Chapter 4: PurchasingProperty may be destroyed and money may lose its purchasing power; but, with proper

purchasing management- character, health, knowledge and good judgement will lead to

increase profitability

Purchasing

Part 1: Introduction

• Purchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise

Part 2: The Role of Purchasing in the Supply Chain

• Purchasing is responsible primarily for inbound or upstream, channel activities whereas logistics spans both inbound and outbound relationship and material flows

Performance metrics

Key b

usin

ess p

rocesses Customer relationship management

Customer service management

Demand management

Order fulfillment

Manufacturing flow management

Procurement

Product development and commercialization

Returns channel

Logistics Management

Information flow

Purchasing

MRP

Tier 1supplier

MRP

managementMaterials

MRP

Production

MPS

distributionPhysical

DRP DRP

Customer

DRPProduct Flow

Just-in-time

EDI EDIQuick response

supplierTier 2

MRP

ConsumerMarketingand sales

Supply Chain Management

• To meet the needs of the manufacturing function or other internal functions for which it was buying

• Focused on getting the right product or service to the right place at the right time, in the right quantity, in the right condition or quality and from the right supplier at the right price

• Played a role in keeping the operation running smoothly by ensuring a reliable source of supply

Part 3: Purchasing Activities

Objectives:

1. Development of the Purchasing Function

• In many ways, purchasing today stand at a crossroads in its development

• Activities such as purchase order placement, expediting and calling to check stock have either been eliminated or are now possible on-line with electronic data interchange (EDI)

Part 3: Purchasing Activities

2. The Role of Purchasing in Total Customer Satisfaction

• The receipt of high quality, reliable goods and services on a timely basis at a reasonable cost often directly affects customer satisfaction

• An organization cannot provide its ultimate customers with better quality goods and services than it receives from its supplier. If a supplier is late with delivery or has quality problems, the quality and availability of the product or service to the customer will be affected

Part 3: Purchasing Activities

Customer

Total customer satisfaction

Quality Cost Delivery Service Quantity Strategic

Organization

Quality Cost Delivery Service Quantity Strategic

Suppliers

Total Customer Satisfaction Depends on Supplier Performance

Part 3: Purchasing Activities

3. The Strategic Role of Purchasing

• Is to perform sourcing related activities in a way that support the overall objectives of the organization

i. Access to External Markets

• Through external contacts with the supply market, purchasing can gain important about new technology, potential new materials or services, new sources of supply and changes in market conditions

Part 3: Purchasing Activities

ii. Supplier Development and Relationship Management

• Purchasing can help support the organization’s strategic success by identifying new and existing suppliers

• Getting suppliers involved early in the development of new products and services or modifications to existing offering can reduce development times

• Among the primary purchasing activities are supplier selection, evaluation and ongoing management (sourcing), total quality management and purchasing planning

Part 3: Purchasing Activities

iii. Relationship to Other Function

• Virtually every department within an organization relies on the purchasing function for some type of information and support

• Purchasing often has the same functional reporting relationship as logistics, which is helpful for coordinating materials management

• Purchasing and logistics need to work closely in coordinating inbound logistics and associated material flows

Part 3: Purchasing Activities

4. Supplier Selection and Evaluation

• The most important activity is selecting the best supplier from among a number of supplier that can provide the needed materials

• There are 5 steps of purchasing process for managing supplier relationship and follow up (please see next slide)

Part 3: Purchasing Activities

5 phases in the selection development and management of purchasing relationships

Phase 2-Identify potential suppliers• Determine selection criteria/approach• Identify potential suppliers

Phase 1-Preliminary phase• Establish need for purchase• Form team is needed

Phase 3-Screen and select• Contact potential suppliers• Evaluate suppliers• Choose

Phase 4-Establish relationship• Document expectation/contacts• provide high attention level• Give prompt feedback

Phase 5-Evaluate relationship• Continue at current level• Expand/build relationship• Reduce/dissolve interaction

Part 3: Purchasing Activities

Purchase Categories

• There are 6 major purchase categories in most companies:

a) Component partsb) Raw materialsc) Operating suppliesd) Support equipmente) Process equipmentf) Services

Part 3: Purchasing Activities

Purchase Categories

• There are 6 major purchase categories in most companies:

Part 3: Purchasing Activities

Evaluating Suppliers

• To determine the impact of supplier performance on productivity, performance must be measured and evaluated

• A variety of evaluation procedures are possible

• Most important always use consistent procedures to increase the objective of the process

• The manager must identify all potential for the items being purchased

• The next step is to develop a list of factors to evaluate each supplier(Please see next slide)

Part 3: Purchasing Activities

Table above uses a five point scale (1=worst rating, 5= highest rating)Prior to evaluating suppliers, management must determine the relative importance of the factors to its particular situation, and assign each a weight. For example, if the product reliability were of paramount importance to the firm, it would be given the highest importance ranting. If price were not as important as product reliability, management would assign price a lower importance ranting. A factor of no importance to the firm would be assigning a zero.

FactorRanting of supplier(1 = Worst Ranting5 = Highest Ranting) 12345

Importance of Factor toYour Firm (10 = NoImportance; 5 = Highest Importance) 12345

WeightedComposite Ranting(0 = Minimum;25 = maximum)

Supplier AProduct reliabilityPriceOrdering convenience

After-sale serviceTotal supplier A

Supplier B Product reliability Price Ordering convenience

After-sale service Total supplier B

Supplier C Product reliability Price Ordering convenience

After-sale service Total supplier C

Example of an evaluation procedure

Selecting Suppliers

• Selecting the right suppliers has an immediateand long term impact on the firm’s ability to

serve its customer

• The supplier selection process is more difficult when materials are being purchased in international markets or for international operations

• Reward associated with proper supplier selection and evaluation; Reduction in the cost of materials increase the

profit margin on every unit manufactured and sold Customer service improvement are possible because

the manufacturing process can operate smoothly with no slowdowns or shutdowns

Part 3: Purchasing Activities

5. Total Quality Management

• Quality management is one of the important consideration in materials acquisition

• Materials of higher quality may require fewer fabrication processes or have a longer life span, resulting in lower overall product costs or higher prices for finished product

• After the required quality level has being determined and specifications developed, usually by manufacturing, it becomes purchasing responsibility to secure the proper materials

• The correct quality specification must be given to suppliers. The supplier that offers the best cost-quality combination that meets the specifications should be selected

Part 3: Purchasing Activities

5. Total Quality Management (cont’d)

• One way that firms might ensure quality is through inspection of incoming materials parts. But, this is costly and time consuming

• Inspection requires human resources, space, and perhaps tests equipment. In addition, incoming inventory is tied up or delayed awaiting inspection

• For this reason, purchasing managers have turned to supplier certification

• In the certification process, the supplier’s quality levels and processes are closely evaluated by members of the buying firm. If they “pass,” the buying organization no longer inspects that supplier’s incoming materials.

Part 3: Purchasing Activities

6. Just-in-Time (JIT)

• JIT focuses on the identification and elimination of waste wherever it is found in the manufacturing system

• Elimination of waste aim of reducing waste and cost throughout the entire supply chain

• JIT implementation involves the initiation of a “pull” system of manufacturing (matching production to known demand)

• the benefits include; significant reductions of raw material, work-in-process, and finished good inventories and large decreases in the amount of space required for the manufacturing process

Part 3: Purchasing Activities

6. Just-in-Time (JIT)

i. Difficulties in Implementing JIT

• One of the most frequently reasons is a lack of cooperation from supplier due to changes in the supplier’s system

• the supplier is asked to manufacture in quantities that may differ from the usual lot sizes and to make frequent deliveries of small lot with precise timing

• The supplier and buyer are normally required to provide

each other with access to their master production planning system, shop floor schedule, and material requirements planning system.

Part 3: Purchasing Activities

ii. Importance of Buyer-Supplier Communication

• Suppliers are given long–range insight into the buyer’s production schedule

• The schedule for the nearest several weeks is frozen allows the supplier to acquire raw materials in a stockless production mode and to supply the buyer without inventory buildups

• Purchases and suppliers must cooperate and have a trusting relationship in order to convert supply chains to JIT operations

• Supplier selection, single sourcing, supply management and supplier communication become critical issues for purchasing and materials managers in implementing JIT

Part 3: Purchasing Activities

7. Purchase Agreement

• The purchase order may specify price and overall quantity, but the supplier will deliver in accordance with a schedule or with daily production needs

• The buyer expects and receives the exact quantity

• Saves much time in negotiating and pricing the order

8. Value Analysis

• When negotiating a purchase agreement, the supplier receives the buyer’s specifications and provides a bid price.

• If the price is too high, the buyer may visit the supplier’s plant to review its processes

• The objective is to identify areas where the supplier’s costs exceed the value added and, if possible, to modify the minimal specifications in order to reduce the supplier’s cost and the bid price.

Part 3: Purchasing Activities

9. “Loose” Engineering Specifications/ Early Supplier Involvement

• The concept of getting the supplier involved in the design process is often called early supplier involvement (ESI)

• Concurrent engineering is a type of early supplier involvement where the engineers in the buying and selling firms work together on product development or product improvement.

• Engineers and quality control people may pay frequent visit to a supplier’s plant to answer engineering questions and identify potential quality problem before they surface.

Part 3: Purchasing Activities

10.Control of Inbound Transportation

• JIT purchasing requires steady, reliable incoming deliveries.

• The objective is to avoid excessive inventory carrying costs for materials that arrive early and avoid disruptions in manufacturing operations when goods arrive late.

• Therefore, the buying firms must become involved in selecting both the transportation mode and the specific carrier

• For example, CTI and Ryder integrated Logistics review manufacturers production schedule pickup of the materials, pickup and time-sequence the materials, and deliver them directly to the JIT production line.

Part 3: Purchasing Activities

11. Supplier Development

• A systematic organizational effort to create and maintain a network of competent suppliers and to improve various supplier capabilities that are necessary for the buying organization to meet its increasing competitive challenges

• Sometimes organizations find that their current suppliers are unable to support stringent JIT quality and delivery requirements

• Such organizations may search for other suppliers or work with suppliers to develop the skills needed to support JIT. Supplier development efforts are increasing as organizations form longer-team relationships with suppliers.

Part 3: Purchasing Activities

12. JIT II

• JIT II is an innovative type of purchasing relationship which aims JIT principles at the purchasing function

• In JIT II, the supplier places one of its employees, called an “in-plant,” in the buying company’s office, replacing a purchaser, planner, and sales person.

• The in-plant representative places order, practices concurrent engineering, and has full access to all of buyer’s facilities, information, and employees.

• The supplier benefits include greater integration with the customer, improved communications, more efficient administrative process, and savings on “sales effort.”

Part 3: Purchasing Activities

Strategic Planning for Purchasing

Part 4: Purchasing Research and Planning

• Supply market analysis

• Risk assessment

• Strategy development and implementation

• Identification of critical purchase

Strategic Planning for Purchasing

Identification of critical purchase

Supply Market

Analysis

Risk Assessment

Strategy Development

and implementation

Part 4: Purchasing Research and Planning

Typical criteria to use in identifying critical

purchases

1) Percentage of product cost2) Percentage of total

purchase expenditure

Typical criteria to use to determine the risk in the

supply market

1) Number of suppliers2) Availability of raw material

to supplier3) Supplier cost4) Technology trends

Typical criteria to use in Risk Assessment

1) Determine the probability of best or worst conditions occurring

Part 4: Purchasing Research and Planning

What?Quality VS Cost

How much?Large VS Small Qty

When?Now or LaterForward buy

Where?Local, international

What price?Lower, Standard

Supply Strategy Development Questions develop for predicted events

Part 4: Purchasing Research and Planning

Cost-Reduction Programs

• An effective cost-reduction program requires; top management support clear definition of goals, measurement of savings reporting on the process and its results individual performance appraisal process

Part 5: Purchasing Cost Management

• A “Cost Reduction” is defined as a decrease in prior purchase price

• Cost avoidance is the amount that would have been paid less the amount actually paid

Part 5: Purchasing Cost Management

Per unit cost______________________________________________________________________

Scenario 1 Cost savings:Current price paid $ 20.00New price $ 19.00

----------Cost saving $ 1.00

Scenario 2 Cost avoidance:Current price paid $ 20.00New price quote by supplier $ 25.00Price obtained from alternate supplier $ 22.00

Cost savingsCurrent price paid $ 20.00

New price quote by supplier $ 22.00---------

Cost saving (actually a $2.00 price increase) -$ 2.00

Cost avoidanceNew price quoted $ 25.00New price actually paid $ 22.00

----------Cost avoidance $ 3.00

Per unit cost______________________________________________________________________

Scenario 1 Cost savings:Current price paid $ 20.00New price $ 19.00

----------Cost saving $ 1.00

Scenario 2 Cost avoidance:Current price paid $ 20.00New price quote by supplier $ 25.00Price obtained from alternate supplier $ 22.00

Cost savingsCurrent price paid $ 20.00

New price quote by supplier $ 22.00---------

Cost saving (actually a $2.00 price increase) -$ 2.00

Cost avoidanceNew price quoted $ 25.00New price actually paid $ 22.00

----------Cost avoidance $ 3.00

Cost Savings versus Cost Avoidance

Part 5: Purchasing Cost Management

Part 5: Purchasing Cost Management

Price Change Management

• Restrict price increase to a reasonable and equitable level

• Reduced delivery lead times, better service, or other opportunities

• Price protection clauses and advance notification of 30, 60, 90 days for price increases

• Determine the impact of engineering changes on product cost

Determine the reason

for the price change request

Strategies to deal with

price increases

Review the price change

by management

Justification of the price change by suppliers

Alternatives for reducing other price elements to offset the

price increase

Handling Price Increase Requests From Suppliers

Part 5: Purchasing Cost Management

Four strategies in in Cost Management purchasing

Part 5: Purchasing Cost Management

1)Forward buying2)Speculative buying3)Volume Contract4)Stockless Purchasing

Four strategies in in Cost Management purchasing

Forward Buying

• Forward buying buy more of a product than is required for current consumption to protect the organization from anticipated shortages or to delay the impact of rising prices

Part 5: Purchasing Cost Management

Speculative Buying

• Speculative buying purchases made not for internal consumption, but to resell at a later date for profit

• Speculative goods may be the same as goods purchased for consumption, but the quantities purchased will be in excess of current or future needs

• An example occurs in diverting of retail goods

Part 5: Purchasing Cost Management

Volume Contract

• As a result of combining purchases can reduce purchase prices and administration costs

• Cumulative volume discount allows a buyer to combine purchase volume and getting lower prices

• Non-cumulative discount the price based on the amount of each order

Part 5: Purchasing Cost Management

Stockless Purchasing

• Arrangement in which a supplier holds the items ordered by the customer in its own warehouse, and releases them as and when required by the customer

• The objectives of stockless purchasing are to;1. Lower inventory levels2. Reduce the supplier base3. Reduce administrative cost and paperwork4. Provide for timely delivery of material

directly to the user

Part 5: Purchasing Cost Management

Partnership Defined

• A partnership is a tailored business relationship based on mutual trust, openness, shared risk and shared rewards that yields a competitive advantage, resulting in business performance greater than would be achieved by the firms individually

Part 6: Managing Supplier Relationship

Arm’s Length

Vertical Integration

Joint Venture

Type IIIType IIType 1

Partnerships

Types of Partnerships

Part 6: Managing Supplier Relationship

Arm’s Length

• a seller typically offers standard product/ services to a wide range of customer who receive standard terms and conditions

• When the exchanges end, the relationship ends

Type I

• The organization involved recognize each other as partners and on a limited basis coordinate activities and planning.

• The partnership usually has a short term focus and involves only one division or functional area within each organization

Part 6: Managing Supplier Relationship

Type II

• The organizations involved progress beyond coordination of activities to integration of activities

• Although not expected to last “forever”, the partnerships has a long term horizon

• Multiple divisions and functions within the firm are involved in the partnerships

Type III

• The organizations share a significant level of integration• Each party views the other as an extension of their own

firm• Typically no “end date” for the partnerships exists

Part 6: Managing Supplier Relationship

Purchasing is looked upon primarily as a service function which is responsible in questioning the customer needs and forge long-term relationships with suppliers.

a)Describe in your own words the definition and the role of purchasing in the Supply Chain Management (3 marks)

b)Briefly discuss the objectives and the importance of purchasing in total customer satisfaction (6 marks)

c) Describe in your own words the strategic role of purchasing .(6 marks)

Question 1

Purchasing managers may consider a broad range of factors when making purchasing decision such as lead time, on time delivery performance, price competitiveness and post purchase sales support .

a)Briefly discuss the 6 major purchase categories in most companies (6 marks)

b)Describe in your own words the concept of JIT and JIT 2, and why purchasing play a significant role in these concepts. (6 marks)

c) From your opinion, why do you need to evaluate your supplier after establishing relationship? (3 marks)

Question 2

In purchasing process, the most important activity is selecting the best supplier from among a number of suppliers that can provide the needed material .

a)Discuss the 5 phases in the selection and management of purchasing relationships.(9 marks)

b)Describe the importance and examples of the purchase agreement. (3 marks)

c) From your opinion, would you like to practise concurrent engineering in your new established organization with your supplier? State your reason. (3 marks)

Question 3

Strategic planning for purchasing is important to determine whether materials problems or shortages might jeopardize current or future production of new or existing product.

a)Briefly discuss the strategic planning criteria for predicted and unpredicted events. (8 marks)

b)Describe in your own words the concept of forward and speculative buying to identify the differences. (4 marks)

c) From your opinion, would you prefer to practise stockless purchasing in your new established organization? State your reason. (3 marks)

Question 4

Managing supplier relationship is very important in sharing business rewarding elements based mutual trust, openness and shared risk.

a)Briefly discuss the type of partnerships exist in supplier relationship. (7 marks)

b)Describe in your own words how handle price increase requests from suppliers. (5 marks)

c) From your opinion, which cost management strategies would you prefer for your organization? State your reason. (3 marks)

Question 5