CHAPTER 3 CATEGORY MANAGEMENT

• Understanding the variety of items a company decides to procure after make-or-buy decisions is key to grasping procurement management's complexity.

Purchases in Steel Eng (Case Study)

• Steel Eng, headquartered in Seattle, Washington, is a leader in the engineering and construction industry with projects spanning North and South America along with a global influence.
• Steel Eng's projects include the Pacific Heights residency, the 13th world's largest commercial plaza, and a waterfront revamp.
• Steel Eng had a purchasing expenditure of over $10 billion in 2022.
• Steel Eng relies on over 12,000 suppliers.
• Over 60% of Steel Eng's purchases are materials, services, and components.
• Construction equipment used by Steel Eng includes drilling equipment, heavy machinery, and tools.
• Technical instruments used by Steel Eng include analyzers and precision measurement tools.
• Safety and maintenance products used by Steel Eng include anti-acid coatings and batteries.
• Logistics and support equipment ensures timely delivery of materials and manpower to project sites.
• Specialized components such as accessories and spare parts, are crucial for certain projects.
• Steel Eng also procures non-production-related items like office supplies, IT, software, professional services, marketing, advertising, and facility management.

Types of Purchases

• Standardized classification assists in systematic management of goods and services.
• Purchases are classified into raw materials, components, consumables (MRO), services, and capital equipment.

Raw Materials

• Raw materials are essential inputs for production, representing a substantial part of purchasing costs, also known as commodities.
• Examples of raw materials include crude oil, wheat, sugar, rice, coffee beans, and metals like gold, copper, silver, and palladium.
• Commodities are sold at similar prices across different suppliers.
• Price fluctuations make purchasing commodities difficult.
• Wheat prices saw volatility between 2014-2024 with significant increases between 2020-2022 due to shortages and the pandemic.
• Managing raw materials requires the ability to assess when to buy them at the right time and quantity.
• Organizations rely on commodity buyers with specific knowledge of operating in commodity supply markets.
• Soft commodities are grown and cannot be stored for extended periods.
• Hard commodities are mined and extracted and tend to be more stable.

Components

• Components are parts included in final products that are usually removable and do not require manufacturing transformation.
• Component Differentiation: Components can be highly differentiated and provide a competitive advantage for the buying company.

Consumables

• Consumables: Also known as maintenance, repair, and operating (MRO) supplies, including cleaning and office supplies, emergency kits, work tools, lubricants, industrial and computer equipment.
• MRO's volume and variety impact spending budgets despite individual low costs with dispersed demand making inventory monitoring difficult.
• Effective MRO management involves monitoring requests and rationalizing demand.

Services

• Encompass all activities a company needs to purchase from external suppliers.
• Services include logistics, transportation, ICT, utilities, safety, training, consulting, facility management, and marketing.
• Services can take the form of quality control, painting, labeling, or packing.
• Services can account for 25-30% of expenses.

Capital Machinery and Equipment

• Capital machinery and equipment includes assets to support internal processes.
• Standard general equipment such as material-handling equipment, computer systems, and furniture.
• Customized machinery and equipment is designed based on company requirements.

The Accounting Perspective

• Purchase categories are assessed through their contribution to operating costs vs. capital assets, and their association with the company's output.
• Categories are interpreted according to the purchase cost lifecycle and the type of use.

Operating vs. Capital Expenses

• The lifecycle of the purchased item distinguishes between operational and capital expenditures.
• Operating expenses (Opex) are incurred during routine business operations.
• Capital expenditures (Capex) reflect investments in assets expected to benefit the company beyond a single fiscal year.

Direct vs. Indirect Expenses

• Direct purchases include raw materials, components, systems, and services integral to the final product with manufacturing.
• Indirect purchases encompass items and services necessary for business operations but are not incorporated into the final product or service.

Direct Purchases in Service Companies (Case Study)

• For retail service companies, direct purchases are products bought from external manufacturers and resold to final customers.
• In luxury stays, direct purchases could be raw ingredients or furniture.
• For pure service companies direct purchases directly contribute to delivering high-quality services like software.

Organization of Purchases: Category Management

• Companies define internal classification systems for managerial purposes based on the concept of purchasing categories.
• A purchasing category is a group of items that are likely to be purchased from the same set of suppliers.
• "Category management" is a strategic approach to purchasing that segments spending into similar areas, enabling strategic opportunities for consolidation and efficiency.

Purchasing Categories and Category Management

• Defining purchasing categories is crucial because they represent the unit of analysis for the procurement process and strategy definition.
• Examples of purchasing categories can include metals, IT hardware, travel, and marketing.

The Category Tree

• A category tree refers to the complete list of purchasing categories within a company that provides a quick overview of the scope of the purchasing organization.
• A category tree visually represents what the purchasing department is responsible for managing throughout the year.
• ElectroTech Inc. manufactures consumer electronics with a focus on specific categories tied to electronics.
• LuxuryStay Hotels has broad categories for better management across multiple properties.
• ElectroTech's categories include the areas of metals, alloys, electrical, etc.
• LuxuryStay's categories include food, furnishings, laundry, etc.
• Category trees guide procurement organization/management.
• Provides tailored procurement strategies, specialized teams for the specific needs.
• Help standardize procurement processes.