Purchasing
Chapter Objectives
Be able to:
Make a strong case for why purchasing is a
critical part of a firm’s supply chain strategy.
Identify and describe the various steps of the
purchasing process, and discuss how this
process will vary according to the type of good
or service being purchased.
Explain why spend analysis is important and
perform a simple spend analysis.
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 2
Introduction
• Why Purchasing is Critical
• The Purchasing Process
• Spend Analysis
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 3
Focus
Sourcing decisions and purchasing activities serve to
link a company with its supply chain partners
• Sourcing decisions – (discussed in Chapter 10)
High level, often strategic decisions regarding which products or
services will be provided internally and which will be provided by
external supply-chain partners
• Purchasing –
The activities associated with identifying needs, locating and
selecting suppliers, negotiating terms, and following up to ensure
supplier performance
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 4
Why Purchasing
is Critical – I
The Changing Global Competitive
Landscape
• To compete globally, you need to
purchase globally
• Global purchasing efforts are
supported by advances in information
systems
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 5
Why Purchasing
is Critical – II
Financial Impact
• For the average manufacturer, 52.5%
of the value of shipments comes from
materials
• Purchasing represents a major
opportunity to increase profitability
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 6
Why Purchasing is Critical
Financial Impact - I
Lowe’s Company
Earnings and Expenses
Sales
COGS
Pretax earnings
$26,491
$18,465
$2,359
Selected Balance Sheet Items
Merchandise inventory
Total assets
$3,968
$16,109
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Every dollar saved in
purchasing for
increases pretax profit
by one dollar
Every dollar saved
in purchasing
inventory
lowers total assets
by one dollar
Chapter 11, Slide 7
Why Purchasing is Critical
Financial Impact - II
3% purchasing reduction in COGS
Earnings and Expenses
Sales
COGS
Pretax earnings
Current
With 3% saving
$26,491
$18,465
$2,359
$26,491
$17,911
$2,913
Selected Balance Sheet Items
Merchandise inventory $3,968
Total assets
$16,109
$3,849
$15,990
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Pretax earnings
increase by
$554 (23.4%)
ROA increases
from 14.6% to
18.2%
Chapter 11, Slide 8
Why Purchasing
is Critical – III
Performance Impact
• Quality
• Delivery
• Ability to exploit new technologies
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 9
Why Purchasing is Critical
Performance Impact - I
Sourcing dialysis machine valves
Cost per
valve
% good
Delivery
lead time
Supplier A
$10
Supplier B
$2
99.8%
95%
Overnight
delivery
1 day to
3 weeks
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 10
Why Purchasing is Critical
Performance Impact - II
Effect of defective dialysis machine
valves
•
•
•
•
Interruption in patient treatment
Rescheduling difficulties
Reduction in the effective capacity for dialysis
Possible medical emergencies
Estimated cost of a failed valve = $1,000
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 11
Why Purchasing is Critical
Performance Impact - III
Sourcing 50 dialysis machine valves
(Total Costs)
Supplier A
Valve costs
Failure
costs
Backup
inventory
Total costs
Supplier B
50 x $10 = $500
50 x $2 = $100
0.2% x 50 valves x
$1,000 = $100
5% x 50 valves x
$1,000 = $2,500
1 valve x $10 = $10
3 valves x $2 = $6
$610
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
$2,606
Chapter 11, Slide 12
The Purchasing Process
Needs identification
Description
No
Supplier identification
and evaluation
Is there a preferred supplier?
Yes
Supplier selection & contracting
Purchase order preparation
Follow up and expediting
Receipt and inspection
Order
cycle
Settlement & payments
Records maintenance
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 13
The Purchasing Process
Needs Identification
Needs identification
• Purchase requisition –
An internal document completed by a user that
informs purchasing of a specific need
• Reorder point system –
A method used to initiate the purchase of
routine items. Typically, each item has a
predetermined order point and order quantity
• Statement of Work/Scope of
Work (SOW) –
Terms and conditions for a purchased service.
Includes how supplier will be evaluated
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 14
The Purchasing Process
Description
Description
The communication of a user’s needs
to potential suppliers in the most
efficient and accurate way possible
• Description by market grade/industry standard
• Description by brand
• Description by specification
• Description by performance characteristics
• Description by prototypes or samples
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 15
The Purchasing Process
Supplier Identification and Evaluation - I
Supplier identification
and evaluation
The amount of effort increases as:
• The complexity of the product
or service increases
• The amount of money that is
committed increases
• The length of the proposed
buyer-supplier relationship
increases
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 16
The Purchasing Process
Supplier Identification and Evaluation - II
Supplier identification
and evaluation
Criteria for supplier
assessment:
• Process and design capabilities
• Management capability
• Financial condition and cost
structures
• Planning and control systems
• Environmental regulation
compliance
• Longer-term relationship potential
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 17
The Purchasing Process
Supplier Selection - I
• Competitive bidding
Supplier selection & contracting
• Negotiation
• Fixed-price contracts
• Cost-based contracts
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 18
The Purchasing Process
Supplier Selection - II
Preferred supplier
Supplier selection & contracting
A supplier that has
demonstrated its performance
capabilities through previous
purchase contracts and
therefore receives preference
during the supplier selection
process
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 19
The Purchasing Process
Supplier Selection - III
Competitive bidding is most
effective when:
Supplier selection & contracting
• The buying firm can provide
qualified suppliers with clear
descriptions of the items or
services
• Volume is high enough to justify
the cost and effort
• The firm does not have a
preferred supplier
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 20
The Purchasing Process
Supplier Selection - IV
Negotiation is most effective when:
Supplier selection & contracting
• The item is new or technically complex
with only vague specifications
• The purchase requires agreement about a
wide range of performance factors
• The supplier must participate in the
development effort
• The supplier cannot determine risks
and costs without input from the buyer
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 21
The Purchasing Process
Supplier Selection - V
Contracting is most effective when:
• There is a large amount of money involved
Supplier selection & contracting
• The business needs specific requirements
that need to be put into writing such as
quality levels, delivery times
Two basic types of contracts:
• Fixed-price – price does not change for life
of contract
• Cost-based – price tied to cost of selected
key input or economic factor
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 22
The Purchasing Process
The Order Cycle
• Purchase order preparation
Purchase order preparation
Follow-up and expediting
Receipt and inspection
Settlement and payment
Records maintenance
74% of firms currently have electronic
data interchange (EDI) with some part of
their supply base
• Follow-up and expediting
• Receipt and inspection
• Invoice clearance and payment
• Records maintenance
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 23
Spend Analysis
Answers the questions:
• What are the top 10 commodities by
annual spend? (provides priority)*
• Which commodities have the most
suppliers? (helps reduce purchasing load)
• Which commodities have the lowest spend
per supplier? (if also among top 10, potential for
savings)
* Similar to ABC analysis to identify critical inventory items based on cost and quantity
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 24
Typical Answer to First
Question
© 2008 Pearson Prentice Hall --- Introduction to Operations and Supply
Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036
Chapter 11, Slide 25
Case Study in Purchasing
The ABCs of Spend Analysis