Purchasing mangement - Puchasing Process - Make Or Buy Decisions - Supplier Selection

SUPPLY CHAIN
MANAGEMENT
Purchasing Management

Purchasing:
Purchasing department in any organization assist with the
identification, selection and acquisition of required materials
and services.
Accomplish this as economically as possible, within acceptable
standards of quality and service.
“Purchasing profession can be defined as the act of obtaining
merchandise; equipment; raw materials; services; or
maintenance, repair and operating (MRO) supplies in exchange
for money or its equivalent”.
INTRODUCTION

Can classified into two categories:
Merchants and Industrial Buyers
Merchant Buyers: Wholesalers and retailers who purchase for resale.
Industrial Buyers: Purchase raw materials for conversion, services,
capital equipment and Operating supplies.
An effective and efficient purchasing system is crucial for
competitive success of a business
INTRODUCTION

The primary goals of purchasing are:
1. Ensure uninterrupted flows of raw materials 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 materials and reliable suppliers.
• Work closely with strategic suppliers to improve quality materials.
• Involving suppliers and purchasing personnel in new product design
and development efforts.
“Purchasing is the crucial link between the sources of supply and the
organization”
THE ROLE OF PURCHASING IN AN
ORGANIZATION

The traditional purchasing process is a manual, paper-based
system.
However, with the improvement of information technology,
personal computers, local area networks and the Internet,
many companies are moving toward a more automated,
electronic-based system.
The goal of a proper purchasing system is to ensure the
efficient transmission of information from the users to the
purchasing personnel and ultimately to the suppliers
THE PURCHASING PROCESS

Manual Purchasing: Older system, prone to duplication
of effort and error.
Step 1 Material Requisition/ Purchase Requisition: The
product, quantity and delivery due date are clearly described
on the material requisition.
Step 2 The Request for Quotation (RFQ): Buyer identifies
suppliers and issues a request for quotation.
Step 3 The Purchase Order: The purchase order is the
buyer's offer and becomes a binding contract when accepted
by suppliers.
THE PURCHASING PROCESS

With advancement in E-commerce sector finding and buying suitable products and
suppliers have become much easier.
Step 1 Material user inputs a materials requisition: Relevant information such as
quantity and date needed.
Step 2 Materials requisition submitted to buyer: At purchasing department (Hard
or Soft Copy)
Step 3: Buyer reviews closed bids and select a supplier
ELECTRONIC PROCUREMENT
SYSTEMS (E-PROCUREMENT)

Advantages of the e-Procurement system:
Time savings: E-procurement is more efficient when (a) selecting and maintaining
a list of potential suppliers, (b) processing requests for quotation and purchase
orders and (c) making repeat purchases.
Cost savings: Buyers can handle more purchases and the manual task of matching
bids to purchase requisitions is reduced.
Accuracy: The system eliminates double-key inputs—once by the materials users
and then once again by the buyers. The system also enhances the accuracy of
communications between buyers and suppliers.
Real time: Buyers have real-time access to the purchase requisition once it is
prepared. Once the purchase requisition is processed, the buyer can post the bid
instantly,

Mobility: The buyer can submit, process and check the status of bids, as well as
communicate with suppliers regardless of the buyer’s geographical location and
time of day.
Trackability: It allows submitters and buyers to track each purchase requisition
electronically through the process—from submission, to approval and finally
conversion to a purchase order.
Management: The system can be designed to store important supplier information,
including whether suppliers are minority or locally owned, thus allowing the buyers
to support such businesses. Summary statistics and supplier performance reports
can be generated for management to review and utilize for future planning.
Benefits to the suppliers: Benefits include lower barriers to entry and transaction
costs, access to more buyers and the ability to instantly adjust to market conditions,
thus making e-procurement attractive to most suppliers.

Outsourcing refer to buying materials or components from suppliers instead of
making them in-house.
Backward vertical integration refers to acquiring upstream suppliers.
Forward vertical integration refers to acquiring downstream customers.
“Make or buy materials or components is a strategic decision that can impact an
organization’s competitive position”
For example, Honda Motor would not outsource the making of its engines because it
considers engines to be a vital part of its automobiles’ performance and reputation.
However, Honda may outsource the production of brake drums to a high-quality,
low-cost supplier that specializes in brake drums.
SOURCING DECISIONS: THE MAKE-OR-
BUY DECISION

Reasons for Buying or Outsourcing
Cost advantage:
• Cost is an important reason for outsourcing.
• Specially components that are non vital to the organization’s operations and
competitive advantage.
• In most outsourcing cases, the quantity needed is so small that it does not justify
the investment in capital equipment to make the item.
• Some foreign suppliers may also offer a cost advantage because of lower labor
and/or materials costs.
Insufficient capacity:
• A firm may be running at or near capacity, making it unable to produce the
components in-house.
• This can happen when demand grows faster than anticipated or when expansion
strategies fail to meet demand.
• The firm buys parts or components to free up capacity in the short term to focus
on vital operations.
BUY DECISION

Reasons for Buying or Outsourcing
Lack of expertise:
• The firm may not have the necessary technology and expertise to manufacture
the item.
• Maintaining long-term technological and economical viability for noncore activities
may be affecting the firm’s ability to focus on core competencies.
Quality:
• Purchased components may be superior in quality because suppliers have better
technologies, processes and skilled labor.
• Suppliers’ superior quality may help firms stay on top of product and process
technologies, especially in high-technology industries with rapid innovation and
short product life cycles.
BUY DECISION

Reasons for Making
Protect patented technology:
• A firm may have developed equipment, product or processes that need to be
protected for the sake of competitive advantage.
• An advantage of not revealing the technology is to be able to surprise
competitors and bring new products to market first, allowing the firm to charge a
price premium.
No competent supplier:
• If suppliers do not have the technology or capability to produce a component.
• The firm may use supplier development strategies to work with a new or existing
supplier to produce the component in the future as a long-term strategy.
BUY DECISION

Reasons for Making
Better quality control:
• If the firm is capable, the make option allows direct control over the design,
manufacturing process, labor and other inputs to ensure that high-quality.
• May have better technologies and processes to produce better-quality
components.
Use existing idle capacity:
• A short-term solution for a firm with excess idle capacity is to use the excess
capacity to make some of its components.
• This strategy is valuable for firms that produce seasonal products.
• It avoids layoff of skilled workers and, when business picks up, the capacity is
readily available to meet demand
BUY DECISION

Reasons for Making
Control of lead-time, transportation and warehousing cost:
• The make option provides better control of lead-time and logistical costs since
management controls all phases of the design, manufacturing and delivery
processes.
• Although raw materials may have to be transported, finished goods can be
produced near the point of use, for instance, to minimize holding cost.
Lower Cost:
• If technology, capacity and managerial and labor skills are available, the make
option may be more economical if large quantities of the component are needed
on a continuing basis.
BUY DECISION

SUPPLY CHAIN
MANAGEMENT
Chapter 2
Purchasing Management

The current sourcing trend is to buy equipment, materials and services
unless self manufacture provides a major benefit such as protecting
proprietary technologies, achieving superior characteristics, or
ensuring suitable supplies.
Break-even analysis is a handy tool for computing the cost-effectiveness
of sourcing decisions when cost is the most important criterion.
Several assumptions underlie the analysis:
1. All costs involved can be classified under either fixed or variable
cost.
2. Fixed cost remains the same within the range of analysis.
3. A linear variable cost relationship exists.
4. Fixed cost of the make option is higher because of initial capital
investment in equipment.
5. Variable cost of the buy option is higher because of supplier profits.
MAKE-OR-BUY BREAK-EVEN ANALYSIS

Consider a hypothetical situation in which a firm has the option to make
or buy a part. Its annual requirement is 15,000 units. A supplier is able to
supply the part at $7 per unit. The firm estimates that it costs $500 to
prepare the contract with the supplier. To make the part, the firm must
invest $25,000 in equipment and the firm estimates that it costs $5 per
unit to make the part.

Supply base refers to the list of suppliers that a firm uses to
understand the strategic role of suppliers.
Firms emphasize long-term strategic supplier alliances by
reducing the variety of purchased items and consolidating
volume into one or fewer suppliers, resulting in a smaller
supply base.
An effective supply base that contributes to a firm’s
competitive advantage is critical to its success.
So its important to understand vital role of supplier
ROLES OF SUPPLY BASE

1. Product and process technology and expertise to support the buyer’s
operations, particularly in new product design and value analysis.
2. Information on the latest trends in materials, processes or designs.
3. Information on the supply market, such as shortages, price increases
or political situations that may threaten supplies of vital materials.
4. Capacity for meeting unexpected demand.
5. Cost efficiency due to economies of scale, since the supplier is likely
to produce the same item for multiple buyers, acquire its materials,
services, supplies and equipment.
ROLES OF SUPPLY BASE

The decision to select a supplier for office supplies or other noncritical
materials is likely to be an easy one.
However, the process of selecting a group of competent suppliers for
important materials, which can potentially impact the firm’s competitive
advantage, is a complex one and should be based on multiple criteria.
1. Process and product technologies: Suppliers should have
capable process technologies to produce superior products at a
reasonable cost.
2. Willingness to share technologies and information: It is vital that
firms seek suppliers that are willing to share their technologies and
information. Suppliers can assist in new product design and
development so buyer can focus more attention on core
competencies.
3. Quality: Product quality should be high and consistent since it can
directly affect the quality of the finished goods
SUPPLIER SELECTION

4. Cost: Unit price of the material is not typically the sole standard in
supplier selection, total cost of ownership is an important factor.
Total cost of ownership or total cost of acquisition includes
• the unit price of the material,
• payment terms,
• cash discount,
• ordering cost,
• carrying cost,
• logistical costs,
• maintenance costs and other more qualitative costs that may not
be easy to measure.
5. Reliability: Besides reliable quality level, reliability refers to other
supplier characteristics. For example, is the supplier financially
stable? Otherwise, it may not be able to invest in research and
development or stay in business. Is the supplier’s delivery lead time
reliable? Otherwise, production may have to be interrupted due to a
shortage of material.
SUPPLIER SELECTION

6. Order system and cycle time: Placing orders with a supplier should
be easy, quick and effective. Delivery lead time should be short, so small
lot sizes can be ordered on a frequent basis to reduce inventory holding
costs.
7. Capacity: The firm should also consider whether the supplier has the
capacity to fill orders to meet requirements and the ability to fill large
orders if needed.
8. Communication capability: Suppliers should also possess a
communication capability that facilitates communication between the
parties.
SUPPLIER SELECTION

9. Location: Geographical location is another important factor in supplier
selection, as it impacts delivery lead-time, transportation and logistical
costs. Some firms require their suppliers to be located within a certain
distance from their facilities.
10. Service: Suppliers must be able to back up their products by providing
good services when needed. For example, when product information or
warranty service is needed, suppliers must respond on a timely basis.
SUPPLIER SELECTION

The issue of how many suppliers to use for each purchased
item is a complex one.
While numerous references propose the use of a single
source for core materials and supplies to facilitate cooperative
buyer–supplier partnerships, single sourcing can be a very
risky proposition.
By increasing reliance on one supplier, the firm increases its
risk that poor supplier performance will result in plant
shutdowns or poor quality finished products.
HOW MANY SUPPLIERS TO USE

Reasons Favoring a Single Supplier
1. To establish a good relationship: Using a single supplier makes it
easier for the firm to establish a mutually beneficial strategic alliance
with the supplier, especially when the firm can benefit from the
supplier’s technologies and capabilities.
2. Less quality variability: Since the same technologies and processes
are used to produce the parts, variability in the quality is less.
3. Lower cost: Buying from a single source helps in lowering the
purchase cost per unit. Single sourcing also avoids duplicate fixed
costs, especially if the part requires special tooling or expensive
setups.

4. Transportation economies: Because single sourcing concentrates
volume, the firm can take advantage of truckload (TL) shipments, which
are cheaper per unit than the less-than-truckload (LTL) rate.
5. Exclusive product or process purchases: If it is a exclusive product
or process, or if the supplier holds the patents to the product or process,
the firm has no choice but to buy from the sole source.
6. Volume too small to split: If the requirement is too small, it is not
worthwhile to split the order among many suppliers. Single sourcing is a
good approach for acquiring supplies and services that do not contribute
to the firm’s core competencies.

Reasons Favoring Multiple Suppliers
1. Need capacity: When demand exceeds the capacity of a single
supplier, the firm has no choice but to use multiple sources.
2. Spread the risk of supply interruption: Multiple sources spread the
risk of supply interruptions due to a strike, quality problem, political
instability and other supplier problems.
3. Create competition: Using multiple sources encourages competition
among suppliers in terms of price and quality. While modern supplier
management philosophy opposes the use of multiple sources simply
to create competition, this may still be the preferred approach for
sourcing non-vital items that do not affect the firm’s competitive
advantage.

4. Information: Multiple suppliers usually have more information about
market conditions, new product developments and new process
technologies. This is particularly important if the product has a short
product life cycle.
5. Dealing with special kinds of businesses: The firms, particularly
government contractors, may need to give portions of their purchases to
small, local or women or minority-owned businesses, either voluntarily or
as required by law.
The number of suppliers to use for one type of purchase has changed
from the traditional multiple suppliers to the use of fewer reliable suppliers
and even to the extent of using single supplier. Relationships between
buyers and suppliers traditionally were short-term, adversarial and based
primarily on cost, resulting in mutual lack of trust. Buyer–supplier
relationships, particularly in integrated supply chain settings, have evolved
today into trusting, cooperative and mutually beneficial long-term
relationships. Firms today reduce their supply base to only the best
suppliers.

Tradition has changed from multiple suppliers to fewer
reliable suppliers and even to the extent of using single
supplier.
Relationships between buyers and suppliers traditionally were
short-term, confrontational and based primarily on cost,
resulting in mutual lack of trust.
Buyer–supplier relationships, particularly in integrated supply
chain settings, have evolved today into trusting, cooperative
and mutually beneficial long-term relationships.
Firms today reduce their supply base to only the best
suppliers.

Responsibilities of the purchasing function of firms changed from a clerical
to corporate strategy that directly affects the competitiveness of the firms.
In addition to the actual buying process, purchasing is now involved in
product design, production decisions and other aspects of a firm’s
operations.
Purchasing structure can be viewed as a scale, with centralization at one
extreme and decentralization at the other.
Centralized purchasing is where a single purchasing department, usually
located at the firm’s corporate office, makes all the purchasing decisions,
including order quantity, pricing policy, contracting, negotiations and
supplier selection and evaluation.
Decentralized purchasing is where individual, local purchasing
departments, such as at the plant level, make their own purchasing
decisions.
PURCHASING ORGANIZATION

Advantages of Centralization:
1. Concentrated volume: An obvious benefit is the concentration of
purchase volume to create quantity discounts, less-costly volume
shipments and other more favorable purchase terms.
2. Avoid duplication: Centralized purchasing eliminates the duplication.
A corporate buyer can research and issue a large purchase order to
cover the same material requested by all units, thus eliminating
duplication of activities.
3. Specialization: Centralization allows buyers to specialize in a
particular group of items. It allows buyers to spend more time and
resources to research materials for which they are responsible, thus
becoming specialized buyers.
4. Lower transportation costs: Centralization allows to take advantage
of truckload shipments. Smaller shipments still can be arranged for
delivery directly from suppliers to the points of use.

Advantages of Centralization:
5. No competition within units: Under the decentralized system, when
different units purchase the same material, a situation may be created
in which units are competing among themselves, especially when rare
materials are purchased from the same supplier. Centralization
minimizes this problem.
6. Common supply base: A common supply base is used, thus making
it easier to manage and to negotiate contracts.

Advantages of Decentralization:
1. Closer knowledge of requirements: A buyer at the individual unit is
more likely to know its exact needs better than a central buyer at the
home office.
2. Local sourcing: If the firm desires to support local businesses, it is
more likely that a local buyer will know more about local suppliers.
The proximity of local suppliers allows materials to be shipped more
frequently in small lot sizes, and is conducive to the creation of closer
supplier relationships.
3. Less bureaucracy: Decentralization allows quicker response, due to
less bureaucracy and closer contact between the user and the buyer.
Coordination and communication with operations and other divisions
are more efficient.

REASONS TO GLOBALIZE
1. Find Better Raw Material
2. Reduce Costs (labour, taxes, tariffs, etc.)
3. Improve Operations
4. Understand Markets
5. Improve Products
6. Attract and Retain Global Talent

POTENTIAL CHALLENGES FOR
GLOBAL SOURCING
Global sourcing has surged due to factors like
improvement of communication and transportation
technologies, the reduction of international trade
barriers and deregulation of the transportation
industry.
However, global sourcing poses additional challenges like
• Dealing with duties, tariffs, custom clearance.
• Currency exchange and political, cultural.
• Labor and legal problems.
• Costs involved in identifying, selecting and evaluating
foreign suppliers can be expansive.

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