2 Purchasing Management

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PURCHASING MANAGEMENT


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Introduction2

Purchasing- Obtaining merchandise, capital equipment; rawmaterials, services, or maintenance, repair, and

operating (MRO) supplies in exchange formoney or its equivalent.


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Purchasing, Procurement, Material and SupplyManagement: The terminologies are interchangeable

Obj: Minimize Cost in the Procurement Function Supply chain management

Obj: Minimize costs and times across the supply chain

Objectives


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Procurement Procedure

Recognize need.Send Purchase requisition Warehouse/ Purchase dept.

Send Item/ Items from Warehouse to requestorInvestigate and select supplier for RFPs andRFQs.

Send RFQ & RFPReceive Supplier Quotation / BidPerform Supplier Evaluation and selection

Prepare and issue purchase order, follow-up.


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The Purchasing Process7

Manual Purchasing -Older system, prone toduplication of effort and error

Step 1-Material Requisition/Purchase Requisition - statingproduct, quantity, and delivery due date are clearly defined.

Step 2- The Request for Quotation (RFQ) - Buyer identifiessuppliers & issues a request for quotation (RFQ).

Step 3- The Purchase Order (PO)- The purchase order isthe buyers offer & becomes a binding contract whenaccepted by supplier.


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The Purchasing Process- Cont.8

Electronic Procurement ( e-Procurement )

Step 1- Material user inputs a materials requisition - relevantinformation such as quantity and date needed.

Step 2- Materials requisition submitted to buyer- at purchasingdepartment (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


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Advantages for the e-Procurement System.

Time savingsCost savings

AccuracyReal timeMobilityTractabilityManagementBenefits to the suppliers

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Purchasing Role in anOrganization

Purchasing Functions: To assureavailability 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 anOrganizationPurchasing 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 theorganization if purchasing function arenot performed properly?


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Issues and their impact on departments

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Issues & Problems Purchasing Manufacturing Inventory Distribution Sales

Late/ early deliveries

Higher or lowerquantity

Below standard / Quality Material

Higher price

Not the right Vendor


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Issues and their impact 13

Issues & Problems Time Cost Image of theCompany

Sales Efficiency

Late/ early deliveries

Higher or lowerquantity

Below standard /Quality Material

Higher price

Not the right Vendor


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The other Roles of Purchasing

Maintain the flow of goods/ services to serve the organizationand its supply chains, at the desired customer service levelson a continuous basisMinimize the investment in inventory to free up capital for

other projectsMaintain the required quality levels of purchased goods andservicesSearch for and develop capable suppliers

Achieve good working relationships with other functionalareas of the organizationMaintain working relations with suppliers.Control vendor performance.Maintain supplier database.


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The Role of Purchasing in anorganization

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Purchasing contributes to these objectivesby:

Actively seeking better materials and reliablesuppliers,Work closely with strategic suppliers to improvequality materials, and

Involving suppliers and purchasing personnel in newproduct design and development efforts.


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Purchasing in Value Chain

Supportactivities

Primary activities

Inbound logistics Materials receiving, storing, and distribution to manufacturing premisesOperations Transforming inputs into finished products.Outbound logistics Storing and distributing productsMarketing and Sales Promotions and sales forceService Service to maintain or enhance product valueCorporate infrastructure Support of entire value chain, e.g. general management planning,

financing, accounting, legal services, government affairs, and QMHuman resources management Recruiting, hiring, training, and development

Technology Development Improving product and manufacturing processProcurement Purchasing input


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Role of Purchasing

Clerical ?Tactical ?Strategic ?

What is the role of Purchasing in an Organization?

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Analyze the Case

BeforeAnnual Budget for PurchasingPurchasing Practices

AfterAnnual SavingsPurchasing Practices

Cost Saving Factors

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Evolution of Purchasing andSupply Management

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

Clerical World War II ManagerialemphasisPurchasingstrategy

Integration intocorporate strategy

Integrationwith supplynetworks andinformationtechnology

2000-Future

Inbound logisticand outboundlogistic

Purchasing as anadministrationfunction


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Cost Drivers

Manufacturing Cost

SG & A Cost

R & D. CorporateAllocation

Material Cost

5530

54.5

Why Purchasing :The Number Makes Difference


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Standard 5% Reduction in 5% Reduction in 5% Increase

Price/Profit Material Content Manufacturing

Cost in Sales

Sales $1.00 $1.00 $1.00 $1.05

Material ($.50) ($0.475) ($.50) ($.525)

Labor/OH ($.30) ($.30) ($.285) ($.315)

Gross Profit $.20 $.225 $.215 $.21 Gross Profit

Improvement Increase 12.5% Increase 7.5% Increase 5%SG&A ($.1) ($.1) ($.1) ($.105)

R&D ($.05) ($.05) ($.05) ($.0525)

Pretax Profit $0.05 $0.075 $0.065 $0.0525

Profit Improvement Increase 50% Increase 30% Increase 5%

Financial SignificanceCost and Profit Improvement


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Standard 5% Reduction in 5% Reduction in 5% Increase

Price/Profit Material Content Manufacturing

Cost in Sales

Sales $1.00 $1.00 $1.00 $1.05

Material ($.50) ($0.475) ($.50) ($.525)

Labor/OH ($.30) ($.30) ($.285) ($.315)

Gross Profit $.20 $.225 $.215 $.21 Gross Profit

Improvement Increase 12.5% Increase 7.5% Increase 5%SG&A ($.1) ($.1) ($.1) ($.105)

RD&E ($.05) ($.05) ($.05) ($.0525)

Pretax Profit $0.05 $0.075 $0.065 $0.0525

Profit Improvement Increase 50% Increase 30% Increase 5%



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Standard $1 Decrease to $1 Increase

Price/Profit Material Content in Sales

Sales $100 $100 $101

Material ($50) ($49) ($50.5)

Labor/OH ($30) ($30) ($30.3)

Gross Profit $20 $21 $20.2

Gross ProfitImprovement Increase 5% Increase 1%

SG&A ($10) ($10) ($10.1)

RD&E ($ 5) ($ 5) ($ 5.05)

Pretax Profit $ 5 $ 6 $ 5.05

Profit Improvement Increase 20% Increase 1%


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Standard $1 Decrease to $1 Increase

Price/Profit Material Content in Sales

Sales $100 $100 $101

Material ($50) ($49) ($50.5)

Labor/OH ($30) ($30) ($30.3)

Gross Profit $20 $21 $20.2

Gross ProfitImprovement Increase 5% Increase 1%

SG&A ($10) ($10) ($10.1)

RD&E ($ 5) ($ 5) ($ 5.05)

Pretax Profit $ 5 $ 6 $ 5.05

Profit Improvement Increase 20% Increase 1%


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Types of Buyers26

Merchant Buyers- wholesalers and retailers who purchase forresale.

Industrial Buyers- purchase raw materials for conversion, services,capital equipment, & MRO supplies.


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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 orderWhat is the best alternative?What transportation mode to choose?Long or short term suppliers? Should we cancel orWho will form the negotiation team and what is the

strategy in negotiation?

Should we use bidding or reverse auction?


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Purchasing Decisions28

Decision Strategic Planning Operational Make or buy?

Keep inventory and how much?

What price to pay?

Where, when and what size to placeorders?

How long is the lead time and when toexpect orders?

What is the best alternative?

What transportation mode to choose?

Long or short term suppliers? Should wecancel orders?

Who will form the negotiation team andwhat is the strategy in negotiation?

Should we use bidding or reverse auction?


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The Reverse Auction

Regular auctions: In a regular auction, purchasersare allowed to place a bid on an item, which is theamount they are willing to pay in order to buy the

item. The person who places the highest bid usuallyends 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 thenplace bids for the amount they expect to be paid inorder to perform such a service or provide such anitem. Generally, the seller who places the lowest bidwill win the job or sell the item.


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Small Value Purchase Orders30

Processing costs can be substantial.

Requisitions ProcessingPurchase Order Processing

Invoice Processing

Payment Processing


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Small Value Purchase Orders34

Processing costs can be substantial. Smallvalue purchases should be minimized through:Procurement Credit Card/Corporate Purchasing card

Blank Check Purchase OrdersBlanket or Open-End Purchase OrdersStockless Buying or System ContractingPetty CashStandardizationAccumulating Small Orders to Create a Large OrderUsing a Fixed Order Interval


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Sourcing Decisions: The Make-or-BuyDecision

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Outsourcing -buying materials and componentsfrom suppliers instead of making them in-house. Thetrend has moved toward outsourcing.

Backward integration refers to acquiringsources of supplyForward integration refers to acquiringcustomers operations.

The Make or Buy decision is a strategic decision.


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Calculations

TOTAL COST TO MAKE = TOTAL COST TO BUY$ 25000 + $ 5Q = $500 + $ 7 Q

7 Q - 5Q = 25,000- 5002 Q = 24,500 UNITS

BREAK EVEN POINT Q = 12,250 UNITS

Total cost at breakeven point, TC(BE) = 25,000 + $5 X12,250

= $ 86,250 Total cost for make option, TC (M) = $25,000+ $5 X20,000

= $125,000

Total cost for buy option TC (B) = $500 + $7 X $20 000

S i i i h k


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Sourcing Decisions: The Make-or-Buy Decision- Cont.

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

Insufficient capacity : A firm may be at or nearcapacity.

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.

Reasons for Buying or Outsourcing


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Sourcing Decisions: The Make-or-Buy Decision- Cont.

Protect proprietary technologyNo competent supplierBetter quality controlUse existing idle capacityControl of logistics- lead-timetransportation, and warehousing costLower cost

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Reasons for Making


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Roles of Supply Base40

Supply Base - suppliers that a firm uses to acquire itsmaterials, services, supplies, and equipment.

Firms emphasize long-term strategic supplier alliancesconsolidating volume into one or fewer suppliers,resulting in a smaller supply base .

Preferred suppliers provide?

Early supplier involvement- Information on the latest trends inmaterials, processes, or designsInformation on the supply marketCapacity for meeting unexpected demandCost efficiency due to economies of scale


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How Many Suppliers to Use

Reasons Favoring aSingle Supplier

To establish a goodrelationshipLess quality variabilityLower costTransportation economiesProprietary product orprocess

Volume too small to split

Reasons FavoringMore than OneSupplierNeed capacitySpread risk of supplyinterruptionCreate competitionInformationDealing with specialkinds of business

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


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Purchasing: Centralized vs.Decentralized

Purchasing Organization dependent onmany factors, such as market conditions &types of materials required.

Centralized Purchasing - purchasingdepartment located at the firmscorporate office makes all the purchasingdecisions.Decentralized Purchasing - individual,local purchasing departments, such asplant level, make their own purchasing

decisions . 43

P h i C t li d


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Purchasing: Centralized vs.Decentralized

Advantages-Centralization

Concentrated volume-leveraging purchasevolumeAvoid duplicationSpecializationLower transportationcostsNo competition withinunitsCommon supply base

Advantages-Decentralization

Closer knowledge ofrequirementsLocal sourcingLess bureaucracy

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A hybrid purchasing organization - both decentralized atthe corporate level and centralized at the business unitlevel may be warranted.

T t l C t f O hi


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Total Cost of OwnershipConcept

freight and inventory costs,

Tolltariffs and duties,currency exchange fees and fluctuations,payment terms,maintenance,

Firms can use total cost analysis as a negotiationtool to inform suppliers regarding areas where

they need to improve.

Total cost of ownership is more than just the purchaseprice; other qualitative and quantitative factors, including

I t ti l P h i /Gl b l


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International Purchasing/GlobalSourcing

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Global sourcing- Opportunity to improve quality, cost, and deliveryperformance.

Requires additional skills and knowledge to dealwith international suppliers, logistics,communication, political environment, and otherissues.

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.

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