers operations.

The Make or Buy decision is a strategic decision.

Make or Buy Decision ?

Consider a hypothetical situation in which a company has the option to make or buy a component part. Its annual requirement is 20,000 units. A supplier is able to supply a part at $7 per unit. The firm estimates that it costs $ 500 to prepare the contract with the supplier. To make the part, the firm must invest $ 25,000 in equipment and the firm estimates that it costs $ 5 per unit to make the part.
COSTS MAKE OPTION BUY OPTION

Fixed cost

$ 25000
$5

$ 500
$7

Variable cost

_____________________________________________ Annual requirements = 20,000

Calculations
TOTAL COST TO MAKE = = = TOTAL COST TO BUY

$ 25000 + $ 5Q
7 Q - 5Q 2Q

$500 + $ 7 Q

25,000- 500 24,500 UNITS = 12,250 UNITS = 25,000 + $5 X

BREAK EVEN POINT Q 12,250

Total cost at breakeven point, TC(BE)

= $ 86,250

Total cost for make option, TC (M)

20,000 =

$25,000+ $5 X

$125,000 = $500 + $7 X $

Total cost for buy option

TC (B)
20,000

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Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Buying or Outsourcing

Cost advantage: Especially for components that are non-vital to the organizations operations.

Insufficient capacity: A firm may be at or near capacity.

Lack of expertise: Firm may not have the necessary technology and expertise. Quality: Suppliers have better technology, process, skilled labor, and the advantage of economy of scale.

Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Making

Protect proprietary technology No competent supplier Better quality control Use existing idle capacity Control of logistics- lead-time transportation, and warehousing cost Lower cost

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Roles of Supply Base

40

Supply Base- suppliers that a firm uses to acquire its materials, services, supplies, and equipment. Firms emphasize long-term strategic supplier alliances consolidating volume into one or fewer suppliers, resulting in a smaller supply base. Preferred suppliers provide?

Early supplier involvement- Information on the latest trends in materials, processes, or designs Information on the supply market Capacity for meeting unexpected demand Cost efficiency due to economies of scale

Supplier Selection
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The process of selecting suppliers, is complex and should be based on multiple criteria:
Product

and

Order

process technologies Willingness to share technologies and information Quality Cost Reliability

System and cycle time Capacity Communication capability Location Service

How Many Suppliers to Use

42

Single-sourcing- a risky proposition. Although trends favor fewer sources, avoid single source.

Reasons Favoring a Single Supplier

To establish a good relationship Less quality variability Lower cost Transportation economies Proprietary product or process Volume too small to split

Reasons Favoring More than One Supplier Need capacity Spread risk of supply interruption Create competition Information Dealing with special kinds of business

Purchasing: Centralized vs. Decentralized

Purchasing Organization dependent on many factors, such as market conditions & types of materials required. Centralized Purchasing- purchasing department located at the firms corporate office makes all the purchasing decisions. Decentralized Purchasing- individual, local purchasing departments, such as plant level, make their own purchasing decisions. 43

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Purchasing: Centralized vs. Decentralized

AdvantagesAdvantagesCentralization Decentralization Concentrated volume Closer knowledge of leveraging purchase requirements volume Local sourcing Avoid duplication Less bureaucracy Specialization Lower transportation costs No competition within units Common supply organization- both decentralized at A hybrid purchasing base the corporate level and centralized at the business unit level may be warranted.

Total Cost of Ownership Concept

Total cost of ownership is more than just the purchase price; other qualitative and quantitative factors, including
freight Toll

and inventory costs,

tariffs

and duties, currency exchange fees and fluctuations, payment terms, maintenance,
Firms can use total cost analysis as a negotiation tool to inform suppliers regarding areas where they need to improve.

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International Purchasing/Global Sourcing

Global sourcing Opportunity

to improve quality, cost, and delivery performance. Requires additional skills and knowledge to deal with international suppliers, logistics, communication, political environment, and other issues.

Import broker or sales agent- performs service for a fee.

Import merchant- buys and takes title to the goods. Trading company- imports & carries wide variety of goods.