Chapter 5 - Purchasing Management

Advantages of Decentralization

-Knowledge of local requirements -Local sourcing -Less bureaucracy

Components of the Total Cost of Ownership

1. Pre-Transaction Costs 2. Transaction Costs 3. Post-Transaction Costs

Return on Assets Effect

A 10% cost reduction generates a significantly higher Return on Assets (ROA) than does a 10% sales increase, given the same number/value of assets

International Purchasing - Specialized Knowledge

Companies pursuing international purchasing arrangements must acquire some specialized knowledge >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

TCO

Factors beyond purchase price consider service costs and life cycle costs - Quantity discounts to encourage buyers to purchase larger quantities - Cash discounts offered for 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 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

Inventory Turnover Effect

Inventory is an asset, it is also financial capital tied up and not available for use in other parts of the business -Inventory turnover represents the number of times the company sold through inventory in a given time period > A high turnover ratio is beneficial because the company is generating sales efficiently to sell inventory > A low turnover ratio is unfavorable it means a company is not selling through products efficiently. The company is making/buying too much inventory for demand and end up throwing out expire or unsaleable products

Small Value Purchase Orders

Processing costs for small value purchases are minimized through: -Credit Card/ Corporate Purchasing Card (P-card) -Blanket or Open-End Purchase Orders -Blank Check Purchase Orders -Petty Cash -Stockless Buying or System Contracting -Standardization & Simplification of Materials & Components -Accumulating Small Orders to create a large order -Using a fixed order interval

Centralized Versus Decentralized Purchasing

Purchasing Organization are dependent on factors, such as market conditions and types of materials required Centralized Purchasing- purchasing located at a firm's corporate office making all purchasing decisions Decentralized Purchasing- Individual, local purchasing departments, at the plant level, making their purchasing decisions

Centralized Versus Decentralized Purchasing

Purchasing Organization are dependent on factors, such as market conditions and types of materials required Centralized Purchasing: Purchasing located at a firm's corporate office making all purchasing decisions Decentralized Purchasing: Individual, local purchasing departments, at the plant level, making their purchasing decisions

Forward Vertical Integration

Refers to a company acquiring one of their customers i.e., buying a wholesaler/distributor to take ownership of that aspect of the supply chain

Total Cost of Ownership (TCO)

TCO is 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 -The four elements of cost are: Quality, Service, Delivery, and Price (QSDP)

Supplier Selection

Typically conducted by a cross functional team. Selecting suppliers is complex and based on multiple criteria using evaluation forms or scorecards.

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 - can usually be described as the transactional function of procurement for goods and services -a term in business representing the function of, and resposibility for, acquiring materials, supplies and services for an organization - it can be a separate department or part of the SCM department within a company

e-Procurement may not work well for every type of purchase

-Inventory of an item is very low -Procuring an item involves complex negotiations -Potential to lower costs through e-Procurement is minimal

Post-Transaction Costs

-Returns from Customer -Replacement -Repair Parts & Labor -Maintenance -Disposal of Returned Product (Activities carried out *following* the actual buy and sell transaction)

The Financial Significance of Purchasing

> Profit-Leverage Effect - a decrease in purchasing directly increases profits before taxes > Return on Assets (ROA) Effect - a high ROA indicates managerial ability generating profits with lower spending > Inventory Turnover Effect - increased inventory turnovers indicate optimal utilization of space and inventory levels, increased, sales, avoidance of inventory obsolescence - inventory is an asset but it is $ tied up

Profit-Leverage Effect

A 10% cost reduction generates significantly more Profit Before Tax than does a 10% Sales Increase

Advantages of Centralization

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

Pre-Transaction Costs

-Identifying Sources -Qualifying Sources -Certifying Sources -Supplier Database Update -Training/Education of Supplier (Activities carried out *prior to* the actual buy and sell transaction)

Advantages of e-Procurement

Time savings: reduction in time between need, release and receipt of order Cost savings: lower overhead costs in procurement Accuracy: a reduction in errors. Elimination of manual paperwork and paperwork 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-added purchasing activities Benefits to the suppliers

Procurement

the process of selecting and vetting suppliers, negotiating contracts, establishing payment terms, and the actual purchasing of goods and services - is concerned with acquiring the goods, services and work vital to an organization - is the umbrella term which the action of purchasing can be found

Purchasing Terms

*e-Procurement*: the business-to-business (B2B) purchase and sale of supplies and services over the Internet *Merchants*: wholesalers and retailers who purchase for resale *Industrial Buyers*: indviduals who purchase raw materials for conversion into products, and/or purchase services, capital equipment and MRO supplies *Contracting*: a term often for the acquisition of services *Supply management*: a newer term that encompasses all acquisition activities beyond the simple purchase transaction

Reasons for Buying (Or Outsourcing)

- Non-Strategic: if it is 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 Constraints: a concept of "extended workbench" short-term supplement for internal capacity with during time constraints or overloaded work centers Lack of Expertise: lack of necessary technology and expertise

Transaction Costs

-Price Negotiation -Delivery Confirmation -Purchase Order Administration -Transportation -Delivery/Receiving -Reconciliation -Taxes/Tariffs/Duties -Invoicing/Payment -Incoming Inspection -Rejected Goods Return to Supplier -Close-out (Activities carried out as *part of* the actual buy and sell transaction)

Reasons for Making

-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

Reasons for Buying (continued)

-Quality: suppliers have better technology, process, skilled labor, etc. -Multi Sourcing Strategy: a strategy using an external supplier in addition to an internal source -Brand Strategy: take advantage of a supplier's brand image, reputation, popularity, etc.

Industrial Purchasing Process Steps

1. A need is identified and a Purchase Requisition is issued 2. Obtain authorization as necessary 3. Identify and evaluate potential suppliers 4. Make supplier selection >Competitive bidding process. A RFP or a RFQ may be issued to qualified suppliers. >Buyer issues a RFP for items which have not been previously purchased or not purchased from a specific supplier being evaluated >Buyer issues a RFQ for routine or repeat purchased items 5. Purchase Order is created and delivered to the supplier >The PO is the Buyer's formal offer to the supplier to obtain the item(s) >The PO becomes a binding contract only when accepted by supplier 6. Supplier confirmation of the Purchase Order 7. Fulfillment 8. Receipt of Goods 9. Invoice 10. Reconciliation 11. Payment 12. Reclamation of Taxes 13. Close out the Purchase Order 14. Analysis

International Purchasing - Potential Challenges

1. Knowledge of international trade policies and procedures 2. Awareness and cost of required tariffs and duties 3. Difficulties in communicating with suppliers due to language barriers, varying time zones, holidays 4. Locating evaluating, sourcing and expediting in global markets 5. Payments and currency management

Additional Make versus Buy Concepts

> In-sourcing (also known as back sourcing): Reverting to in-house production when external services do not meet expectations > 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

Backward Vertical Integration

A company acquires one or more of their suppliers i.e., a manufacturer buying a key supplier of a critical material and taking ownership

The Make versus Buy Decision

Deciding whether to produce and item internally or buy it from an outside supplier Make: producing materials or products internally Buy/Outsource: Buying materials and/or components from suppliers instead of making them in-house *Analyze all relevant expenses associated with developing the capability to make a product >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 suppliers (internal or external), and impact on customers and suppliers

Purchasing Terms (continued)

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 interest and qualified suppliers for goods or services that the organization needs to obtain Bid: a tender, proposal, or quotation submitted in response to a solicitation from a contracting authority Competitive Bidding: offers submitted by multiple individuals or firms competing for a contract, privilege, or right to supply specified services or merchandise Purchase Requisition: document that defines the need for goods and/or services. An internal document. Dos not constitute a contractual relationship with an external party. Purchase Order (PO): the Buyer's offer to the supplier to acquire goods or services. Becomes a legally binding contract ONLY when accepted by the supplier

Risks & Benefits of Outsourcing

Risks associate with outsourcing include: -Potential loss of control -Increase reliance on suppliers -Increased need for supplier management Benefits. Outsourcing allows a firm to: -Concentrate on core capabilities -Reduce staffing levels -Accelerate reengineering efforts -Reduce internal management problems -Improve manufacturing flexibility

The Basic Purchasing Process

The purchasing process can vary from one organization to another, but there are some key elements The process usually starts with a demand for a material, component or a service

International Purchasing - Reasons for Global Sourcing

The opportunity to improve quality, cost, and delivery performance -To exploit global efficiencies: >Access to low cost labor and materials >Advantage of 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

The Role of Purchasing in an Organization

The primary goals of purchasing are: 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 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 developmental efforts

e-Procurement

the term used to describe the automation, through web-enabled tools, of the non-strategic and transactional activities that would otherwise consume the majority of a buyer's time including: >Automation provides increased enterprise level visibility of all purchases >e-Procurement tools typically automate all or part of the following processes: -solicitation developmental toos; RFI, RFP, RFQ -execution and analysis -reverse auction capabilities