Chapter 2 – Purchasing
Management
Chapter 2 Learning Objectives
You should be able to:
Understand the role of supply management and its strategic impact on an organization’s
competitive advantage
Understand the traditional purchasing process, e-procurement, public procurement and green
purchasing
Understand and know how to handle small value purchase orders
Understand sourcing decisions and the factors impacting supplier selection
A Brief History Of Purchasing Terms
Purchasing – Obtaining merchandise, capital equipment; raw
materials, services, or maintenance, repair, and operating (MRO)
supplies in exchange for money or its equivalent
Merchants – Wholesalers and retailers who purchase for resale
Industrial Buyers – Purchase raw materials for conversion,
services, capital equipment, & MRO supplies
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A Brief History Of Purchasing Terms
Purchasing - key business function for acquiring materials, services, &
equipment
Contracting - term often used for the acquisition of services
Supply Management - a newer term to describe the expanded set of
responsibilities of purchasing professionals
◦ Institute of Supply management defined supply management as the “Identification, acquisition,
access, positioning, and management of resources an organization needs or potentially needs in
the attainment of its strategic objectives.”
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The Role of Supply Management in an
Organization
The primary goals of purchasing are:
◦
◦
◦
Ensure uninterrupted flows of raw materials at the lowest total cost,
Improve quality of the finished goods produced, and
Maximize customer satisfaction.
Purchasing contributes to these objectives by:
◦
◦
◦
Actively seeking better materials and reliable suppliers,
Work closely with and exploiting the expertise of strategic suppliers to improve quality and
materials
Involving suppliers and purchasing personnel in new product design and development
efforts.
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The Role of Supply Management in an
Organization (Continued)
The Financial Significance of Supply Management
Profit-Leverage Effect
A decrease in purchasing expenditures directly increases profits before taxes
(assuming no decrease in quality or purchasing total cost)
Return on Assets (ROA) Effect
A high ROA indicates managerial prowess in generating profits with lower
spending (caveat- ROA ratios vary from one industry to another)
Inventory Turnover Effect
Increased inventory turnovers indicate optimal utilization of space and
inventory levels, increased sales, avoidance of inventory obsolesce
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The Purchasing Process – Manual Purchasing
Suppliers
Purchasing
Storage/Warehouse
Users/Requisition
Accounting
START
Materials
Requisition
MR 1
Materials
Requisition
MR 1
Materials
Available?
No
MR 2
MR 2
MR 3
Yes
Issue PO
Purchase
Order
PO 1
Materials
Requisition
MR 1
Purchase
Order
PO 1
PO 2
MR 2
PO 2
PO 3
MR File
PO 4
Accounting
Information
for charging the
appropriate
department
MR 2
Issue
Materials
Materials
+
DO 3
DO 2
Delivery
Order
DO 1
PO File
PO 3
MR File
DO 2
MR 2
Ship
Materials
+
DO 2
PO 2
Delivery
Order
DO 1
INV 2
Invoice
INV 1
MR 2
Materials
Materials
+
Accounts Payable
PO 2
Delivery
Order
DO 1
Invoice
INV 1
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The Purchasing Process – e-Procurement
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 (hardcopy or electronically).
Step 3- Buyer assigns qualified suppliers to bid –
Product description, closing date, & conditions are given.
Step 4- Buyer reviews closed bids & selects a supplier
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General E-Procurement Process
The Purchasing Process –eProcurement
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The Purchasing Process –eProcurement
(Continued)
Advantages of the e-Procurement System
◦ Time savings
◦ Cost savings
◦ Accuracy
◦ Real time
◦ Mobility
◦ Trackability
◦ Management
◦ Benefits to the suppliers
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Small Value Purchase
Orders
Processing costs for small value purchases are minimized through:
◦ Procurement Credit Card/Corporate Purchasing Card (P-card)
◦ Blanket or Open-End Purchase Orders
◦ Blank Check Purchase Orders
◦ Stockless Buying or System Contracting
◦ Petty Cash
◦ Standardization & Simplification of Materials & Components
◦ Accumulating Small Orders to Create a Large Order
◦ Using a Fixed Order Interval
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Sourcing Decisions – The Make or
Buy Decision
Outsourcing –
Buying materials and components from suppliers instead of making them in-house. The
trend has moved toward outsourcing.
Backward vertical integration –
Refers to acquiring sources of supply
Forward vertical integration –
Refers to acquiring customer’s operations.
The Make or Buy decision is a strategic decision
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Sourcing Decisions – The Make or
Buy Decision
(Continued)
Reasons for Buying or Outsourcing
◦ Cost advantage –
◦ Especially for components that are non-vital to the organization’s operations, suppliers may have economies of scale
◦ Insufficient capacity –
◦ A firm may be at or near capacity and subcontracting from a supplier may make better sense
◦ Lack of expertise –
◦ Firm may not have the necessary technology and expertise
◦ Quality –
◦ Suppliers have better technology, process, skilled labor, and the advantage of economy of scale
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Sourcing Decisions – The Make or
Buy Decision
(Continued)
Reasons for Making
◦ Protect proprietary technology
◦ No competent supplier
◦ Better quality control
◦ Use existing idle capacity
◦ Control of lead-time transportation, and warehousing cost
◦ Lower cost
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Roles of Supply Base
Supply Base - list of suppliers that a firm uses to acquire its materials,
services, supplies, and equipment
◦ Firms emphasize long-term strategic supplier alliances consolidating volume into
one or fewer suppliers, resulting in a smaller supply base
Preferred suppliers provide:
◦ Product and process technology and espertise to support buyer’s
operations, particularly new product development and value analysis
◦ Information on latest trends in materials, processes, or designs
◦ Information on the supply market
◦ Capacity for meeting unexpected demand
◦ Cost efficiency due to economies of scale
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Supplier Selection
The process of selecting suppliers, is complex and
should be based on multiple criteria:
Product and process technologies
Willingness to share technologies & information
 Early supplier involvement (ESI)
Quality
Reliability
Cost
 Total cost of ownership or acquisition
Order system & cycle time
Capacity
Communication capability
Location
Service
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How Many Suppliers to Use
Single-source - a risky proposition. Current trends favor fewer sources.
Reasons Favoring a Single Supplier
To establish a good relationship
Less quality variability
Lower cost
Transportation economies
Proprietary product or process
Volume too small to split
Reasons Favoring Multiple Suppliers
Need capacity
Spread risk of supply interruption
Create competition
Information
Dealing with special kinds of business
Case Snapshot – John
Deere & Company
Supply Chain Cost Reduction Challenges: Deere and Company has a diverse product range, which
includes a mix of heavy machinery for the consumer market, and industrial equipment, which is made
to order. Retail activity is extremely seasonal, with the majority of sales occurring between March and
July.
The Path to Cost Reduction: The company undertook a supply chain network-redesign program,
resulting in the commissioning of intermediate “merge centers” and optimization of cross-dock
terminal locations.
Deere & Company also began consolidating shipments and using break-bulk terminals during the
seasonal peak. The company also increased its use of third-party logistics providers and effectively
created a network that could be optimized tactically at any given point in time.
Supply Chain Cost Management Results: Deere & Company’s supply chain cost-management
achievements included an inventory decrease of $1 billion, a significant reduction in customer
delivery lead times (from ten days to five or less) and annual transportation cost savings of around
5%.
Distribution Network Design
Video link
Purchasing – Centralized vs.
Decentralized
Purchasing Organization is dependent on many factors, such as market conditions & types of
materials required
◦ Centralized Purchasing - purchasing department located at the firm’s corporate office
makes all the purchasing decisions
◦ Decentralized Purchasing - individual, local purchasing departments, such as plant level,
make their own purchasing decisions
Purchasing – Centralized vs.
Decentralized
(Continued)
Advantages Centralization






Concentrated volumeAvoid duplication
Specialization
Lower transportation costs
No competition within units
Common supply base
Advantages Decentralization
 Closer knowledge of
requirements
 Local sourcing
 Less bureaucracy
Purchasing – Centralized vs.
Decentralized
(Continued)
A hybrid purchasing organization
Decentralized-centralized (large multiunit org)- decentralized
corporate and centralized at business unit
Centralized-decentralized (large org w/centralized control)
centralized large national contracts at corporate level and
decentralized items specific to business unit
Global Sourcing Terms
Import Broker – Sales agent who performs transactions for a fee (They do not take title to the
goods)
Import Merchant – Buys and takes title to the goods and resells them to a buyer
Tariff – An official schedule showing the duties, taxes, or customs imposed by the host country on
imports or exports
Non-tariff barriers – import quotas, licensing agreements, embargoes, laws and other
regulations imposed on imports and exports
International Purchasing/Global
Sourcing
Reasons for Global Sourcing –
Opportunity to improve quality, cost, and delivery performance
Potential Challenges –
Requires additional skills and knowledge to deal with international suppliers, logistics,
communication, political environment, and other issues
International Purchasing/Global
Sourcing (Continued)
Countertrade – goods and/or services of domestic firms
are exchanged for goods and/or services of equal value
or in combination with currency from foreign firms
Counter trade can include
Barter - complete exchange of goods or services of equal
value without the exchange of currency
Offset - exchange agreement for industrial goods or
services as a condition of military-related export
International Purchasing/Global
Sourcing (Continued)
Counter trade can include
Direct Offset - involves coproduction, or a joint venture and exchange of related goods or
services
Indirect Offset - involves exchange of goods or services unrelated to the initial purchase.
Counterpurchase - the original exporter agrees to sell goods or services to a foreign importer
and simultaneously agrees to buy specific goods or services from the foreign importer
Procurement for Government &
Non-Profit Agencies
Public Procurement or Public Purchasing – purchasing & supply function for
government & non-profit sector.
Public Procurement is characterized by:
 Competitive bidding - contract is usually awarded to lowest priced responsive & responsible bidder
◦ Sealed Bids are used to satisfy the Invitation for Bid (IFB) and are opened in public display
 Bid Bonds - incentive to fulfill contract
 Bid or Surety Bonds - successful bidder will accept contract
 Performance Bonds - work will be on time and meet specifications
 Payment Bonds - protection against 3rd party liens not fulfilled by bidder
Procurement for Government &
Non-Profit Agencies
(Continued)
Rules that often govern Government & Non-Profit Procurement:
Federal Acquisition Streamlining Act (1994) –
Removed restrictions on bids less than $100,000. Micro purchases (less than $2,500) can
be made without bidding
Buy American Act (1933) –
US government purchases and 3rd party purchases using federal funds must buy 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
Supply Chain in E-Commerce
Do you know what Dropshipping is?
Questions?
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