Chapter 14Performance measurement and governance in purchasing

ProgramFactors influencing purchasing performance measurementWhy measure purchasing performance?How to assess purchasing performance?Measuring purchasing performancePurchasing budgets, purchasing savings and other performance measureSarbanes Oxley and procurement governancePurchasing audit as a management tool

Purchasing performance measurementOn of the major factor that influences the measurement of purchasing results, is how management looks upon the role and importance of the purchasing function

Management may look at purchasing as a (1)Operational and administrative activity: Management evaluates purchasing operations primarily on parameters such as order backlog, administrative lead-time, number of orders issued, numbers of requests for quotations issued, adherence to existing procedures, etc. Commercial activity: Management is aware of the savings potential which purchasing may represent. Parameters being used here are the total savings reported by purchasing, number of quotations issued, variance reports, inflation reports, etc.

Purchasing performance measurementManagement may look at purchasing as a (2)Part of integrated Logistics. Management becomes aware that price hunting has its drawbacks and may lead to sub-optimization. Evaluation is aimed at quality improvement, lead time reduction and improving supplier delivery reliability.Strategic business area. Purchasing is actively involved in deciding the companys core business. Management evaluates purchasing on i.e. the number of changes in its supply base and its contribution to the bottom line in terms of savings realized.

The way purchasing activities are measured and judged will differ for every company considered; this makes it almost impossible to develop one uniform method or system for performance measurement in purchasing

Purchasing performance measurement

Alternative viewpointsHierarchical position purchasing Performance indicatorsOperational and administrative activityLow in the organization Number of orders, order backlog, authorization, Commercial activityReporting to management Savings, price variances, number of RFQs, number of single/sole sources,Part of integrated LogisticsPurchasing is integrated with other materials related functionsQuality, purchasing lead time, delivery reliability, Strategic business areaPurchasing is represented in top-managementEarly involvement in purchasing process, Should cost analysis, make-or-buy, number of tenders and e-auctions, changes in its supply base,

Why measure purchasing performance?What benefits can be derived from a systematic performanceevaluation?

Better decision making Better communication with other departmentsBetter visibility of purchasing performanceBetter motivation of buyersCollectively, these comments indicate that purchasing performance evaluation should result in higher added value of the purchasing function

Assessing purchasing performancePurchasing performance is considered to be the result of two elements:

Effectiveness: Results actual / Results planned(e.g. material costs, quality, logistics, innovation ..)

Efficiency: Cost actual / Cost planned(e.g. administrative lead times, orders per purchaser..)

Purchasing performance thus can be defined as the extent to which thepurchasing function is able to realize its predetermined goals at thesacrifice of a minimum of the companys resources (i.e. costs)

Measuring purchasing performanceThere are four dimensions on which measurement andevaluation of purchasing activities can be based

Price / cost dimensionsProduct / quality dimensionsLogistics dimensionsOrganizational dimensions

These dimensions are strongly related with each other

PurchasingMaterials costs/pricesProduct / qualityPurchasing logisticsPurchasingorganizationPurchasingeffectivenessPurchasingefficiencyPurchasing performanceMaterials price/cost controlMaterials price/cost reductionInvolvement of purchasingin new Product developmentPurchasing and Total Quality controlAdequate requisitioningOrder and inventory policy Supplier delivery reliabilityPersonnelManagementProcedures & policiesInformation systemKey areas of purchasing performance measurement

Purchasing price/cost dimension

This dimension refers to the relationship between standard and actual prices paid for materials and services. A distinction is made between: Price/cost control Continuous monitoring and evaluation of prices and price increases as they are announced by suppliers (e.g. ROI measures, materials budgets, price inflation reports)Price/cost reductionContinuous monitoring and evaluation of activities initiated to reduce costs in a structured way (e.g. searching new suppliers, value analysis, substitute materials)

What should be measured?Budgets are important instruments for performance planning and monitoring with regard to the price/cost dimension.

Purchasing Product/Quality dimension

This dimension refers to purchasings responsibility to secure that products and services are delivered by suppliers in conformance with specifications and requirements. Purchasings involvement in new product development Examples of measures: number of man hours spent by purchasing on innovation projects, number of technical change orders and initial sampling reject ratePurchasings contribution to Total Quality Control Examples of measures: reject rates on incoming goods, number of approved / certified suppliers

What should be measured?

Purchasing Logistics dimension

This dimension refers to purchasings role to contribute to an efficient incoming flow of purchased materials and services. This includes the following major activities: Control of the timely and accurate handling of materials requisitionsControl of timely delivery by suppliersControl of quantities delivered

Supplier evaluation and vendor rating are techniques used to monitor and improve supplier performance in terms of quality and delivery reliability.What should be measured?

Organizational dimension of purchasing

This dimension includes the major resources that are used to achieve the goals and objectives of the purchasing function: Purchasing staffPurchasing ManagementPurchasing procedures and guidelinesPurchasing information systems

What should be measured?

* Note: C = continuous and I = IncidentalWhat should be measured?Examples of purchasing performance indicators

DimensionMeasurement aimed atC/I*ExamplesPurchased materials prices and costsPurchased materials cost control

Purchased materials cost reductionC

CMaterials budgets, variance reports, price inflation, reports, purchasing turnoverPurchasing cost saving and avoidances, impact on return and investmentProduct / quality of purchased materialsEarly purchasing involvement in design and developmentIncoming inspection quality control and assuranceI

CTime spent by purchasing on design and engineering projects, sampling reject rate (%)Reject rate (%), line reject rate (%), quality costs per supplierPurchasing logistics and supplyMonitoring requisitioning Delivery reliability (quality and quantity)

I/CPurchasing administration lead times, order backlog (per buyer), rush orders, delivery reliability index per supplier, materials shortages, inventory turnover ratio, JIT deliveriesPurchasing staff and organizationTraining and motivation of purchasing staffPurchasing management qualityPurchasing systems and proceduresPurchasing researchITime and workload analysis of purchasing department, purchasing budget, purchasing and supply audit

Each of the four dimensions can be measured and evaluated at different levels of aggregation, such as:

Line item levelIndividual supplier levelLevel of the individual buyerDepartment levelOverall company level

What should be measured?

Purchasing budgetsPurchasing materials budgetOften determines over 50% of the cost price of end productsPlanning and control instrumentForecasting volumes of goods and pricesFrequent meetings purchasers and production plannersPurchasing budget indirect materialsMaintenance equipment, spare parts, office suppliesBased on historical usage plus a certain marginInvestment and tooling budgetResponsibility of management, purchasing has a supporting roleBased on production planDepartmental budgetOrganizational costs based on a fixed amount of employees

Purchasing savingsSavings on purchasingAvoiding costs, differences in historical and current prices without a sustainable characterCosts reduction, different supplier or change in specification; sustainable characterPoints of attention for a cost reduction program:Clear objectives considering purchasing savingsEliminate influences on which purchasing has no influenceDifference between expected and actual savingsIndependent verification of purchasing savings

Ratios and key performance indicatorsExample of measurements for the quality of incoming goods and servicesPercentage rejected deliveries related to the number of total deliveries made.Percentage rejected, but repaired goods.Cost related to repair of incoming goods and services.Line reject rate, due to inferior quality of components.Cost related to quality inspection Number of credit notes to suppliersNumber of quality claims to suppliers and amounts involved.

Ratios and key performance indicatorsFor which products does one want this information?Problematic suppliersEssential for proceeding of productionCritical vs. Non critical deliveriesBased on data delivery reliability indices can be calculatedUnclear relation between used resources and results could be a problem in purchasing performance measurementsAssessment of functioning of a purchasing department can be done using a purchasing auditWhile reporting this data the validity and reliability can form a problem

Case Sarbanes-OxleyCorporate governance for avoiding scandalsStrict rules introduced by American senators Sarbanes and Oxley (SOx)Procurement governance for purchasing processesPurchasing is sensitive for fraudInstallation of a CPO for controlling and describing purchasing transactions and processesResponsible for designing processes together with the CEO and the CFO

Purchasing audit as management toolThrough a purchasing audit, management may assess the extent to which goals and objectives of the purchasing department are balanced with its resources.

The audit must be conducted in such a way that people do not feel threatened and in a way which builds trust and generates professionalism

Audits can be preventive or corrective in nature:Preventive audits can be compared with periodical check-upsCorrective audits focus on acute problems apparent in the functioning of the department

Purchasing audit as management toolElements of a purchasing audit

Factors that influence final purchasing performance:

Requirements that the corporate system lays down for the purchasing functionChanges in the supply chain of the companyOpportunities provided by the supplier market to fulfill the materials requirementsPurchasing audit as management tool

Purchasing audit as management toolGoals and objectives

Goal orientationWhat are the purchasing departments goals?What are the purchasing departments responsibilities?To what extent are the purchasing departments tasks stated in objective and verifiable terms?Client orientationDoes the purchasing department communicate efficiently with its internal customers?Is there adequate reaction to the requirements and wants of the internal customers?Is the purchasing department sufficiently aware of new internal developments and changes in the supplier market?RiskWhat are the major risks with regard to price behavior of high-value items and with regard to availability of critical materials?Is purchasing sufficiently aware of these risks and what measures have been taken in order to cope with them?In general, is continuity of supply and purchasing operations sufficiently guaranteed?Part 1

Purchasing audit as management toolResources

Results and resourcesTo what extent does purchasing meet its tasks and objectives?Is the purchasing department adequately equipped in terms of people and systems to be able to meet expectations?What measures are taken in order to improve on results on the one hand and systems and human resources on the other hand?FlexibilityDoes purchasing adequately react to changing materials requirements and internal customer needs?Is purchasing sufficiently interested in and pursuing new technology?What important changes have taken place in the service and organization of the purchasing department?ManagementIs teamwork within purchasing department sufficiently developed?Is the purchasing department a well-respected partner for discussion of internal customer problems?What measures have been taken in order to keep the quality of human resources up to date?Part 2

Calculation of supplier delivery index (1)

SupplierToo early in weeksOn timeToo late in weeksToo many/ few>8 8-5 4-3 21123>4Weight factor001111,00,90,60,20,00,5

Calculation of supplier delivery index (2)

Supplier XDelivery timeQuantityPO numberDeliveryReceivedOrderedQuantityWeightScoreWeight factorScorein weekin weekquantityreceivedfactorfactor12345635381201200,2 x 10020023456135321201200,6 x 10060034561235351201201 x 100100045612335351201301 x 1001000,5 x (130-120)-556123435351201101 x 1001000,5 x (120-110)-5Total380-10Supplier delivery index(actual score/maximum score) x 100%= 370/500 x 100%=74%

ConclusionsPerformance measurement in purchasing is a crucial part of the purchasing management process. Purchasing performance measurement is important since it will lead to a greater visibility and recognition by other business functions. Objective performance measurement is a difficult matter as it is hampered by poor definitions and reporting. When measuring purchasing performance, it is suggested to focus both on purchasing effectiveness and efficiency.