Supply Chain Management Chapter 5: Procurement and Purchasing

Reasons for Making

-Protect proprietary technology -No competent supplier -Better quality control -Use existing idle capacity -Control of lead-time transportation, and warehousing cost -Overall Lower cost

Skills to Exhibit by Purchasing Professionals

1. Interpersonal *communication* 2. Make *decisions* 3. Work in *teams* 4. *Analytical Skills* 5. *Negotiation Skills* 6. *Customer Focus* 7. Manage *chance* 8. *Persuasion* 9. *Strategic* Skills 10. Understand *business conditions*

3. e-Procurement

B2B purchase and sale of suppliers over the internet

Backward v. Forward Vertical Integration

Backward Vertical Integration - A company acquiring (buying) one or more of their *supplier* ex. a manufacturer buying the key suppliers of a critical material to take ownership of this aspect of the supply chain Forward Vertical Integration - A company acquiring (buying) one or more of their *customers* ex. a manufacturer buying a wholesaler/distributor to take ownership of this aspect of their supply chain

Gov't and NP - Bonds

Bidders are required to furnish a *bond* as an incentive to ensure that the successful bidder will fulfill the contract awarded

In-sourcing v. Co-sourcing

In-sourcing - *reverting* (going back) *to in-house* production when external quality, delivery, and services do not meet expectations Co-sourcing - the *sharing of a process or function* between internal staff and external provider Using dedicated staff at an external provider that works exclusively under your control and direction

Automation provides ___________ of all purchases.

Increased visibility

International Purchasing - Specialized Knowledge

Need to have specialized knowledge on such topics: - *Tariffs* - Duties, taxes, or customs imposed by the host country for imported or exported goods. - *Non-Tariffs* - Quotas, licensing agreements, embargoes, laws, and regulations imposed on imports and exports - *Countertrade* - International trade by exchange of goods rather than by currency

6. Contracting

Often used for the acquisition of services

7. Request for Information (RFI)

Process to collect written information about the capabilities of various suppliers

Financial Significance of Purchasing

Profit-Leverage Effect Return on Assets (ROA) Effect Inventory Turnover Effect

Risk & Benefits of Outsourcing

Risk Associated with Outsourcing: - Potential *loss of control* (overproduction, intellectual properties) - Increased reliance on suppliers -Increased need for supplier management Benefits. Outsourcing allows firms to: - Concentrate on *core capacities* - Reducing staffing levels - Accelerate re engineering efforts - Reduce internal management problems - Improve manufacturing flexibility

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.

4. Merchants

Wholesalers and retailers who *purchase for resale*

Purchasing is the process of how ______________________ from an external third party.

goods and services are ordered

Advantages of Centralized Purchasing

-Concentrated volume -Leveraging purchase volume -Avoid duplication -Specialization -Lower transportation costs -No competition within units -Common supply base

International Purchasing - Challenges

1. Knowledge of *trade policies* 2. *Cost* or tariffs and duties 3. Difficulty in *communication* 4. Locating, evaluating, and *sourcing* in global markets 5. Payment and *currency* 6. *Time Span* negotiation 7. *Cultural, political, and labor* problems 8. *longer transportation* lead times necessitating additional inventory 9. Specific *documentation requirements* 10. *Legal matters*

12 Purchasing Steps

1. Need is Identified, and Purchase Requisition is issued 2. Obtain Authorization 3. Identify and Evaluate Potential Suppliers 4. Make Supplier Selection 5. PO is created and delivered to supplier 6. Supplier *Confirms* PO 7. Fulfillment 8. Receipt of Goods 9. Invoice and Reconciliation 10. Payment 11. Close out PO 12. Analysis

5. Industrial Buyers

Individuals within an organization who purchase raw materials for *conversion* into products, and/or purchase services, capital equipment, and MRO supplies.

4 Elements of TCO

TCO =Q+S+D+P 1. Quality 2. Service 3. Delivery 4. Price

Purchasing is also commonly used in business to represent the _____________ of, and the _______________ for, acquiring materials, supplies, and services for an organization.

(1) Functions (2) Responsibilities

e-Procurement is used to describe the automation, through web-enabled tools, of the ____________ and _______________ activities that would otherwise consume the majority of a buyer's time.

(1) Non-Strategic (2) Transactional

Other factors beyond purchase price include: 1. ___________ Discounts 2. ___________ Discounts 3. ___________ may be offered such as: Special Delivery Special Packaging Preparation of promotional displays Sub assembly operations in a supplier's plant 4. _________ associated with procurement activities itself such as: Screening potential suppliers Negotiation Order Preparation Order Transmission 5. _______________ costs related to defective finished goods must also be considered, such as: Scrap Rework Recycling Recovery of materials Warranty Repair costs

(1) Quantity (2) Cash (3) Value-Added Services (4) Administrative Expenses (5) Poor Supplier Qualities

- The Basic e-Procurement process consists of: 1. An electronic _________________and/or ________________________ 2. An _______________ (which might be one with the receipt) 3. A _______________ - W/ High Dollar Purchases, process includes a. Authorization of the PO b. Reconciliation of the invoice

(1)a. PO (1)b. Receipt of Goods (2) Invoice (3) Payment

Government and Non-Profit Purchasing

*Government* purchases = expenditures made in the private sector by all levels of government *Non-Profit* purchases = expenditures made in the private sector by all levels of non-profit organizations - Gov and NP is different from private industrial purchasing b/c public requires *openness, visibility, and accountability* since it is the *public's money that is being spent*

Factors to Consider for Make v. Buy

*Quantitative* - incremental cost of either making or purchasing the item, such as the availability of manufacturing facilities, needed resources, and manufacturing capacity. *Qualitative* - more subjective, and include control over quality, the reliability, and reputation of the potential suppliers (internal/external), and the impact of the decision on customers and suppliers

Step 1. Need is Identified, and Purchase Requisition is issued

- *Request for goods and services* to be submitted to Procurement/Purchasing organization for action. - Initiated by user within an organization

Step 6. Supplier *Confirms* PO

- *Supplier formally agrees to supply the item(s) per specifications, terms, and conditions described on PO* - PO becomes a *legally binding contract* between the Buyer and Supplier for the item(s) specified -*PO BECOMES A BINDING CONTRACT ONLY WHEN ACCEPTED AND CONFIRMED BY THE SUPPLIER*

Profit-Leverage Effect

- A *decrease* in purchasing expenditures directly *increases* profits before taxes (assuming no decrease in quality or purchasing total cost) - *Bottom line impact $ for $*

Bid bond

- A 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.

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

Payment Bond

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

Competitive Bidding

- A procurement process in which bids from competing suppliers, for *the right to supply* specified materials or services, are requested - Aims at obtaining goods and services at the lowest prices *by stimulating competition and by preventing favoritism* - *Open Competitive Bidding* = Sealed bids are opened in full view of all who may wish to witness the bid opening - *Closed Competitive Bidding* = Sealed bids are opened in presence only of authorized personnel - Competitive bidding does *NOT allow for negotiations*; a contract is awarded to the best/lowest priced responsive and responsible bidder

Gov't and NP Bid

- A proposal or quotation submitted in response to a solicitation from a contracting authority - A sealed bid = enclosed in a sealed envelope and submitted in response to an invitation to bid

2. Purchase Order (PO)

- A*Commercial Document* - The official offer issued by a buyer to a seller to acquire goods or services. - Used to control the purchasing of products and services from external suppliers - Indicates: Types, quantities, Agreed Prices of products and services - Becomes a *LEGALLY BINDING CONTRACT ONLY WHEN ACCEPTED BY SUPPLIER*

Organization of Purchasing

- CPO = Chief Procurement Officer = Executive level - Dependent of market conditions and types of materials required

Institute of Supply Management (ISM)

- Defines Supply Management = "Identification, acquisition, access, positioning, and management of resources an organization needs, or potentially needs, in the attainment of its strategic objectives" - *Includes the function of determining the materials and services that a company needs*

1. Purchase Requisition

- Document that defines the need for goods and/or services - *Internal* document - Does *NOT* constitute a contractual relationship with external party - Generated by user department, to notify purchasing personnel of items to order, quantity, and timeframe - Also contains authorization to proceed with purchase.

Inventory Turnover Effect

- Increased inventory turnovers indicate optimal utilization of space and inventory levels, increased sales, avoidance of inventory obsolesce - Inventory is an asset but it is also financial *capital tied up* and not available for use in other parts of business - Inventory turnover represents the number of times the company *sold through inventory in a given time period* - COGS / Avg. Inventory = Inventory Turnover - High turnover ratio = *beneficial* b/c it means the company is generating sales efficiently to sell inventory - Low turnover ratio = *unfavorable* b/c it means the company is not selling efficiently. Company is likely buying or making too much inventory for demand, and may end up throwing away unsaleable products.

Step 3. Identify and Evaluate Potential Suppliers

- May be determined from a list of *approved suppliers* - RFI may be used to collect info from potential suppliers on their supplying capabilities - Buyers can skip to this step if they already know which supplier they will buy from

Step 12. Analysis

- Measurements of *efficiency and accuracies* of the procurement process - Specific PO data and information captured and used during periodic supplier performance meetings

Benchmarking

- Measuring what other businesses do best, and matching their performance to improve own supply chain - Obtained data formally and informally

Step 8. Receipt of Goods

- Once Buyers received items, Buyers will conduct a form of *receipt process* where the items are checked to ensure they conform to the details of the PO, including quality and quantity - Confirmation receipt may be sent to Supplier

International Purchasing - For Global Sourcing

- Opportunity to improve *cost, quality, and delivery* performance - To exploit global *efficiencies* - To respond to insufficient domestic capacities - To achieve access to better process and product technology - Due to a change in the domestic business environment - To take advantage of reciprocal trade and counter trade arrangement

Step 10. Payment

- Payment processed using an appropriate payment method assuming the item(s) is received and *meets all of the criteria* of the PO

Assessing and Improving the Purchasing Function

- Periodic Monitor the purchasing function's performance against set standards, goals, and industry benchmarks - Surveys or audits can be administered as self -assessments among purchasing staff as part of the annual evaluation process

Step 2. Obtain Authorization

- 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 authorizations may be necessary when value exceeds threshold

e-Procurement tools typically automate all or part of the following processes:

- Solicitation (Asking to obtain supplies) tools such as RFI, RFP, RFQ - Execution and analysis - Reverse auction capabilities

Step 9. Invoice and Reconciliation

- Supplier provides an invoice for the items ordered - Invoice either accompanies the items or is sent separately to the buyer - The *invoice may need to be reconciled to the PO and goods receipt before payment is made.* (3-way Match) (i.e., Invoice, PO, and Goods Receipt must match)

Step 4. Make Supplier Selection

- Suppliers under go a *competitive bidding process* - Initiated through RFP or RFQ - Issue RFP for items buyer have not previously purchased before, or not purchased by certain supplier - Suppliers provide proposal to supply items, including price and delivery - Issue RFQ for routine/repeat purchased items - Suppliers provide price and delivery options on quotes - A supplier is selected from RFQ and RFP bids received based on criteria determined by the buyer, including price, availability, quality, delivery, costs, etc.

Step 7. Fulfillment

- The Supplier *delivers the items* to the buying organization as per the PO

Procurement

- The process of selecting and vetting suppliers, negotiating contracts, establishing payment terms, and the actual purchasing of goods and services. - Overarching or "umbrella" term within which the action of purchasing can be found.

Step 5. PO is created and delivered to supplier

- To inform the supplier of the *intent to purchase* - To identify the item(s) to be procured, quantity required, the requested delivery date(s), the price to be paid, delivery location, and any terms and conditions that relate to the order. - *PO is the Buyer's formal offer to the supplier to obtain the item(s)*

Make v. Buy Decision

- the act of deciding whether to produce an item internally (make) or buy item from an outside supplier (buy) - A *strategic* decision

Total Cost of Ownership (TCO)

- the sum of all the costs associated with every activity in the supply stream of a product - Procurement professionals recognize that although the *purchase price* of an item remains very important, it is *only one part of the total cost of ownership*

Advantages of Decentralized Purchasing

-Knowledge of local requirements -Local sourcing -Less bureaucracy

Reasons for Buying

-Non-strategic -Cost advantage -Insufficient capacity -Temporary capacity constraints - the concept of *"extended work bench"* which involves short-term supplementing internal capacity with external capacity during time of constraint or overloaded work centers -Lack of expertise -Quality -Multi-sourcing strategy -Inventory considerations - Opting to have the *supplier hold inventory* of the time or materials required to produce the item. -Brand strategy

Components of TCO

-Pre-transaction costs - Activities carried out *prior to* the actual buy and sell transaction Ex. Identify sources, Quantifying sources, Certifying sources, Supplier Database update, Training/Education of suppliers -Transaction costs - Activities carried out *part of* the actual buy and sell transaction Ex. Price Negotiations, Delivery Confirmation, PO administration, Transportation, Delivery/receiving, Reconciliation, Taxes/Tariffs/Duties, Invoicing/Payment, Incoming inspection**, Rejected goods return to suppliers, Close-Out -Post-transaction costs - Activities carried out *following* the actual buy and sell transaction Ex. Returns from customer, replacement, repair parts and labor, maintenance, disposal of returned product

Purchasing Contributes to these Objectives by:

1. Actively seeking reliable suppliers 2. Working with the *expertise* of strategic suppliers to improve quality and materials 3. Involving suppliers and purchasing personnel in new product design and development efforts.

3 Primary Objectives of Purchasing

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

Assessment Criteria includes:

1. Participating in and leading multi functional teams 2. Participating in value engineering efforts 3. Optimize supply base 4. ESI initiatives 5. e-Procurement 6. Further supplier integration 7. Contribute to new product development 8. Improve time to market 9. Initiate supplier cost reduction programs 10. Creation of strategic alliances

Purchasing Terms

1. Purchase Requisition 2. Purchase Order 3. e-Procurement 4. Merchants 5. Industrial Buyers 6. Contracting 7. Request for Information (RFI) 8. Request for Proposal (RFP) 9. Request for Quote (RFQ)

8. Request for Proposal (RFP)

A detailed capabilities document used to determine a supplier's *capability and interest* in the production of a product or service.

9. Request for Quote (RFQ)

A document used to solicit (obtain) bids from *interested and qualified suppliers* for goods or services that the organization needs to obtain.

Return on Assets (ROA) Effect

A high ROA indicates managerial prowess in generating profits with lower spending

Supply Management

A newer term that *encompasses all acquisition activities* beyond the simple purchase transaction.

3 parts of Procurement

A. Purchasing Management (Chapter 5) B. Strategic Sourcing (Chapter 6) C. Supplier Relationship Management (Chapter 7)

Buy/Outsource

Buying materials, components, or products from a supplier(s) instead of, or in addition to, making them in-house (i.e., buying from a 3rd party external source)

Centralized v. Decentralized Purchasing

Centralized - Purchasing department is a the firm's corporate office, makes all purchasing decisions Decentralized - Individual, local purchasing departments, such as plant level, making their own purchasing decisions

International Purchasing - Service Providers

Companies can hire *Service Providers* who already have the specialized skills and knowledge necessary to deal with international purchasing issues and challenges Some include: *Import Brokers* - Agents licensed by governmental regulatory authority to conduct business on behalf of importers, for a service fee. - they take the burden of filling out import paperwork, and clearing products through customs barriers for importers. *Import Merchant* - A person/company engaged in the purchase and sale of imported commodities for profit - they buy and take title to the goods being imported and then sell the goods domestically *Trading Company* - Buy products in one country and sell them in different countries where they have their own distribution network - they mostly work with high production volume products such as raw materials, chemicals etc. May carry a variety of goods

Step 11. Close out PO

PO closed when: - All terms and conditions have been met - PO is received and complete

Make

Producing (i.e., manufacturing) materials or products internally (i.e., operations owned by the company)

Order of Purchasing Terms

Purchase Requisition --> Purchase Order (PO) --> Supplier Confirmation of PO

Advantages of e-Procurement

a. *Time Saving* - A reduction in time between the need recognition and the release and receipt of an order b. *Cost Saving* - Lower overhead costs in the purchase area c.*Accuracy* - A reduction of errors. Virtual elimination of manual paperwork d. *Real Time* - Improved communication both within company and with suppliers e. *Management* - Purchasing personnel spend less time on processing of PO and invoices, and more time on strategic value-added purchasing activities. f. *Mobility* - Access virtually anywhere g. *Trackability* - Real-time status tracking h.*Benefits to the Supplier*

Procurement is concerned with acquiring all the _______________ that is vital to an organization

goods, services, and work