purchasing 1: buying behaviour, processes and strategy

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Catrin LammgårdPhD, lecturer, researcherDeptm of Business Administration, IFEL, B5Handelshögskolan vid Göteborgs UniversitetPhone +46 31 786 1457E-mail: catrin.lammgard@handels.gu.se

Purchasing 1:

Buying behaviour, processes and strategy

2020-02-06

Catrin Lammgård 2019

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Book-versions:

LATEST : Van Weele (2019), Purchasing and supply chainmanagement, 7 edition, Cengage. English

Catrin Lammgård 2011

2014, 6th edi

Older:

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Chapters in 7 edi:

• The role of purchasing in the value chain 1

• Industrial Buying Behavior 2

• The Purchasing management process 3 (just pp)

• Buying Business Services 4 (just pp)

• Purchasing and Business strategy 7

• Purchasing and Facilities management - (just pp)

• Summaries pp-slides: 58-64

• Extra slides (extra material if you are interested ) pp-slides: 65-77

Agenda Purchasing 1

What is important when you buy?Motive?Decision-maker?

Chapter 1 : Purchasing in the value chain Chapter 2: Industrial buying behavior: decision making in purchasing

Source: van Weele (2019) Purchasing and Supply Chain Management.

Summary differences:

Source: van Weele (2014) Purchasing and Supply Chain Management.

Organizational buying behavior:

n Professional purchasing

n Derived (fluctuating) demand

n Inelastic prices

n Geographical concentration

n Limited number of customers

n Large order quantities and large amounts of money involved

Source: van Weele (2014) Purchasing and Supply Chain Management.

Purchasing and SCM are recognized as key drivers, in a competitive business environment!

Often60-80%

Profitn Why purchase anything? (efficiency, compentence/innovation)n Is purchasing important? (1% revenue vs 1% cost

reduction)n Purchasing management=source of competitive

advantage…key to profitability

Volvo example: n If you buy 70% of your input and your sales margin is 3%,

what will be the bottom line of: 1% reduction in costs of input vs.1% reduction in conversion costs* with the same sale price?

n …23% profit increase vs 10%

What is profit?

*Conversion costs=production costs minus input material purchasedi.e. labor and Overhead (OH) costs on production

Purchasing in the value chain

The value chain consists of: n value activities and n a margin (achieved by these activites)

In essence: all activities need to be performed so that the total value generated by the company, as perceived by itscustomers, is more than the sum of costs……..value-adding!!

Source: van Weele (2010) Purchasing and Supply Chain Management.

Goal: a sustainable competitive advantage

Directprocurement

Indirectprocurement

(Eg. buying ofproduction items)

Difference procurement?

Concepts!

Some differences:

Purchasing: Price vs funcionality, Purchasing processvsProcurement: Total cost of ownership (TCO), Purchasing process+SC optimization

Models of industrial buying behavior

Variables that affect the buying process:

n Characteristics of the product (eg. Routine products)

n Sums of money involvedn Strategic importance (eg. Low-cost bottleneck products)

n Characteristics of the purchasing marketn Degree of riskn Role of the purchasing department in the organizationn Affect of purchase on existing routines (eg. Training needed)

Models of industrial buying behavior

Variables that affect the buying decision:

n Task variables¨ tasks, responsibilities and competences

n Non-task variables¨ personality

eg. risks, avoid conflictBUT group decision-making…referred to as the

Decision-making unit (DMU) or Buying centrew/ different roles but share common goals and risks

The purchasing process

A professional buyer is a facilitator for the supply process:

n Identifying new, potential suppliers n New product development

n Supporting internal customers n Preparing and carrying out contract negotiationsn Setting up requisitioning and ordering routines (ex.e-

procurement)n Maintain and monitor ordersn Monitoring outstanding orders (financial)n Follow up and evaluation of supplier performance

Source: van Weele (2010) Purchasing and Supply Chain Management.

What are the tasks for you as a professional buyer?

The purchasing process

1 2 3 4 5 6

Source: van Weele (2019) Purchasing and Supply Chain Management.

Purchasing situations

New task situation§ Completely new product from unknown suppliers§ High uncertainty regarding outcome§ (e.g. acquisition of capital goods like production equipment)

Modified Rebuy§ New product from known supplier§ Existing product, new supplier§ Moderate uncertainty regarding outcome

Straight rebuy§ Known product from known supplier§ Low uncertainty regarding outcome § (e.g. consumable items like office supplies, electricity

Three types of purchasing situations:

All steps are not always included!

Often Framework agreements (FWAs)

The specification phase

Purchase order specification

¨ Quality specifications (eg. standards)¨ Logistics specification (q, place, time)¨ Maintenance specification (eg. service and spare parts)¨ Legal and environmental requirements (eg.HSE)¨ Target budget (constraints)

Functional specifications (for user)Technical specifications

contains

1

Order winners:

n …key reasons for buying that product.n For example: if competing on price, than productivity improvements

interesting

Order qualifiers:

n an ”entry ticket”. n For example: basic performance standards, an environmental label

Order winners and order qualifiers are:

-specific to individual segments-may change over time: where is the product in the product life cycle?

Supplier selection and assessment

The selection step contains a number of separate steps:

1) Determine the method of subcontracting (turnkey or partial)2) Preliminary qualification draw up bidders list-can be based on Request for information (RFI) that invites suppliers to submit general info to qualify for a tender

3) Prepare Request for quotation (RFQ) and analysis of the bids4) Supplier selection

2

Negotiation and contracting

n Fixed-price plus incentive fee (eg. better performance)

n Cost-plus contract (different forms eg. cost plus % fee/guaranteed min.)

n Cost-reimbursable (eg. hourly rates-remember maximum price)

n Agreement with price-adjustment (escalation clauses) (eg. index)

3

-penalty clauses (bötesklausuler)-warranty conditions (garantivillkor)-terms of delivery (eg.Incoterms)

-prices and terms of payment:

Source: van Weele (2014) Purchasing and Supply Chain Management.

INCOTERMS

Ordering and expediting

Establishing ordering routines

For example:n Exception expediting: buyer only takes action when the organization sends out signals of material shortages

n Routine status check: preventing materials supply and quality problems – few days before promised delivery, the buyer contacts the supplier to confirm delivery date

n Advanced status check:for critical purchase parts – a detailed production plan will be handed over to the buyer and during the process the buyer will carry out periodic checks

4+5

Follow up and evaluation

The buyer’s role continues after the new product has been taken into production.

■ Compare invoice with the original order■ Solve delivery issues■ Supplier assessment:

¨ Keep track of supplier’s quality, delivery record, competitiveness and innovativeness (affect the vendor rating)

¨ Need it for the next purchasing process

6

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Case: Procter & Gambler

• Largest consumer product company in the world• $84 billions- 300 products-150 manufacturing units• 90 000 suppliers (100 000 3 years earlier), cut down more• 400 key suppliers (1/4 of the purchases)• 1700 purchasers employed• Cuts of costs instead of increase in price (when raw materials increase)• http://www.pg.com/en_US/brands/index.shtml

50 leadership brands represent 90% of sales and profit (of which 25 are Billion-Dollar Brands, each generating >$1 billion in annual sales)

E-procurement solutions

■ Electronic market places: searching for suppliers

n eg. www.aeroxchange.com for the aviation industry

*13 of the world's airlines to create a global, neutral eCommerce platform

*“Over 55,000 Purchase Orders are processed through Aeroxchange each month”

■ Electronic auctions: the electronic trade exchange popular

■ Electronic catalogue and ordering systems: more efficient order handling.

E-procurement solutionsForms of E-auctions:n Open Request for information (RFI) / request for

proposal (RFP):¨ Qualification before auction¨ Supplier is invited based on the offer

n Reversed auction¨ input price determined by buyer¨ offers are visible, suppliers can see how far away they are from the best

offer

n Forward auction: ¨ Vendor determines the price¨ Several buyers announce their offer to the auctioneer

E-procurement solutions

n Most popular method for buyers : reversed auction¨ High volumes to cover the auction costs¨ Sufficient competition¨ Equal opportunities for all suppliers¨ The buyer has to be interesting for the supplier

n e-auctions: costs -5% to -40%n Suppliers: not popular as their margins will decrease

E-procurement solutions

Source: van Weele (2014) Purchasing and Supply Chain Management.

Purchasing:

Major bottlenecks and problems

n Too detailed specification aimed for one supplier

n Inadequate supplier selection eg. (bank) references

n Personal relationships competitive?

n Contracts not good eg. incomplete, not presentn Too much emphasis on price total-cost-of-ownership (TCO) n Poor administrative processesn Problems in delivery phase eg. quality problems n Suppliers are not systematically assessed , unprofessional

Source: van Weele (2014) Purchasing and Supply Chain Management.

Chapter 3The purchasing management process

Primary tasks and responsibilities

n Secure timely and undisturbed availability of purchased goods and services

n Control and reduction of all purchasing-related spendn Reduction of the company’s risk exposure in relation

to its supply marketsn Contribution to product and process innovation, the

development task

Changing purchase agenda

Source: van Weele (2014) Purchasing and Supply Chain Management.

Traditionally:

Price vs value

Drivers of development

n Business context¨ More competition, more mature technology used à more pressure

towards purchasingn Company strategy

¨ More explicit about goals and objectives, à greater chance purchasing is integrated in company strategy

n System development¨ Information and communication technologies (ICT) are important

enablersn Top management commitmentn Functional leadership

Source: van Weele (2019) Purchasing and Supply Chain Management.

Example Supplier relationships at Volvo Group

(not Volvo Cars)

-has one of the largest purchasing departments in the world

2015: appr. Euro 21 billion (today about SEK 227 miljarder/billion)

36 000 first-tier suppliers and subcontractors

Code of Conduct

Chapter 4Buying business services

Classification of services

Classification on organizational activity(Axelsson & Wynstra, 2002):

¨ Facility services¨ Financial services¨ ICT services¨ Transportation and distribution services¨ Operational services¨ Research and development and technical services¨ Human resource services¨ Marketing services

The approach of services (co-)determines the way in whichthe purchasing process and operational phase are designed

What are the differences to goods?

What is a service?Service: a process consisting of a series of more or less tangible activities, that normally take place in the interaction between customer- and supplier employees, and/or physical resources and systems, that are offered as an integrated solution to customer problems.

Source: van Weele (2014) Purchasing and Supply Chain Management.

¨ Combination with physical goods is possible¨ Reaction to a customers’ problem or need¨ Production is the interaction between customer and supplier

Differences between goods and services

Purchasing process for services

* Throughput: ex number of hours needed*Output/Outcome specification preferred* Output - Service Level Agreements (SLA) e.g. keeping the machine runninginstead of focusing how well the maintenance activities were conducted

Specification:

n When delivered ?Ex. An architect´s design fulfill tech. criteria but not taste?

n Agreements on access to company information n Key performance indicators (KPI’s) have to be tracked using

SLA (agree on critera to be used)n Periodic assessment and evaluation by buyer

Contracting:

Post-contractual stage

…important for a successful service delivery.

¨ Interaction between buying organization and supplier important

¨ Much time is in specifying the service, too little time is put in the process of realizing what this demands from both parties

¨ Outsourcing (jobs done by employees of a third party)

Cont. Purchasing process for services

Chapter 7Purchasing and business strategy

Cost leadership and differentiation

Porter (1980) defines three strategies leading to a distinguishing market position:

1. Cost leadership main focus: continually reducing the cost price of the final product.

2. Differentiation aims at marketing products which are perceived by the customer as being unique (design, technology, service etc)

3. Focus strategy aims at serving a particular, clearly defined group of customers in an optimal way

The consequence of not making a choice between the strategicalternatives is that the company will be unable to build up a sustainable competitive advantage in the end-user market.

Integrating purchasing into business strategy

From an earlier edition…

Choices regarding the strategic triangle

1. Primary customer groupsn Match product and customern Focused marketing plann Choose between specific vs. standard solutions

2. Major competitorsn Sustainable competitive advantagen Competitive benchmarking

3. Major suppliersn Investigate core competencesn Subcontracting if activities can not be performed in a competitive

way

Purchasing portfolio analysis

Kraljic’s (1983) product portfolio based on two variables:

1. Purchasing’s impact on the bottom linethe profit impact of a given supply item measured against criteria such as cost of materials, total cost, volume purchased

2. Supply riskmeasured against criteria such as short-term and long term availability, number of potential suppliers, structure of supply markets.

Purchasing product portfolio

Leverage products= Hävstångsprodukter

Supplier portfolio

Product categories

n Strategic products:¨ Often high-tech, high-volume products¨ Only one supply source available¨ Significant share in cost price of end product

¨ Three situations possible:n Buyer-dominated segmentn Supplier-dominated segmentn Balanced relationship à a partnership may develop over time

Product categories

n Bottleneck products:¨ Relatively low value, vulnerable regarding supply¨ Few alternatives available¨ Supplier is often dominating the market

n Routine products:¨ Large variety in products¨ Low value per product¨ High transaction costs

n Leverage products:¨ Choice between different suppliers¨ Low switching costs¨ Relatively high share in end product price

Purchasing portfolio-analysis

Four basic supplier strategies: (See book)

1 Partnership (strategic products)

2 Competitive bidding (leverage products)

3 Secure supply (bottleneck products)

4 Category management and e-procurement solutions(routine products)

Limitation: ”The Dutch Windmill”- see book.

Purchasing portfolio analysisIn developing effective supplier strategies, the following questions may be helpful:n Does the present purchasing strategy support our business strategy?n What is the balance of power between our company and our major

suppliers?n Are the strategic products and services sourced from the best in class-

suppliers? n What percentage of our purchasing requirements is covered by contracts? n To what extent are internal operations benchmarked against specialist

suppliers?n What opportunities exist for collaboration with suppliers with product

development, quality improvement, lead time reduction?

20-80 rule: 20% of the products and suppliersrepresent 80% of purchasing turnover

Purchasing and facilities management

Housing & accomodation

Purchasing and facilities managementMajor categories of expenditure

Breakdown purchasing spend

Facility goods and services are part of indirect sourcing

Source: van Weele (2014) Purchasing and Supply Chain Management.

Purchasing and facilities managementn Spend is sometimes higher than spend on direct goods and

services:¨ Outsourcing of processes¨ Average 50:50

n Cost stucture: labour highest costn Purchasing for the primary process is usually absent

(=no physical production)n Management often little effort in support activities n The service sector is changing to an international arena

*service companies strive to improve their services for the end user whilst reducing operational costs

Summary-overview

Conclusion- industrial buying behavior

n Industrial buying behavior was discussed from:¨ Organizational perspective ¨ Models that regard the interaction between two or more parties

n Purchase process model offers organizations a tool for structuring their purchasing processes.

n E-procurement solutions offer the purchasing professional many opportunities to deal with problems.

Conclusion- purchasing management processn Most companies have a large potential for improvement

in the area of purchasing management.

n The systematic approach of the purchasing management process can help make this potential visible and accessible.

n However, it takes time to put all the elements of the purchasing management process in place.

Conclusion- servicesn The number of services is increasing and becomes more

important for a company

n Professionalizing services buying is far from simple.

n Buying services in a professional way is challenging

¨ the specification may take much more time then for goods ¨ the quality of the service provided may be embedded in unique

human expertise, an objective selection criteria (hard to compare suppliers).

Conclusion – facilities management

n Services companies represent a growing share of economic activity in most European countries.

n For reasons of effectiveness buyers should be primarily service driven rather than cost driven.

n Facility goods and services are part of indirect sourcing.

Conclusion-purchasing and business strategyn Purchasing and supply management is getting a more prominent

position due to the strategic reorientation of many companies.n The purchasing strategy cannot be separated from the corporate

policy or from competitive strategy.n When developing specific supplier strategies purchasing product

portfolio of Kraljic (1983) may be very helpful.

Conclusion- category sourcing

n Effective supplier management is another cornerstone for a successful business strategy.

n The international competitive arena forces manufacturers to look continuously for ways to improve their value propositions to customers.

n The foundation of any category sourcing plan is a sound spend analysis. The purchasing spend is categorized in homogeneous product categories though a category tree.

n The road to partnership is long and difficult. There are no easy ways or short cuts to success.

Extra slides

n -not compulsory but read if you are interested in knowingmore….

Chapter 3The purchasing management process

Standard purchasing procedure (1)

1. Send an offer of collaboration to the best companies, (confidential)

2. Reject offers delivered after the deadline3. Proceed with an opening session of the letters4. Countersign the offers5. Draw up a comparative table of costs6. Proceed with a consistency check on technical level7. Check debit-equity ratio of the companies8. Preselect the two best proposals (quality and costs)

Source: van Weele (2010) Purchasing and Supply Chain Management.

Standard purchasing procedure (2)9. Check the references10. Draw up assessment grid of recent realizations11. Compare costs and renegotiate item by item12. Recommend a final choice13. Maintain contact with the other supplier (avoid monopoly)14. Draft the contract with legal department15. Write to the companies not chosen to notify them of

refusal16. Regularly sound out the competition17. Preserve our partners’ long-term motivations

Professionalizing purchasing

Major principles of purchasing policies:

n Business alignment¨ Develop a purchasing and supply strategy

n Integrated, cross-functional approachn Performance driven

¨ internal customersn Purchasing and supply (market) research

the systematic study of all relevant factors which may affect supply and demand of goods and services,

o Sourcing policy

o Direct versus indirect buying

o Make-or-buy analysis

o Integration between purchasing and other functional areas

o Setting up a purchasing information and control system

o Centralized or decentralized purchasing

o Standardization

Examples of areas for action in purchasing

Chapter 16Purchasing and facilities management

Housing & accomodation

Improve customer orientation (1)

1. Analyze and document internal customer /product categories:n the total purchasing spend per department?n What is purchased through the purchasing function/department?

2. Assess internal customer satisfaction:n bottlenecks in the relationship ?

3. Target setting (detailed action plan):n What customer/product category combinations the purchasing department

will reinforce its positionn The actions necessaryn The expected results

4. Cross functional buying teams and organizational structure:n Teams with specialists from user departments

5. Develop sourcing strategies:n Use purchasing portfolion Detailed action plan per purchasing category

6. Implementation:n Careful monitoring and results in terms of:

¨ Savings generated¨ Customer satisfaction¨ Administrative lead time

Improve customer orientation (2)

Buying indirect goods and services

Suggestions for cost savings:¨ Reduction of number of suppliers¨ Introducing category sourcing¨ Analyze user pattern ‘end of year fever’¨ Product standardization¨ Reviewing current contracts and agreements¨ Reducing transaction costs¨ Outsourcing the purchase of small items and contracts