CHAPTER 7 Purchasing Video on Supplier Quality Assurance https://www.youtube.com/watch?v=rcV JHbDvpV0 • •7:18 •Overview of quality management with Suppliers. •Key terms: quality, conformance, measurement, improvement 2 Purchasing Considered “the process of buying” Purchasing department has major responsibility for locating suitable sources of supply and for negotiating prices Requires input from ▪ Marketing ▪ Engineering ▪ Manufacturing ▪ Manufacturing Planning and Control • What materials to order • When to order them 3 Purchasing and Profit Leverage • On average 50% of sales revenue by manufacturing companies used for ▪ Raw materials ▪ Components ▪ Supplies • This gives the purchasing function tremendous potential to increase profits 4 Income Statement Sales $100 Cost of Goods Sold Purchases $50 Other expenses $40 Profit Before Tax 90 $ 10 Assume a profit before tax of 10% 5 Income Statement (With Sales Increase) Sales $110 Cost of Goods Sold Purchases $55 Other expenses $44 Profit Before Tax 99 $ 11 To increase profits by $1, sales must increase by 10% 6 Income Statement (With Reduced Purchase Cost) Sales Cost of Goods Sold Purchases Other expenses Profit Before Tax $100 $49 $40 89 $ 11 To increase profits by $1, decrease costs by 2% • A 10% increase in sales has the same impact on profits as a 2% decrease in the purchase cost • Leverage effect is 5:1 7 Objectives of Purchasing • Obtain goods and services ▪ Of the required quantity and quality ▪ At the lowest possible cost ▪ Ensure best possible service and delivery ▪ Develop and maintain good supplier relations ▪ Select products and suppliers that minimize the impact on the environment 8 Purchasing Functions To satisfy purchasing objectives, some basic functions must be performed such as, • Determining purchasing specifications ▪ Right quality ▪ Right quantity ▪ Right time (delivery) ▪ Right place (delivery) • Selecting supplier ▪ Right source ▪ Negotiating terms and conditions (right price) ▪ Issuing and administration of PO’s and agreements 9 Outsourcing As the process of “…having suppliers provide goods and services that were previously provided internally.” APICS Dictionary 14th edition • Company concentrating on core competencies 10 Outsourcing • Shift from working with inside staff (operations) to working with outside suppliers • Emphasis on contracts • Services as well ▪ Cafeteria ▪ Cleaning ▪ Maintenance ▪ Information Technology ▪ Finance Better, faster, cheaper 11 Offshoring It is one method of outsourcing • Special type of outsourcing • Outsourcing to a company in a different country • Internet and efficient shipping can make attractive • Availability of educated offshore workforce • Multimodal supply chains 12 Purchasing Cycle Consists of following steps: 1. Receive and analyze purchase requisitions 2. Select suppliers, issue quotations 3. Determine the right price 4. Issue purchase orders 5. Follow up to ensure correct delivery 6. Receive and accept the goods 7. Approve invoice for payment 13 1.Receiving and Analyzing Requisitions • From planners (MRP system) and all other users • Purchasing will ▪ Identify originator, account number, approvals ▪ Check material specifications ▪ Verify quantity and unit of measure ▪ Verify delivery date and place ▪ Ensure all supplemental information 14 2. Selecting Suppliers • Often from a list of approved suppliers • Input from engineering and design 15 2.Requesting Quotations • Written inquiries sent to enough suppliers (RFQ) ▪ To ensure competitive and reliable quotes are received • Quotes are analyzed for ▪ Price ▪ Total cost ▪ Compliance to specification ▪ Terms and conditions of sale ▪ Delivery ▪ Payment terms 16 3. Determining the Right Price • Not always the lowest • May involve negotiations • Responsibility of the Purchasing Department 17 4.Issuing a Purchase Order • Legal document • Forms a contract with the supplier upon acceptance • Copies to • Supplier • Originator • Accounting • Receiving • Purchasing file 18 5.Follow-up and Delivery • Ensure on-time delivery • Negotiate any changes • Take corrective action ▪ Expedite as required ▪ Find alternative sources of supply ▪ Work with suppliers to resolve problems ▪ Reschedule production 19 6.Receiving and Accepting Goods • Receiving inspects goods for correct quantity and any damage • Accepts goods and generates a receiving report ▪ Send to quality for further inspection ▪ Hold goods damaged in transit • Copies to Accounting, Purchasing 20 7.Approving Invoice for Payment • 3-way match ▪ Original Purchase Order ▪ Receiving Report ▪ Invoice • Price including discounts • Quantity • Send approval to Accounts Payable 21 When Establishing Specifications Several factors must be taken into consideration: • Quantity requirements • Price requirements • Functional requirements Purchasing can help to make the “best buy” 22 Quantity Requirements • Small volume ▪ Find a standard item • Large volume ▪ Design for economies of scale ▪ Reduce cost ▪ Satisfy functional needs 23 Price Requirements • Represents economic value buyer puts on the item. If the item (finished product) is to be sold at a low price, the manufacturer (buyer) will not want to pay a high price for a component part. • The economic value placed on the item (finished product) must relate to the: • use of the item (finished product) • anticipated selling price of the finished product 24 Functional Requirements • What the item is expected to do • Set by the end user ▪ Performance expectations ▪ Aesthetic expectations • Example: functional specifications for a car ▪ Run reliably? ▪ Make you look cool? ▪ Safety? ▪ Fuel efficiency? 25 Functional Specifications and Quality Functional specifications are closely tied to the quality of a product or service. There are 4 phases to providing user satisfaction: • Quality and product planning ▪ Meeting the expectations of the marketplace • Quality and product design ▪ Determining the specifications • Quality and manufacturing ▪ Meeting the specifications • Quality and use ▪ Satisfying customer expectations 26 Value Analysis “the systematic use of techniques that identify a required function, establish a value for that function, and finally provide that function at the lowest overall cost.” APICS Dictionary 14th edition 27 Functional Specification Description Can be described by a combination of the following ways: 1. Brand 2. Physical and chemical specifications ▪ Material and method of manufacturing ▪ Performance 3. Engineering drawings 4. Miscellaneous methods 28 Description by Brand • Items are patented or the process is secret • Special supplier expertise • Small quantity ▪ Not worth the effort of developing specifications • Preferred by ▪ Customers ▪ Buyer 29 Description by Brand • Reputation of the supplier ▪ Guarantees / warranties • Limits competition ▪ Higher price ▪ Easy to inspect • Product liability is the responsibility of seller 30 Description by Specification • Physical and chemical specifications ▪ Buyer-defined • Material and method of manufacture ▪ Environmental issues • Performance specifications ▪ State what the item is supposed to do ▪ Uses supplier expertise 31 Characteristics of Specifications • Carefully designed • Too loose - May not provide a satisfactory product • Too detailed – Costly to develop and may limit suppliers • Should allow for multiple sources • Provide standard for performance • Can be difficult to do, e.g., colors • May be more expensive than standard products • Used when volume is sufficient to warrant costs 32 Standard Specifications • Set by government and nongovernmental agencies ▪ Examples - SAE 10W30 motor oil, Underwriters Laboratories (UL), ASME steel standards • Widely known and accepted • Lower in price • Adaptable to customers needs • Market grades ▪ Describe many aspects of a product ▪ Example - Eggs: Grade A small, medium or large 33 Engineering Drawings • Detailed description of parts ▪ Finishes ▪ Tolerances ▪ Materials used ▪ No other way to describe the item • Expensive to produce • Can be used for inspection 34 Miscellaneous Attributes • Samples are used • Colors / patterns to be specified • Combination of methods ▪ Example: specifying curtains • Drawing of the window dimensions • Fire or safety rating • Type of material to use • Samples of pattern desired 35 Selecting Suppliers • The right supplier ▪ Can supply the quality needed ▪ Has the capacity to deliver the quantity needed and on time (JIT deliveries) ▪ Makes a profit, but at a good price ▪ Contributes to the improvement of product 36 Sourcing • Sole sourcing • Only one supplier is available because of Patents, technical specs, raw material, location • Multiple sourcing ▪ Use of more than one supplier for an item ▪ Competition results in lower price, better service ▪ Continuity of supply • Single sourcing ▪ Decision to select one supplier ▪ Long-term partnership 37 Factors in Selecting Suppliers 1. Technical ability 2. Manufacturing capability 3. Reliability 4. After-sales service 5. Location 6. Lean capabilities 7. Other considerations 8. Price 38 1.Technical Ability • Do they have the technical capability? • Is there a program of product development and improvement? • Can they assist in improving your product? • Their products become part of your product 39 2.Manufacturing Capability • Can they consistently meet the specifications and quality desired? ▪ Quality control programs ▪ Competent personnel • Do they have good manufacturing planning and control systems? ▪ To supply information on delivery 40 3.Reliability • Reputable • Stable • Financially strong 41 4.After-Sales Service • Service organization • Supply of spare parts • Technical support 42 5.Supplier Location • Location may affect delivery time • Local inventories • May be required for after-sales service ▪ Will your customers require service? 43 6.Lean Capabilities • • • • Accurate, on-time deliveries Value relationship Work in partnership to remove waste Information and delivery systems in place for quick shipments 44 7.Other Considerations • Credit terms • Reciprocal business • Health and safety record • Willingness to hold inventory 45 8.Price • Not always the lowest • May include other services • Price considerations ▪ Landed cost – price plus handling and delivery ▪ Total cost of ownership issues 46 Type of Relationship between Supplier and Buyer • Ongoing relationship with mutual dependency • Supplier can depend on future business • Buyer can be ▪ Assured supply of quality products ▪ Technical support ▪ Product improvements ▪ Problem solving 47 Identifying Suppliers • • • • • • Salespersons of supplier company Internet Catalogues Trade magazines Trade directories Information obtained by salespeople 48 Supplier Selection Factors Things that must be considered as part of what we will be buying Weights The relative importance of each of the factors Rating How well each supplier compares on each factor Ranking The weight times the rating 49 Supplier Ranking 1. Select the factors 2. Assign a weight to each factor 3. Rate the suppliers for each factor 4. Rank each supplier Multiply the weight by the rate for each factor 50 Supplier Ranking Figure 7.1 Supplier rating 51 Supplier Ranking • Includes the input of many people • Includes many factors • Narrows the choice by eliminating lowest scores ▪ Previous example shows two main contenders 52 Price Determination • Direct influence on company’s profit • 50% of cost of goods sold (COGS) • Best price would include the best mixture of ▪ Function ▪ Quantity ▪ Service ▪ Price “You get what you pay for” 53 Basis for Pricing • Fair price ▪ Competitive ▪ Gives seller a profit ▪ Allows buyer to make a profit • Upper limit (market decides) ▪ Established by buyers • Lower limit (seller decides) ▪ Established by sellers 54 Analyzing Costs • Fixed Costs ▪ Costs incurred no matter the volume of sales • Equipment • Insurance • Overhead • Variable Costs ▪ Costs which vary with the volume produced • Direct labor • Direct materials 55 Analyzing Costs Total cost = fixed cost + (variable cost/unit)(volume) Unit cost = total cost volume = fixed cost volume + variable cost per unit 56 Break-Even Point • The volume of sales where total revenue equals total costs • A seller must have sufficient volume to make a profit • Knowing the seller’s break even point is useful in negotiations ▪ Increased volume may lower price paid 57 Break-Even Analysis 58 Break Even Point -example Fixed Cost = $5,000 Variable Cost = $6.50 / unit Selling Price = $15 per unit Average cost for 1000? Average Cost = $5,000 ÷ 1000 + $6.50 = $11.50 per unit To find the Break-even Point Let X = Number of Units $15X = $5,000 + $6.50X $8.50X = $5,000 X = 588.2 units The volume must exceed 588.2 units to make a profit 59 Price Negotiation • Buyer needs knowledge of seller’s costs • Buyer must have sufficient clout • Should benefit both supplier and buyer • Savings must justify the time and effort required 60 Negotiations - Type of Product • Commodities ▪ Price is determined by the market ▪ Concern for future contracts • Standard products ▪ Price set by catalogue listings ▪ Little room for negotiation • Small value items ▪ Try to reduce ordering costs or increase volume • Made-to-order items (negotiation possible) ▪ Quotations from a number of sources 61 Impact of MRP on Purchasing Purchasing - two categories of activity • Procurement ▪ Establishing specifications, selecting suppliers, determining price, negotiations • Supplier scheduling and follow-up ▪ Same as production activity control ▪ Execute the master schedule and the MRP ▪ Ensure good use of resources, minimize WIP, provided the desired level of customer service 62 Planner/Buyer Concept • Production activity control ▪ Controls the flow of work through the plant ▪ Schedules need for components • Purchasing ▪ Coordinates the flow of goods from suppliers Plans are going to change! 63 Planner/Buyer Concept • Responsibility of planning and buying • Works with the Master Scheduler and other Planner/Buyers • Handles fewer components • Smoother flow of information ▪ Knowledge of factory needs ▪ Matches material requirements with supplier capabilities 64 Planner/Buyer Responsibilities • Determining material requirements • Developing schedules • Issuing shop orders • Issuing material releases to suppliers • Establishing delivery priorities • Controlling orders in the factory and to suppliers • Handling all activities associated with buying and production scheduling • Maintaining close contact with suppliers 65 Contract Buying • Long term contract with a supplier for small volume items ▪ Authorize releases against the contract when goods are needed • Supplier may be given a copy of the material requirements plan • Requires close coordination • Works best with planner/buyer concept 66 Supplier Responsiveness and Reliability • Material requirements often change • Suppliers must be able to react to change • Flexibility ▪ In volume ▪ In products needed • Reliable ▪ In delivery promises 67 Close Relationship with Suppliers • Supplier flexibility and reliability • The need to understand each others capabilities and constraints • Cooperation and teamwork • Very frequent communications • Between the buyer/planner and the supplier’s production planner 68 Electronic Data Interchange (EDI) • Electronic exchange of information between customers and suppliers ▪ Purchase orders ▪ Invoices ▪ Material requirements plans • Reduces time involved • Avoids costly paperwork 69 Vendor-Managed Inventory • Supplier maintains an inventory of certain items at the customer’s plant • Customer only pays for the inventory when it is actually used • Usually for standard, small value items ▪ Fasteners ▪ Electrical components 70 The Internet • Internet ▪ Open public access to posted information ▪ Valuable source of supplier and product information • Intranet ▪ Internal to company personnel only • Extranet ▪ Between participating companies 71 Environmentally Responsible Purchasing • Why the Purchasing Department? • First-hand knowledge of price trends for waste products • Contact with salespeople (excellent source of information as to possible uses of waste material) • Familiarity with company’s needs or uses for material within the organization • Knowledge of legislation for transportation and handling of environmentally-sensitive materials 72 Environmentally Responsible Purchasing • The 3 R’s ▪ Reduce ▪ Reuse ▪ Recycle 73 Reduce The most important of the 3R’s • Purchasing’s contact with suppliers of new ‘green products’ ▪ Water based cleaners ▪ Low VOC paints (volatile organic compound) ▪ Lead free solder • Contact with suppliers ▪ Returnable containers ▪ Lean operations (reduce waste) 74 Reuse • Reprocessing of scrap • Packaging materials • Sale of by-products 75 Recycle The least effective of the 3R’s • Suppliers are often a good source of disposal / refund • Empty containers • Regrind plastics 76 Purchasing and the Supply Chain With ERP and SCM software, information exchange have become easier. Allowed companies to expand their planning and control perspectives to include upstream (suppliers) and downstream (distributors and customers) entities. This has led to management of • Flow of physical materials • Flow of money • Flow of information • Flow of materials back to the company - Reverse logistics 77 Purchasing and the Supply Chain • Customer relationship management (CRM) • Build and maintain strong customer base • Supplier relationship management (SRM) ▪ Build and maintain close, long-term relationships with key supplies One critical reason for developing formal links and relationships in the supply chain is to help control: • Bullwhip effect ▪Growing fluctuations of uncertainty and material demands through each node of the supply chain 78 Bullwhip Effect Figure 7.3. Bullwhip effect 79 Supply Chain Management Organizational Implications • Total cost focus ▪ Not just price ▪ Includes transportation, storage, handling ▪ Value stream mapping ▪ Mutual value analysis with suppliers ▪ Cross-functional teams for decision-making ▪ Centralized vs. decentralized purchasing ▪ Mutually advantageous supplier negotiations 80 Supply Chain Management Organizational Implications • Information sharing ▪ Costs ▪ Schedules ▪ Inventory levels • Measurement systems ▪ All aspects of the supply chain • Growth in electronic business (Internet) • Consideration of environment for acquisition, storage, use and disposal of materials 81 Supply Chain Management Savings • More effective product specifications • Leveraging through volume discounts and supplier consolidation • Lower costs through long-term contracts and efficient communications • Lower payment costs ▪ Credit cards ▪ Electronic commerce ▪ Blanket orders ▪ Reduced environmental costs 82 Bullwhip Effect https://www.youtube.com/watch?v=2nl mkTYZG5s •5:30 minutes •Fast and thorough description of the Bullwhip effect. (graphics, lecture) •Key terms: Supply chain, bullwhip, inventory, quality. 83 Purchasing https://www.youtube.com/watch?v=eB_1Z6oC5Z U 10:11 minutes This video explains the role and importance of purchasing and supply management and how it changed into a driver of business success. The scope of purchasing is discussed as well as different definitions ranging from ordering, buying to value chain management. 84
