Chapter 10

5. Purchasing Manager's Index (PMI)

- Diffusion Index >50=Growth; <50=Contraction

• Fixed costs

- Generally remain the same regardless of the number of units of products or services produced

• Contract Cancellation

- Happens, frowned upon, negotiate terms

Responsible bidder

Fully capable and willing to perform the work Submits a bid that conforms to the invitation for bid.

Trade discounts:

Granted by a manufacturer to a particular type of distributor or user.

Bid (or surety) bond

Guarantees that if the bidder wins it will accept the purchase contract; if the supplier refuses, the extra costs to the buyer of going to an alternative source are borne by the insurer.

Indirect costs

Incurred in the operation of a production plant or process, but normally cannot be related directly to any given unit of production.

Semivariable costs:

May vary with the number of units produced but are partly variable and partly fixed.

Sherman Antitrust Act of 1890

States that any combination, conspiracy, or collusion with the intent of restricting trade in interstate commerce is illegal.

The Robinson-Patman Act basically requires that suppliers:

must sell the same item, in the same quantity, to all customers at the same price. The Robison-Patman Act of 1936 is also known as the Federal Anti-Price Discrimination or the "one-price law." It stipulates that a supplier must sell the same item, in the same quantity, to all customers at the same price. There are specific exceptions such as quantity discounts.)

• Semivariable costs

- Vary with the number of units of products or services produced but are partly variable and partly fixed

7. Other

- custom-ordered items and materials that are special to the organization's product line

• Bidders must be qualified to

- make the item according to the buyer's specifications - deliver it by the date required

Cumulative discount:

Varies in proportion to the quantity purchased over a period of time not on the size of any one order.

3. Government Data

- BEA, WSJ, Producer Price Index (PPI) etc.

4. Cost-plus-incentive-fee (CPIF)

- Both buyer and seller agree on a target cost figure, a fixed fee, and a formula under which any cost over- or underruns are shared • Incentivizes supplier efficiency

• Direct costs

- Can be specifically and accurately assigned to a given unit of production of a product or service - Most direct costs are "variable"

2. Commodity Exchanges

- Chicago, London, etc.

Most Favored Nation(customer)

- Clause specifying firm X will always get lowest price

2. Cost-plus-fixed-fee (CPFF)

- If the item is experimental and the specifications are not firm, or if future costs cannot be predicted - Buyer to reimburse supplier for all reasonable costs incurred (under a set of definite policies under which "reasonable" is determined) in doing the job or producing the required item or service, plus a specified dollar amount of profit - A maximum amount may be specified for the cost

5. Services

- Includes many types of services, such as advertising, auditing, consulting, architectural design, legal, insurance, personnel travel, copying, security, and waste removal - Negotiation is commonly used - Size and volume can be effectively used as leverage

• Indirect costs

- Incurred in the operation of a production plant or service process, but normally cannot be related directly to any given unit of production of a product or service - Often referred to as "overhead"

6. Resale

- Items formerly manufactured in-house but now outsourced - Items sold in the retail sector (clothing sold in general-line department stores; food in supermarkets; tools in hardware stores; and tires, batteries, and accessories in gasoline/filling stations)

4. Capital Assets

- Long-term assets - Not bought or sold in the regular course of business - Have an ongoing effect on operations - Have an expected use of more than one year - Involve large sums of money, generally depreciated - Tangible (land, buildings, and equipment) or intangible (patents, copyrights, ideas, knowledge) - Long-term assets that are not bought or sold in the regular course of business, have an ongoing effect on the organization's operations, have an expected use of more than one year, involve large sums of money, and generally are depreciated - May be tangible (e.g., land, buildings, and equipment) or intangible (e.g., goodwill)

3. Maintenance, repair and operating (MRO) supplies and small-value purchases (SVPs)

- MRO items do not become part of the end product - Items of small comparative value - Consolidation of suppliers is beneficial - Procurement cards used here - Spot-Checking is used - Try to reduce order cost

• Difference between Cost & Price?

- Needs to be a good balance so suppliers don't get put out of business and lessen the suppliers in the market giving them more power and making it harde

3. Cost-no-fee (CNF)

- Only costs are reimbursed - Buyer must persuade supplier that there will be enough subsidiary benefits from doing a particular job • New equipment, contracts, etc.

• Cost approach

- Price is set greater than direct costs, allowing for sufficient contribution to cover indirect costs and overhead, and leaving a margin for profit

1. Firm-fixed-price (FFP)

- Price not subject to change, under any circumstances - Hard long term, worse for service providers

• Variable costs

- Vary directly and proportionally with the units of products or services produced

1. Creditworthiness

- Moody's, S&P, Fitch

A cash discount of 1/15, N/30 (1 percent cash discount if payment is made in 15 days, with the gross amount due in 30 days) is the equivalent of what approximate interest rate?

24. If the buying company does not pay within the 15-day discount period but instead pays 15 days later, the effective cost for the use of that money for the 15 days is 1 percent (the lost discount). Because there are approximately 24 15-day periods in a year, 1% × 24 = 24%, the effective annual interest rate.)

Firm bidding

A policy of notifying suppliers that original bids must be final and revisions will not be permitted under any circumstances.

Most-Favored-Customer clause:

A price protection clause (sometimes referred to as a "most-favored-nation clause") specifies that the supplier, over the duration of the contract, will not offer a lower price to other buyers, or if a lower price is offered to others, it will apply to this contract as well.

Hedging

A simultaneous purchase and sale in two different markets which are assumed to operate so that a loss in one will be offset by an equal gain in the other.

Commodity exchanges:

An organized commodity exchange provides an established marketplace where the forces of supply and demand may operate freely as buyers and sellers carry on their trading.

Quantity discount:

Applies to particular quantities and varies roughly in proportion to the amount purchased.

Cost-Plus-Incentive-Fee (CPIF:) contract:

Both buyer and seller agree on a target cost figure, a fixed fee, and a formula under which any cost over- or underruns are shared.

Direct costs:

Can be specifically and accurately assigned to a given unit of production, for example, direct material is 10 pounds of steel or direct labor is 30 minutes of a person's time on a machine or assembly line.

Resale:

Can be subdivided into two groups (1) items that formerly were manufactured in-house but have been outsourced to a manufacturing supplier, and (2) items sold in the retail sector, such as clothing sold in general-line department stores and food sold through supermarkets.

• Robinson-Patman Act

Supplier must sell same item, at same quantity, to all customers at the same price

Cost-Plus-Fixed-Fee (CPFF) contract:

The buyer agrees to reimburse the supplier for all reasonable costs incurred (under a set of definite policies under which "reasonable" is determined) in doing the job or producing the required item, plus a specified dollar amount of profit.

Forward buying

The commitment of purchases in anticipation of future requirements beyond current lead times.

Fair price

The lowest price that ensures a continuous supply of the proper quality where and when needed and returns a reasonable profit to the supplier.

Firm-Fixed-Price (FFP) contract:

The price set is not subject to change, under any circumstances.

The lowest price that ensures a continuous supply of the proper quality where and when needed and allows the supplier to make a reasonable profit, is commonly known as:

a fair price. Fairness implies benefits to both (all) parties. For the buyer, a fair price motivates the seller to provide the right goods or services (quality) in the right quantity to the right time and place at the right service level. For the seller, a fair price means that in return for meeting the buyer's requirements, the seller's costs are covered and a reasonable profit is generated.)

The fairest possible means of treating all suppliers alike in a competitive bidding situation is to:

establish a policy of firm bidding. Feedback: (Competitive bidding, if executed correctly, is the best way to create a level playing field for all bidders. The goal is to avoid introducing bias or prejudice into the process. The best way to do this is to require firm bidding which disallows revisions to the bid.)

Buyers typically prefer a:

firm-fixed-price (FFP) contract. (A firm-fixed price contract is perceived as a zero risk deal for the buyer from a cost perspective. All of the other types mean that elements of cost can change.)

Items for which prices are comparatively stable and likely to be quoted on a list-price-less-discounts basis are called:

standard production items Standard production items are a range of items commonly obtainable from multiple sources. Changes in price do occur, but they are moderate and far less frequent than with raw materials. Prices usually are obtained from online or hard-copy catalogs or similar publications of suppliers, supplemented by periodic discount sheets.)

Hedging is a way to:

try to minimize price and exchange risks. Hedging is a form of insurance. Commodity exchanges provide a manufacturer an opportunity to offset transactions, and thus to protect, to some extent, against price and exchange risks.)

Substitutability

• Ability of an alternative product to act as a "substitute" for a similar good • Enables "The Market Approach" to cost

Competitive Bidding Requirements

• Bidders must be qualified to - make the item according to the buyer's specifications - deliver it by the date required • Bidders must be sufficiently reliable in other respects to warrant serious consideration as suppliers • Enough qualified bidders to ensure a competitive price • No more bidders than necessary for competition

Relational Pricing

• Most Favored Nation(customer) • Escalator Clause • Contract Cancellation

Market Approach to Pricing

• Prices are set in Market and may not be directly related to Cost

Escalator Clause

- Provides for increase decrease or both if prices change in way party cannot control • Pegged to index - Bureau of Labor Statistics, Material/Commodity Indices

4. Expert data

- Sales reps, other buyers, - make sure they're trustworthy

2. Parts, components, and packaging

- nuts and bolts, valves and tubing; prices are fairly stable and quoted on a basis of "list price with some discount" - Fasteners, many forms of commercial steel, valves, and tubing, whose prices are fairly stable and are quoted on a basis of "list price with some discount - Quoted on "list-less-certain-discounts" - Price changes are moderate and far less frequent than raw mats - Prices obtained from online or hard-copy catalogs

1. Raw and semiprocessed materials

- sensitive commodities, such as copper, wheat, and crude petroleum, and steel and cement - Price can be easily determined because so readily bought and sold on well know - Published market quotes are higher than should be - Price trend is very important for this group of purchases - "careful and studious timing" to get best price

Four Contract Pricing Options

1. Firm-fixed-price (FFP) 2. Cost-plus-fixed-fee (CPFF) 3. Cost-no-fee (CNF) 4. Cost-plus-incentive-fee (CPIF)

• Conditions required for hedging in commodity market:

1. Future trading allowed 2. Close correlation between "basis" and other grades 3. Reasonable (but not necessarily consistent) correlation between "spot" and "future" prices

Commodity Exchanges

1. Products capable of reasonably accurate grading 2. Enough buyers and sellers that no one can influence market • Some allow Hedging - Opportunity to offset transaction (to some extent) against price & exchange risks • Via simultaneous buying

Seven Types of Purchases

1. Raw and semiprocessed materials 2. Parts, components, and packaging 3. Maintenance, repair and operating (MRO) supplies and small-value purchases (SVPs) 4. Capital Assets 5. Services 6. Resale 7. Other

Multiple discount:

For example, 10, 10, and 10 means that for an item listed at $100, the actual price to be paid by the purchaser is ($100 - 10%) - 10%($100 - 10%) - 10%[($100 - 10%) - 10%($100 - 10%)] = $100 - $10 - $9 - $8.10 = $72.90. The 10, 10, and 10 is, therefore, equivalent to a discount of 27.1%.

Fixed costs

Generally remain the same regardless of the number of units produced.

Performance bond:

Guarantees work will be done according to specifications and in the time specified. If another supplier does rework or completes the order, purchasing is indemnified for these extra costs.

Cost-No-Fee (CNF) contract:

If the buyer can argue persuasively that there will be enough subsidiary benefits to the supplier from doing a particular job, then the supplier may be willing to do it provided only the costs are reimbursed.

Price protection clause:

In a long-term contract for raw materials or other key purchased items with one or more suppliers, the buyer may want to keep open the option of taking advantage of a lower price offered by a different supplier.

Special items:

Includes custom-ordered items and materials that are special to the organization's product line.

Small value items

Includes items of small comparative value such as maintenance, repair, and operating (MRO) supplies.

Services:

Includes many types of acquisitions from intangible to a combination of intangible with a tangible component; includes advertising, auditing, consulting, architectural design, legal, insurance, personnel travel, copying, security, and waste removal

Standard production items:

Includes nuts and bolts, many forms of commercial steel, valves, and tubing, whose prices are fairly stable and are quoted on a basis of "list price with some discount."

Raw materials:

Includes sensitive commodities, such as copper, wheat, and crude petroleum, but also steel, cement, and so forth.

Capital goods:

Long-term tangible or intangible assets that are not bought or sold in the regular course of business, have an ongoing effect on the organization's operations, have an expected use of more than one year, involve large sums of money, and generally are depreciated.

Sherman Anti-Trust Act

Outlaws price collusion, conspiracy, etc.

Cash discount:

Price discount offered for early payment; for example, a 2/10 net 30 cash discount means a discount of 2 percent if payment is made within 10 days, with the gross amount due in 30 days. This is the equivalent of earning an annual interest rate of approximately 36 percent.

Payment bond:

Protects the buyer against liens that might be granted to suppliers of material and labor to the bidder, in the event the bidder does not make proper payment to its suppliers.

Escalator clause:

Provides for either an increase or decrease, or both, in price if costs change

Robinson-Patman Act (Federal Anti-price Discrimination Act of 1936):

States that a supplier must sell the same item, in the same quantity, to all customers at the same price.

Public purchasers are required to award contracts to the lowest "responsible" and "responsive" bidder. This means the bidder is:

fully capable and willing to perform the work and submits a bid that conforms to the invitation for bid. (By definition, a responsible bidder is fully capable and willing to perform the work; a responsive bidder submits a bid that conforms to the invitation for bid.)

Costs incurred in the operation of a production plant or process, are called:

indirect costs Feedback: (Indirect costs or overhead normally cannot be related directly to any given unit of production. Some examples are rent, property, taxes, machine depreciation, expenses of general supervisors, data processing, power, heat, and light. They may be fixed or variable.)

The cost approach to pricing:

means prices are set to cover direct costs, contribute to indirect, and attain a profit. Feedback: (The cost approach to pricing is cost-based, that is price is derived from the cost structure of the good or service. Price, then, is a certain amount over direct costs, allowing for sufficient contribution to cover indirect costs and overhead and leaving a certain margin for profit.)

Legislation against price discrimination

• Sherman Anti-Trust Act • Robinson-Patman Act

What is a Fair Price?

• The lowest price that ensures a continuous supply of the proper quality where and when needed - Implies continuous supplier profitability

Conditions for Competitive Bidding

• There must be at least two, and preferably more, qualified bidders • The suppliers must want the business - a "buyer's market" - Specifications must be clear • No collusion between bidders