Chapter 5: Purchasing Management

Request for Proposal (RFP)

A detailed low-level capabilities evaluation document that is used to precisely determine a supplier's capability and interest in the production of a customized product or service

Request for Quote (RFQ)

A document generally used to solicit bids from interested and qualified suppliers for goods and services that an organization needs to obtain

Return on Assets (ROA) Effect

A high ROA indicates managerial ability generating profits with lower spending * a 10% cost reduction generates a significantly higher Return on Assets than does a 10% sales increase, given the same number/value of assets

Bid

A tender, proposal, or quotation submitted in response to a solicitation (ex: RFP, RFQ) from a contracting authority

Competitive bidding (government+non profit)

A transparent procurement method in which bids from competing suppliers are invited by openly advertising the scope, specifications, and terms and conditions of the proposed contract as well as the criteria by which the bids will be evaluated

Components of TCO: Transaction Costs

Activities carried out as part of the actual buy and sell transaction (Ex: price negotiation, transportation, payment, etc)

Components of TCO: Post- Transaction Costs

Activities carried out following the actual buy and sell transaction (Ex: returns for customers, maintenance, disposal, etc)

Components of TCO: Pre-Transactional Costs:

Activities carried out prior to the actual buy and sell transactions (ex: identifying sources, certifying sources, etc)

International Purchasing service providers

Companies can use service providers which already have the specialized skills and knowledge to deal with international purchasing issues and challenges

Purchase Requisition

Document that defines the need for goods and/or services. An internal document. Does not constitute a contractual relationship with any external party. (paper based or electronic)

Assessing the purchasing function

It is preferable to periodically monitor the purchasing function's performance against set standards, goals, and or industry benchmarks

Small Value Purchase Orders

Processing costs for small value purchases are minimized through: (Credit cards, blanket or open end purchase orders, blank check purchase orders, petty cash, stockless buying or system contracting, standardization and simplification of materials and components, accumulating small orders to create a large order, and using a fixed order interval)

Centralized Purchasing

Purchasing located at a firm's corporate office making all purchasing decisions

Four elements of cost

Quality, Service, Delivery, and Price (QSDP)

Make vs Buy Decision

Quantitative factors: incremental costs of making or purchasing the item, availability of manufacturing facilities, needed resources, and manufacturing capacity. Qualitative factors: are subjective including control over quality, reliability and reputation of the suppliers, and impact on customers and suppliers. * Make vs Buy is a strategic decision

Forward Vertical Integration

Referes to a company acquiring one of their customers (Ex: buying a wholesaler/ distributer to take ownership of that aspect of the supply chain

In-sourcing (aka back sourcing)

Reverting to in-house production when external services do not meet expectations

Import Brokers

agents licensed by the governmental regulatory authority to conduct business on behalf of importers, for a service fee (They take the burden of fulling out important paperwork, and clearing products through customs barriers for importers)

bid bond

debt secured by a bidder for the purpose of providing a guarantee that the successful bidder will accept the contract once awarded. if not, the bond would be forfeited

Sealed bid

document enclosed in a sealed envelope and submitted in response to invitation to bid

Purchase Order

The Buyers offer to the supplier to acquire goods or services. Becomes a legally binding contract only when accepted by the supplier

Purchasing

The action of obtaining merchandise, capital equipment, raw materials, services, or maintenance, repair, and operating (MRO) supplies in exchange for money, or its equivalent. A process of how goods and services are ordered

Supplier Selection

Usually conducted by a cross functional team. Common criteria include: (Product and process technologies, reliability, quality, cost, capacity, service, etc)

Benchmarking

measuring what other businesses do best and matching their performance is an effective approach to improving your supply chain

Supply Management

term that encompasses all acquisition activities beyond the simple purchase transaction. (The identification, acquisition, access, positioning, and management of resources an organization needs or potentially needs in the attainment of its strategic objectives.

Contracting

the acquisition of services

e-Procurement

the automation, through web enabled tools, of the non-strategic and transactional activities that would otherwise consume the majority of a buyers time, including: -Automation provides increased enterprise level visibility of all purchases e-procurement tools typically automate all or part of the following processes (RFI, RFP, RFQ, Execution and analysis, reverse auction capabilities)

Purchasing (cont.)

the function of, and responsibility for, acquiring materials, supplies, and services for an organization. can be a serape department or a part of the supply chain management department

CPO

Chief Procurement Officer which many companies have in their executive leadership team

E-procurement steps

* Can consist of up to 9 steps depending on complexity * at a bare minimum (electronic purchase requisition and/or purchase order, invoice which might include receipt, and payment) * Higher dollar purchases will include: (autorization of the PO, and reconciliation of the invoice)

Benefits of outsourcing

* Concentrate on core capabilities * Reduce staff levels * Accelerate reengineering efforts * Reduce internal management problems * Improve manufacturing flexibility

Rules that often govern government and non-profit procurement

* Federal acquisition streamlining act - removed restrictions on bids less than $100,000. Micro purchases (less than 2500) can be made without bidding * Buy american act - US government purchases and 3rd party purchases using federal funds must buy from US source if the US good is not more than a certain differential above the foreign good * Green purchases - Variety of federal, state, and local initiatives to include environmental and human health considerations when making purchases

Reasons for Buying (or outsourcing)

* Non-Strategic - If its a non strategic item * Cost advantage - Suppliers may provide benefit of economies of scale, especially for non-vital components to operations * Insufficient capacity - a firm at or near capacity * Temporary Capacity Contraints - a concept of "extended workbench" short - term supplements for internal capacity with during time constraints or overloaded work centers. * Lack of expertise - Lack of necessary technology and expertise * Quality - Suppliers have better technology, processes, skilled labor, etc * Multi Sourcing strategy - a strategy using an external supplier in addition to an internal source * Inventory considerations - have the supplier hold inventory of the item or the materials required to produce the item * Brand strategy - take advantage of a supplier's brand image, reputation, popularity, etc

Risks of outsourcing

* Potential loss of control * Increased reliance on suppliers * Increased need for supplier management

Reasons for Making instead of Buying

* Protect Proprietary technology * No competent supplier * Overall lower cost * Better quality control * Use existing idle capacity * Control of lead-time * Control of transportation and warehousing costs

Total cost of ownership factors beyond purchase price, service costs, and life cycle costs

* Quantity discounts - encourages buyers to purchase larger quantities * Cash discounts - offered to prompt payment of invoices * Value added services- such as special delivery, special packaging, preparation of promotional displays, or subassembly operations in a supplier's plant * Administrative expenses - the procurement activity itself - screening of potential suppliers, negotiation, order preparation, and order transmission * Poor supplier Quality- costs related to defective finished goods, scrap, rework, recycling or recovery of materials, related warranty administration and repair costs

International purchasing- Reasons for global sourcing

* The opportunity to improve quality, cost, and delivery performance * To exploit global efficiencies (low cost labor and materials, tax breaks and low trade tariffs) * Respond to insufficient domestic capacity * Achieve access to better process and product technology * A change in domestic business environment * take advantage of reciprocal trade and countertrade arrangements

Advantages of e-procurement system

* Time savings - reduction in time between need, release, and receipt of order * Cost savings - Lower overhead costs in procurement * Accuracy - reduction in errors. Elimination of manual paperwork and handling * Real time - improved communication within company and suppliers * Mobility * Tractability * Management - personnel spend less time on processing of PO's, invoices, with more time on strategic value-adding purchasing activities * Benefit to the suppliers

Purchasing Process Step 5: Purchase Order is created and delivered to the supplier

- (A PO is generated and forwarded to the supplier to inform them of the intent to purchase.) - (The purchase order will identify the items to be procured, the quantity required, the requested delivery date, and the price to be paid. It will also identify the delivery location and any terms and conditions that relate to the order) - ( The PO is the buyers formal offer to the supplier to obtain to items. It becomes a binding contract only when accepted by supplier)

Purchasing Process Step 2: Obtain authorization as necessary

- (A purchase requisition may be routed to an authorized approver depending on the type of material or service being requested and/ or the dollar value of the request) - (Multiple authoritarians, in a prescribed sequence, to various management levels of the org may be necessary if the value exceeds a specific threshold)

Purchasing Process Step 13: Close out the purchase order

- (If the PO has been received complete, and all terms and conditions have been met, then the PO should be closed out in the purchasing system)

Purchasing Process Step 4: Make supplier Selection

- (If the buyer already knows which supplier they will buy the item from, move to the next step) -(If not, a competitive bidding process may be initiated. A RFP or RFQ may be issued to qualified supplier, to identify proposed alternatives for supplying the desired material or service, and to obtain price and availability information.) * (Buyer issues a Request for Proposal for items which have not been previously purchased, or not purchased from a specific supplier being evaluated. Suppliers provide their proposals to supply the items including price and delivery) * Buyer issues a Request for Quotation for routine or repeat purchased items. Suppliers provide a price and delivery quotes on the specific items requested) - (A supplier is selected from the RFP or RFQ bids received based on criteria determined by the buyers. including price, availability, quality, delivery costs, etc.)

Purchasing Process Step 12: Reclamation of Taxes

- (In some situations, the supplier will be obligated to charge a tax, but the buyer may be eligible to retain some or all of the tax based on corporate status )

Purchasing Process Step 11: Payment

- (Invoice payment processed using an appropriate payment method assuming the items received and meets all of the criteria established on the PO)

Purchasing Process Step 3: Identify and evaluate potential suppliers

- (May be determined from a list of company approved suppliers) - (Alternatively, may use a Request for Information, to collect information from potential suppliers on their capabilities and interest in supplying the material or service)

Purchasing Process Step 8: Receipt of Goods

- (Once the items arrive at the designated location, the buyer will typically conduct some form of receipt process where the items are checked to ensure that they conform to the details of the PO, including quality and quantity) - (A confirmation of receipt may also be sent to the supplier)

Purchasing Process Step 9: Invoice

- (Supplier prepares an invoice for the items ordered and transmits to the Buyer. The invoice either accompanies the item or is sent separately)

Purchasing Process Step 10: Reconciliation

- (The invoice may need to be reconciled to the purchase order and the goods receipt before payment is made. Sometimes referred to as a 3- way match.)

Purchasing Process Step 6: Supplier confirmation of the Purchase Order

- (The supplier formally agrees to supply the items per the specifications, terms, and conditions described on the Purchase Order) - (The Purchase Order then becomes a legally binding contract between the buyer and the supplier)

Purchasing Process Step 7: Fulfillment

- (The supplier ships/delivers the items to the buying organization as per the PO)

Purchasing Process Step 1: A need is identified, and a purchase requisition is issued

- (request for goods and services submitted to the procurement/ purchasing organization for action) - (typically initiated by a user within an organization)

Inventory Turnover effect

- Inventory Turnover represents the number of times the company sold through inventory in a given time period. - increased inventory turnovers indicate optimal utilization of space and inventory levels, increased sales, avoidance of inventory obsolesce. - inventory is an asset but it is $ tied up

Total Cost of Ownership (TCO)

- The sum of all the costs associated with every activity in the supply stream of a product. - Purchase price of an item is important, but only one part of the total cost of ownership.

Purchasing contributes to these objectives by:

- actively seeking better materials and reliable suppliers - Working with the expertise of strategic suppliers to improve quality and materials - involving suppliers and purchasing in new product design and development efforts

Advantages of centralized purchasing

- concentrated volume - leveraging purchase volume - avoiding duplication - specialization - lower transportation costs - no competition within units - common supply base

Advantages of decentralized purchasing

- knowledge of local requirements - local sourcing - less bureaucracy

Where e-procurement may not work as well

- procurement of critical items only available through a few suppliers - inventory of an item is very low - procuring an item involves complex negotiations - Potential to lower costs through e-procurement is minimal

Purchasing Process Step 14: Analysis

-(Measurements of the efficiency and accuracy of the procurement process) -( Specific PO data and information captured and used during periodic supplier performance meetings)

Primary goals of purchasing

1. Ensure uninterrupted flows of materials and services at the lowest total cost 2. Improve quality of the finished goods produced 3. Optimize customer satisfaction

Co-sourcing

1. The sharing of a process or function between internal staff and an external provider 2. Using dedicated external staff at a provider working exclusively under your control and direction

Characteristics of world class procurement organizations

1. being a trusted advisor to the business - having high level of involvement in the company's budgeting and planning cycle 2. Driving suppliers to innovate - effective at harnessing the intellectual capital of their suppliers to bring new and innovative solutions to bear 3. providing analytics backed insights - working closely with the business during operations planning and budgeting periods to provide predictive insights on supply markets. 4. Protecting the business from risk - have formal risk management programs that includes completing supplier risk assessments 5. Taking an agile approach to staffing - talent management sets procurement leaders apart from the pack , they provide more training and invest more in retention planning, and they pay higher salaries.

Potential challenges of international purchasing

1. knowledge of international trade policies and procedures 2. awareness and cost of required tariffs and duties 3. Difficulties in communication with suppliers due to language barriers, time zones, holidays. 4. Locating, evaluating, sourcing, and expediting in global markets 5. payments and currency management 6. longer time span for negotiations 7. the potential for cultural, political, and labor problems 8. potentially longer transportation lead times necessitating additional inventory 9. specific and varying documentation requirements 10. Handling legal matters and the process for settling disputes

Purchasing function assessment criteria

1. participating in and leading multifunctional teams 2. participating in value engineering efforts 3. optimize supply base 4. Create ESI initiatives 5. Utilize e-procurement 6. further supplier integration 7. contribute to new product development 8. improve time to market 9. inititate supplier cost reduction programs 10. Creation of strategic alliances

Backward Vertical integration

A company acquiring one or more of their suppliers ( Ex: manufacturer buying a key supplier of a critical material and taking ownership)

Profit Leverage effect

A decrease in purchasing directly increases profits before taxes (assuming no decrease in quality or purchasing total cost) * A 10% cost reduction generates significantly more Profit before Tax than does a 10% Sales increase

Trading Companies

Buy products in one country and sell them in different countries where they have their own distribution networks (They mostly work with high production volume products such as raw materials, chemicals, etc. They may carry a wide variety of goods such as from a catalog)

Decentralized Purchasing

Individual, local purchasing departments, at the plant level, making their purchasing decisions

Competitive bidding

Offer submitted by multiple individuals or firms competing for a contract, privilege, or right to supply specified services or merchandise

Merchants

Wholesalers and retailers who purchase for resale

performance bond

a debt secured by a bidder for the purpose of providing a guarantee that the work will be on time and meet specifications

Import merchants

a person or company engaged in the purchase and sale of imported commodities for profit (they buy and take title to the goods being important and then sell the goods domestically)

Specialized knowledge needed for international purchasing

companies must acquire some specialized knowledge in: * Tariffs - Duties, taxes, or customs imposed by host country for imported or exported goods * Non-tariff barriers - quotas, licensing agreements, embargoes, laws and regulations imposed on imports and exports * Countertrade - trade by exchange of goods rather than by currency

Industrial Buyers

individuals who purchase raw materials for conversion into products, and/or purchase services, capital equipment, and MRO supplies

Payment Bond

is a debt secured by a bidder for the purpose of providing protection against 3rd party liens not fulfilled by bidder

Procurement

the process of selecting and vetting suppliers, negotiating contracts, establishing payment terms, and the actual purchasing of goods and services. Concerned with "acquiring the goods, services, and work vital to the organization"