Procurement and Supply Chain Management PDF

**Mrkt 412 Procurement and Supply Chain Management** **Chapter 1: Procurement Management and the Related Terms** 1. **Introduction** Any commercial transaction, however, simple always involves a buyer and seller. Thus, procurement is one of the basic functions of any business. The buyer requires certain goods and materials to satisfy this wants. He/she seeks a seller who can and is willing to supply him/her with what he/she needs. Together they negotiate a mutually satisfactory price and the deal is complete In modern business organizations, procurement is an important activity as manufacturing, marketing or engineering, in order to achieve some desired objectives. Progressive firms have no doubt about buying impact on total quality, cost, delivery, technology and responsiveness to the needs of external customers. Within highly competitive industry, procurement must become more than a reactive order placer than negotiate buying contract. Individual procurement can range from simple to highly complex. More complex procurement requires buying experts. It is in a relatively simple procurement, however, that justification for specialized department can be found. **1. 2 The concept of procurement** **"**Procurement" is a term whose origin can be traced to early government organizations. Today, it is widely used by the armed forces to define one of several supply functions involved in logistic activities. In the broader sense, the government defines the procurement to include the entire process by which all classes of resources (people, materials, facilities, and services) for a particular project are obtained. Although the tem "procurement" originated in government organizations, for many years it has also been used by industries. The meaning of procurement in industry parallels its meaning in government. In both cases, the procurement concept encompasses a wide range of supply activities than does the purchasing concept **1.3 Other related concepts** - **Purchasing** Purchasing has been defined by many authors in different ways: Some of the definitions are: 1. Purchasing is the function of buying machinery, tools, general supplies, raw materials, etc...required by an organization (N.K.Nair,1990) 2. The term purchasing most often refers to the day-to-day management of material flows and information (Monglkaetal,1998) 3. Purchasing is obtaining from external sources all goods and services, capability and knowledge which are necessary for running, maintaining, and managing the company's primary and support activities, at the most favorable conditions (Weele,2000) 4. Purchasing comprises the essential activities associated with the acquisition of materials, services and equipment used in the operation of the organization. (W.Dobler,1996) All the above definitions revolve around the same concept that purchasing is the process of obtaining material input for the organization. All organizations require supplies of materials and services from outside sources. In this course, we can use purchasing and procurement interchangeably because both concern with the incoming of goods and services from outside suppliers. Procurement (Purchasing) is a material activity that goes beyond a simple act of buying, and it includes the planning and policy activities covering a wide range of related and complementary activities. Included in such activities are: -the research and development required for the proper selection of materials and sources; -determining the specification in terms of required quality and quantity of the goods and services that need to be bought, \- preparing and conducting negotiation with the supplier in order to establish an agreement, \- placing the order with the supplier -the follow- up to ensure proper delivery and monitoring and controlling the order (i.e expediting). \- the inspection of incoming shipments to ensure both quantity and quality compliance with order, \- the development of proper procedures, methods, and forms to enable the purchasing department to carry out established policies, \- the coordination of the activities of the purchasing department with such other external divisions of the concerns such as traffic, receiving, storekeeping, and accounting, so as to facilitate a smooth operation, and \- the development of a technique of effective communication with top management of the company so that a true picture of the performance of the procurement function is presented. A number of specific activities are performed by a typical procurement department. The primary responsibilities of a procurement department involve buying, value analysis, and purchasing research. Many procurement departments, however, also include activities such as inventory control, stores, receiving, subcontracting, and traffic. Consequently, when one encounters the term "procurement department" the name alone does not reveal precisely what operations are involved. - **Supplies Management**: - Supply management is a process responsible for the development and management of a firm's total supply system both internal and external components. At an operational level, it includes and expands the activities of buying functions and the procurement process. The supply management concept represents the most advanced stage in the evolutionary development of the purchasing (procurement) sphere of activity. - **Materials Management:** - Materials management, as practiced in business today, can be defined as a confederacy of traditional materials activities bound by a common idea- the idea of an integrated management approach to planning, acquisition, conversion, flow and distribution of production materials from the raw- materials state- to the finished --product state i. Production control ii. Inventory control iii. Stores control iv. Traffic control **Production Control**: - production department is the department determining the requirements of materials and parts to be purchased and manufactured. It is responsible for the conversion of raw materials into semi-finished and finished goods. **Inventory control:** - Inventory control is the techniques of maintaining store keeping items at the desired levels, **be it raw materials**, **semi-finished products** and **finished products**. The department keeps detailed and up-to-date record of inventory, and order status, and potential demand for each production part and materials. Management and control inventories include the laying down of the policy to be allowed regarding the holding of stocks of raw materials and finished products and the implementation of this policy in the business. The objective of inventory control is to ensure enough supply of all materials and supplies of the proper quality essential to the business with the least inventory and inventory carrying cost. **Stores Control: -** materials handling stands for **art** and **scienc**e involving **the moving**, **packin**g and **storing of items** in any firm. It includes all those activities that are concerned with the **preparation, placing, and positioning** of the materials to facilitate their movement and storage. These activities in particular are: - Receipts of materials and products and their storage - Issues of materials and products from the store house - Internal transport of materials and products including their process, transfer - Packing and dispatching of finished products - Research in materials handling and with least cost of operating with it **Traffic control:** - Traffic control is the class of materials management that controls the inbound shipment of procured materials and the outbound shipment of finished products to customers. Physical distribution is a necessary as well as costly activity. In the developed economy, the distribution sector typically accounts for one-third of the gross domestic product. **Purchasing control**: - purchasing control involves in the monitoring and controlling of procurement procedures, processes, and principles. While buying goods, the purchaser should follow the procurement principles **1. 4 Objectives of Procurement Management** From an operating or functional perspective, it is necessary to develop a set of statements that provide practical and useful targets for decision making process. In this sense, some basic objective of procurement and supply chain management are identified and discussed as follows: **1. To support company operations with an uninterrupted flow of materials and services.** This is the most fundamental of all purchasing and materials management objectives. In a logistical sense this is a key reason for the existence of the department. Responsibility for performance of the function is located in a single operating unit, thereby facilitating co-ordination and control of the supply activities. **2. To buy competitively:** Buying competitively involves keeping abreast of the forces of supply and demand that regulate prices and availability of materials in the market place. At times, it also involves an understanding of a supplier's cost structure, coupled with ability to minimize and improve the supplier's costs structure and then to negotiate price and service arrangements that are fair relative to the supplier's costs. A buyer who pays significantly more than his/ her competitor does for a given material or service generally is not buying competitively. **3. To buy wisely:** Buying wisely involves a continual search for better values that yield the best combination of price, quality, and service, relative to the buyer's needs. This frequently involves coordination with users in defining the need. It may also involve co-coordinating and reconciling users' needs with suppliers' capabilities to achieve optimal value considering both issues. A firm that buys a silver-plated part when a copper plated part could perform the function just as well usually is not buying wisely. It is the combination of buying competitively and buying wisely that typically contributes most to the profitability of the firm. **4. To keep inventory investment and inventory losses at a practical minimum**. Although maintaining a large inventory is one way to achieve objective number one, it is also costly. Research indicates, most firms today pay indirect costs between 25 and 35 percent of the average inventory value per year for the convenience of having the inventory available. Hence, the materials management job is to achieve a reasonable balance between the level of inventory required to support operation and the cost of carrying the inventory. Through proper buying, packaging, and storing, it is also the department's objective to minimize losses that occur as a result of deterioration, obsolescence, theft, and so on **5. To develop reliable and effective sources of supply.** Cooperative suppliers that are willing to work with a buyer to help solve the buying firm's problems and to minimize its materials-related costs are an invaluable resource. Progressive buyers today tend increasingly to "buy suppliers", as opposed simply "buying products". The identification, investigation, selection, and in some cases development of competent and responsive suppliers is a buyer's paramount responsibility. It is difficult indeed for a firm to perform optimally if it cannot depend on the planned performance of **a reliable contingent of suppliers.** **6. To develop good relationships with the vendor community and good continuing relationships with suppliers. Good relationships with suppliers are imperative, and good relationships with potential suppliers are invaluable. The achievement of the preceding objective on a continuing basis is virtually impossible if mutually satisfactory continuing relationships are not maintained. Potential suppliers are much more interested and eager to acquire a firm's business if the buying firm is likely to be a "good customer". And, when a contractual relationship has been formed with a supplier, the myriad operating problems that inevitably arise throughout the life of the contract are much more easily and effectively solved when the relationship is sound and mutually beneficial. Suppliers naturally direct their research, provide advance information on new products and prices, and in general give better service to such customers.** **7. To achieve maximum integration with the other departments of the firm. It is essential for buyers to understand the major needs of their using departments, so that these needs can be translated into materials support actions. While these actions vary from firm to firm, they normally require the purchasing and materials operation to support a using department in one or more of its major responsibilities. The most common types of support involve actions such as developing materials standardization programs (in co-ordination with ongoing design programs), forecasting future prices and general business conditions, performing economic make-or buy analyses, and serving as a repository of information and data from suppliers regarding new materials, processes, prices, and materials availability.** **8. To administer the procurement and materials management function in a professional, cost-effective manner.** **Management should expect the preceding seven objectives to be achieved in a professional manner at a cost that is commensurate with their value to the total organization. This involves the acquisition and development of highly competent personnel who are motivated to perform their responsibilities effectively, with the overall goal of helping the firm maintain a competitive position in its industry. Such personnel also serve as a reservoir of talent from which future executives of the firm can be drawn.** ***1.5 Procurement policies, types and principles*** ***What is a policy? A policy is a statement that describes in very general terms an intended course of action. After the fundamental objectives of an activity are established, policies are developed to serve as general guidelines in making operating decisions that channel actions toward achievement of the objectives. To facilitate this process, a set of operating procedures is subsequently developed that details the specific actions to be taken to get the job done. (Dobler, 1996: 45).*** ***Procurement management develops policies to support its buyers and support staff. These policies are general outlines clarifying procurement management's position on a subject.*** ***1.5.1 Types of procurement policies*** ***1. Auction buying and/or non-auction buying*** ***If the purchase requisition requests an item with no outstanding supplier, then purchasing must obtain auction/quotation from potential suppliers. If the requested materials are new or high value items, they bought through auctions or bids. Buying forwards request for quotation to suppliers invited to submit a bid. The form provides a space for the information that suppliers require to provide an accurate quotation, including the description of the item, quantity required, date needed, and delivery location. The supplier completes the form by providing name, contact person, unit cost, net amount, and any appropriate payment terms. Procurement evaluates the quotations and selects the most qualified supplier to provide the item.*** ***In case of routine items for which supplier relationships have already been developed auction or quotation may not be required to select suppliers. Furthermore, items of small value whose purchase is repetitive may not require request for quotation or auction.*** ***2. Blanket order and/or open end orders*** ***In blanket or open end buying, the buyer notifies the supplier regarding quantity requirements and delivery schedules from time to time. In this buying approach, there exists and established relationship and contract between the company and the supplier. It is an agreement to furnish all of the buyer's needs for particular items for a designated period of time. Under this type of blanket order, the quantity is not fixed until the time period has elapsed.*** ***The unique purpose of a blanket order is to buy a variety of items for which there are frequent deliveries from one source. The blanket order is best for items with low unit value, but high annual usage, whose rate of usage cannot be accurately planned*** ***3. Planned order and/or rush order*** ***Every department executive tries to develop an orderly and systematic pattern of operation that efficiently utilizes the resources of that department. In a well-run procurement department, systematic analysis and processing of most orders is completed in a few days after the purchase request is received. This is a planned order, however, some times the procurement unit may handle the emergency needs that inevitably arise in any business operation. Therefore, a special procedure for processing rush order is needed.*** ***In case of emergencies, it is unwise to accept oral requisitions in person or over the telephone. The requisitionner should state the need in writing and, preferably, deliver it to the buyer in person. For purposes of identification emergency requisitions can be printed on paper of different color, or they can be identified with a visible emergency sticker. Typically, the buyer should process these requisitions immediately and telephone emergency orders to the supplier. However, the order should never be placed without assigning it a purchase order number. For most buying, a confirming purchase order subsequently should be mailed to the supplier.*** ***Steps should be taken to discourage all rush orders that arise because of poor planning of the using departments. In practice, three approaches have proved successful.*** ***i. There should be an effort to coordinate the activities of using group or production scheduling and purchasing*** ***ii. The organization should design a system to reduce unjustifiable requests, requires the requisitionner to obtain approval from a general management executive for all emergency requisitions.*** ***ii. To assess the requisitioning department a predetermined service charge for each emergency requisition processed.*** ***4. Policies affecting external relationships and image*** ***Irrespective of public relations and advertising expenditures, a firm's procurement and sales departments contribute heavily to the shipping of its public image.*** ***i. Sales people -- to promote favorable vender relations, all sales people should be treated fairly and courteously.*** ***ii. Orientation and policy booklets -- careful and complete communication with vendor facilitates the development of good relations. Towards this end, many companies prepare an organization booklet, which is given to all vendors calling on (visiting) the purchasing department.*** ***iii. Competitive bides -- competitive-bidding process implies that the lowest qualified bidder will get the contract. Most companies establish definite policies to guide all buying personnel in handling bidding activities both before and after the issuance requests for bid.*** ***iv. Sample -- in the interest of good vendor relaxations, a definite policy (and related procedures) should be established to ensure fair and uniform treatment of all samples by all buyers.*** ***v. Plant visits: - they have three different benefits*** *** Provide an opportunity for a buyer to learn more about the current technical and manufacturing aspects of the product he/she buys*** *** Enable a buyer to discover a great deal of "inside" information about specific suppliers.*** *** Permit a buyer to develop reliable personal acquaintances and friendship among suppliers' personnel.*** ***5. Policies on supplies sources*** *** Sources of supplies decisions frequently produce substantial impact on both inside and outside the buyers' firm.*** *** For this reason, it is essential that carefully conceived policies be included in the policy manual with regard to:*** *** The number and size of source*** *** Source selection criteria*** *** Local sources*** *** Foreign sources*** *** Development of new sources etc.*** ***6. Policies concerning ethical practices*** *** Procurement professionals in any organization have ethical obligations to three groups of people: employers, suppliers, and their purchasing peers*** ***Most organizations include the following in their policy manuals.*** ***- Procurement personnel must not become involved in any situation that produces a conflict of interest*** ***- Procurement personnel must not be involved in any situation that results in a sense of development of personal obligation to any supplier*** ***- Buyers must treat all vendors fairly, without bias or prejudice*** ***- Buyers are obligated to strive for an equitable settlement of business dealings for both firms i.e. the buyer's firm and the sellers firms.*** ***- Buying personnel are expected to protect any information that is proprietary to the buying firm or to vendors' firms*** ***- Purchasing personnel are expected to conduct themselves generally in ways that bring credit to them personally, to their firms and to the larger body of purchasing colleagues.*** ***7. Buying policies (policies related to timing)*** ***The procurement executive must make a fundamental policy decision concerning the timing of purchase for certain major materials. Basically, the buyer can choose one of the two alternatives:*** ***- To buy according to current requirement or*** ***- To buy according to market conditions*** ***Based on the two alternatives, some companies coordinate buying closely with production schedules and buy in small lots so as to minimize their cost of inventories. Other companies buy greater / larger quantity at one time so as to take advantages of low market prices and quantity discount.*** ***The following are some of the policies relating buying time.*** ***1.5.2 Polices on the buying time*** ***The type of procurement conducted by different organizations may be varied depending upon the needs of the organizations and their goals. The quality and quantity of materials affect the price, time and type of purchases. Organizations should have time for their production process, because materials could have increased/decreased in price seasonally depending on the circumstances.*** ***The following different types of procurement can be practiced by different organizations*** ***1. Hand to mouth buying - It is the practice of buying material to satisfy current operating requirement in quantities smaller than those normally considered economical.*** ***There are a number of reasons for pursuing a hand to mouth buying policy*** ***- If material requirements can be fulfilled from local or nearly markets*** ***- If prices are stable and quantity discounts are not available*** ***- In case of shortage of working capital or storage space*** ***- If forecast reveals a decline in the price of materials.*** ***- When the products are in the process of redesigning with the result that its materials need may change.*** ***Advantages*** *** It saves money when prices are dropping*** *** It prevents inventory losses that result due to technological change and*** *** It provides the firm required additional cash for operating purpose*** ***Limitations*** *** It leads to high buying and administrative expenses (ordering costs, price discounts, etc.)*** *** There is a risk of running out of stock*** ***2. current- requirement buying -This is a buying practice in excess of a hand-to mouth quantity. This is the most common methods of buying to satisfy short range requirements. The method obtains the most economical quantity by using EOQ models which balances the costs, quantity discount, inventory cost, obsolescence cost... into account.*** ***3. Market Buying- It is buying raw materials at a time when market prices are the lowest for them and there is a high probability of an upward price increase in the future. This policy is pursued for commodities of seasonal nature like cotton.*** ***4. Buying on long-range contract*** ***It is pursued in the case of materials which are needed in substantial quantities and on continuous basis. The company gives a long-term contract to a supplier to deliver materials periodically at an agreed price.*** ***5. Hedging. Hedging is a procedure designed to minimize risks resulting from adverse price fluctuations in a cash commodity.*** ***It is buying now for delivery at future date. Thus, a firm anticipating a price rise, may buy a given quantity of material of a specified quality and at a contracted price for delivery in a future time.*** ***6. Forward buying - The policy of forward buying includes all purchasing in excess of the minimum stock required to keep the plant operating on a basis of normal output and average delivery times. It includes all purchases for contingency reserves but excludes all speculative purchases or advance purchases made with the objective of realizing speculative profit.*** ***A sound policy of forward buying is essential to successful purchasing, and the purchasing agent in conjunction with top management should define the company's forward buying policy regarding both its objectives and its extent*** ***Some of the common reasons for forward buying are:*** *** To provide a margin of insurance for possible strikes from the side of supplier or similar developments like carrier interruptions.*** *** To take advantage of quantity discounts and favorable transportation rates by consolidating insurance*** *** To protect the company against risk of forecasted shortage of materials*** ***7. Speculative buying - Speculative buying involves purchasing in excess of normal requirements with the intention of generating profit on price movement by reselling the purchased items. This kind of purchasing is not pursued by manufacturing concerns. A manufacturing company is in business to profit from the production and distribution offered to its customers not from speculation in the material market.*** ***The distinction between forward buying and speculative buying lies in the reason for making the advance purchases. Forwarded buying is done because operational considerations or supply conditions suggest the need for an inventory reserve. Speculative buying on the other hand is conducted with the hope of profiting from price changes. Speculative buying applies for merchandising type of business.*** ***1.6 Procurement principles*** ***It is believed that for procurement to be efficient and effective five things are essential. These five things are commonly known as the five R's. These are: to buy goods and services in the right quality, right quantity, at the right time, right price and from the right source of supply. In the following section we will discuss these in detail (Nair, 1990.*** ***1. Right quality: - First and foremost, quality must be properly defined. No general description of the character of the material or desired attributes will be sufficient, like 'high quality' or 'poor or low quality' etc. The right quality is the suitability of an item for a given purpose. Material quality is when it satisfies the intended needs (goal/purpose), at least cost. The best quality need not be the right quality.*** ***For one job the best grade may be the right quality, whereas for another job the lowest grade may be the right quality. For example, let us take copper and gold. Which material would we select for electric wiring? Would we use the gold because it is the best quality? No, even if gold satisfies the intended need, it will result in unnecessary costs, which means gold is not the right quality for electric wiring purpose.*** ***Quality that is superior to the job requirement means avoidable expense and simply inferior quality might result in a rejection of materials and eventual production hold-up or complaints from the users. The quality of different commodities is described in different ways. Quality can be stated in terms of standard specification, composition, end-use, brand or trade names, market standards etc.*** ***Describing the right quality in the purchase requisition and order enables a supplier to understand the exact requirement of the buyer and to submit a quotation under equal conditions with other competitors.*** ***2. Right quantity. - In the case of recurring items, the right quantity is the quantity that may be procured at a time with minimum total cost and which prevents shortage. If the quantity is large the price is generally lower but the inventory carrying cost goes up. Too much inventory may lead to more carrying cost, obsolescence and ordering cost, even if it has benefits of buying on discount. Too little quantity may interrupt operation, due to sock-out and scarcity. Thus, buying goods in the right quantity will have a lot of role in making the procurement function more effective and efficient.*** ***In the case of special buying, it is just the quantity required for carrying out the job. Excess buying will result in blocking money on items, which may not be used for an indefinite time and have possibilities of deterioration.*** ***3. Right time: - Right time implies that in order to be effective, purchases should be made in such a way that stores make materials available at the time when they are needed. In the case of regularly used or recurring items, right time means the time when the stock reaches the minimum level. The responsibility for adhering to this time is shared both by stock control and the purchase section. In short, this means that the materials should be available when the manufacturers require them. Arranging delivery much earlier than the required delivery time or after production hold-up is not efficient buying. The former means over-stocking and blocking of money, while the letter means loss of production.*** ***In the case of special requirement, i.e. materials required for special jobs, the procurement section should see that such materials are delivered on time. It is however, implied that the procurement section should get reasonable time for procuring the materials.*** ***4. Right price: - The right price is the one which brings the best ultimate value. It need not be the lowest price that should be determined in combination with other factors such as quality, ultimate life, delivery time, after-sales service etc. The factors that affect the price are:*** ***- Quality and quantity required*** ***- Urgency of requirements*** ***- Demand and supply of material in market*** ***- Whether there is room for competition or not*** ***- Whether the requirements are standard or not standard*** ***- Whether the requirements are respective or not*** ***- Whether the past business relationship was good or not*** ***The larger the quantity the lower is the price but one has to determine whether the higher inventory carrying cost or lower price on a large quantity is beneficial.*** *** When requirements are urgent generally higher prices have to be paid*** *** Standard items are easy to make and are produced in bulk quantities. Therefore, their prices are comparatively lower than those of non-standard items.*** *** Items which are readily available in the market are cheaper than those specially manufactured*** ***5. Right source of supply: -The right source should possess the necessary financial resources to handle the commitments including the procurement of raw materials which may be difficult to obtain and the technical ability to supply the required quantity (present and future) and quality of goods at the satisfactory price. The location of the supplier is also of importance in selecting the supplier. This will avoid delivery delays and high transportation charges, facilitate personal contact between the buyer and the supplier; enable better after sales service etc. A visit to prospective supplier's workshop or stock room may enable the buyer to assess the capabilities of the firms.*** 1. ***Define the concept of procurement*** 2. ***Explain the concept of purchasing*** 3. ***What are the different classes of materials management?*** 4. ***Discuss the place of purchasing in business organization*** 5. ***Explain the objectives of procurement*** 6. ***What is procurement policy?*** 7. ***Discuss the different types of procurement policies*** 8. ***What action should be taken in order to discourage all rush orders which arise due to poor planning?*** 9. ***What are the five R's of procurement?*** 10. ***What are the factors that affect pricing?*** **Chapter Two: Supply Chain Management** **2.1 Introduction** Supply chain consists of all parties involved, directly or indirectly, in fulfilling a customer request. The supply chain not only includes the manufacturer and supplier, but also transporters and all other functions involved in receiving and filling a customer request. These functions include, but are not limited to, new product development, marketing, operations, distribution, finance, and customer service. Consider a customer walking into a super market store to purchase detergent. The supply chain begins with the customer and their need for detergent. The next stage of this supply chain is the super market retail store that the customer visits. The super market stocks its shelves using inventory that may have been supplied from a finished-goods warehouse that the supermarket manages or from a distributor using trucks supplied by a third party. The distributor in turn is stocked by the manufacturer. The manufacturing plant receives raw material from a variety of suppliers who may themselves have been supplied by lower level suppliers. A supply chain is dynamic and involves the constant flow of **information**, **produc**t, and **funds** between different stages. For example, the super market provides the product as well as pricing and availability information to the customer. The customer transfers funds to super market. The super market conveys point- of- sales data as well as replenishment orders to the warehouse or distributor, who transfers the replenishment order via trucks back to the store. The super market transfers funds to the distributor after the replenishment. The distributor also provides pricing information and sends delivery schedules to the super market. Similar information, material, and fund flows take place across the entire supply chain. The primary purpose for the existence of any supply chain is to satisfy customer needs, in the process generating profit for itself. Supply chain activities begin with a customer order and end when a satisfied customer has paid for his/ her purchase. The term supply chain conjures up images of product or supply moving from **suppliers** to **manufacturers** to **distributors** to **retailers** to **customers** along a chain. It is important to visualize **information, funds, and product flows** along both direction of this chain. The term supply chain may also imply that only one player is involved at each stage. In reality, a manufacturer may receive material from several suppliers and then supply several distributors. Thus, most supply chains are actually networks. It may be more accurate to use the term supply network or supply web to describe the structure of supply chains. A typical supply chain may involve a variety of stages. These supply chain stages include: - Customers - Retailers - Wholesalers/Distributors - Manufacturers - Components/Raw material supplier **The Objective of Supply chain** The objective of every supply chain is to maximize the overall value generated. The supply chain generates the difference between what the final product is worth to the customer and the effort the supply chain expands in fulfilling the customer's request. For most commercial supply chains, value will be strongly correlated with supply chain profitability, the difference between the revenue generated from the customer and the overall cost across the supply chain. For example, if a customer purchases a computer from Dell Company and pays Birr10, 000, it represents the revenue the supply chain receives. The process in the Dell company and other stages of the supply chain incur costs to convey **information**, **produce components, store them, transport them, transfer funds, and so on**. The difference between the Birr 10,000 that the customer paid and the sum of all costs incurred by the supply chain to produce and distribute the computer represents the supply chain profitability. Supply chain profitability is the total profit to be shared across all supply chain stages. The higher supply chain profitability, the more successful the supply chain. Supply chain success should measure in terms of supply chain profitability and not in terms of the profit at an individual stage. **Decision Phases in a Supply Chain** Successful supply chain management requires many decisions relating to the flow of information, product, and funds. These decisions fall into three categories or phases, depending on the frequency of each decision and the time frame over which a decision phase has an impact. 1. **Supply chain strategy or design:** During this phase, a company decides how to structure the supply chain over the next several years. It decides **what the chain's configuration will be, how resources will be allocated, and what processes each stage will perform**. Strategic decisions made by companies include the location and capacities of production and warehousing facilities, the products to be manufactured or stored at varies locations, the modes of transformation to be made available along different shipping legs, and the type of information system to be utilized. A firm must ensure that the supply chain configuration supports its strategic objective during this phase. Supply chain design decisions are typically made for the long term (a matter of years) and are very expensive to alter on short notice. Consequently, when companies make these decisions, they must take into account uncertainty in anticipated market conditions over the next few years. 2. **Supply chain planning**: For decision made during this phase, the time frame considered is a quarter to a year. Companies start the planning phase with a forecast for the coming year of demand in different market. Planning includes decisions regarding which markets will be supplied from which locations, the subcontracting of manufacturing, the inventory policies to be followed, and the timing and size of marketing promotion. Planning establishes parameters within which a supply chain will function over specific period of time. In the planning phases, companies must include uncertainty in demand, exchange rates, and competition over this time horizon in their decisions. Given a shorter time horizon and better forecasts than design phase, companies in the planning phase try to incorporate any flexibility built into the supply chain in the design phase and exploit it to optimize performance. As a result of the planning phase, companies define a set of operating polices that govern short-term operation. 3. **Supply chain operation**: The time horizon here is weekly or daily, and during this phase companies make decision regarding individual customer orders. At the operational level, supply chain configuration is considered fixed and planning policies are already defined. The goal of supply chain operations is to handle incoming customer orders in the best possible manner. During this phase, firms allocate inventory or production to individual orders, set a date that an order is to be filled, generate pick lists at a warehouse, allocate an order to a particular shipping mode and shipment, set delivery schedules of trucks, and place replenishment orders. Because operational decisions are being made in the short term, (minutes, hours, or days), there is less uncertainty about demand information. Given the constraints established by the configuration and planning policies, the goal during the operation phase is to exploit the reduction of uncertainty and optimize performance. The design, planning, and operation of supply chain have a strong impact on overall profitability and success. **Process View of a Supply Chain** A supply chain is a sequence of processes and flows that take place within and between different stages and combine to fill a customer need for a product. There are two different ways to view the processes performed in a supply chain. 1. **Cycle view**: The processes in a supply chain are divided into **a series of cycles**, each performed at the interface between two successive stages of supply chain. 2. **Push/pull view**: The processes in a supply chain are divided into two categories depending on whether they are executed in response to a customer order or in anticipation of customer orders. Pull processes are initiated by a customer order whereas push processes are initiated and performed in anticipation of customer orders. - Customer order cycle - Replenishment cycle - Manufacturing cycle - Procurement cycle **Customer Order Cycle** The customer order cycle occurs at the customer/retailer interface and includes all processes directly involved in receiving and filling the customer's order. Typically, the customer initiates this cycle at retailer site and the cycle primarily involves filling customer demand. The retailer's interaction with the customer starts when the customer arrives or contact is initiated and ends when the customer receives the order. The processes involved in the customer order cycle include: - Customer arrival - Customer order entry - Customer order fulfilment - Customer order receiving **Customer Arrival:** The term customer arrival refers to the customer's arrival at the location where he/ she has access to his/ her choices and makes a decision regarding a purchase. The starting point for any supply chain is the arrival of the customer. Customer arrival can occur when - The customer walks into a supermarket to make a purchase - The customer calls a mail order to telemarketing center - The customer uses the web or an electronic link to a mail order firms From the supply chain perspective, the key flow in the process is the customer's arrival. The goal is to facilitate the contact between the customer and the appropriate product so that the customer's arrival turns into a customer order. At a supermarket, facilitating a customer order may involve managing customer flows and product displays. At a telemarketing center, it may mean ensuring that customers do not have to wait on hold for too long. It may also mean having systems in place so that sales representatives can answer customer queries in a way that turns calls into order. The objective of a customer arrival process is to maximize the conversation of customer arrivals to customer orders. **Customer order entry**: The term customer order entry refers to customers informing the retailer what products they want to purchase and the retailer allocating products to customers. At a supermarket, order entry may take the form of customers loading all items that they intend to purchase onto their carts. At a mail order firm's telemarketing center or web site order entry may involve customers informing the retailer of the items and quantities they select. The objective of the customer order entry process is to ensure that the order entry is quick, accurate, and communicated to all other supply chain processes that are affected by it. **Customer order fulfillment**: During this process, the customer's order is filled and sent to the customer. At a supermarket, the customer performs this process. At a mail order firm, this process generally includes picking the order from inventory, packing it, and shipping it to the customer. All inventories will need to be updated, which may result in the initiation of the replenishment cycle. In general, customer order fulfillment takes place directly from the manufacturer's production line. The objective of the customer order fulfilment process is to get the correct orders to customers by the promised due dates at the lowest possible cost. **Customer order receiving**: During this process, the customer receives the order and takes ownership. Records of this receipt may be updated and payment completed. At a supermarket, receiving occurs at the checkout counter. For a mail order firm, receiving occurs when the product is delivered to the customer. **Replenishment Cycle** The replenishment cycle occurs at the retailer/distributer interface and includes all processes involved in replenishing retailer inventory. It is initiated when a retailer places an order to replenish inventories to meet future demand. A replenishment cycle may be triggered at a supermarket that is running out of stock of the required product or at a mail order firm that is low on sock of a particular product. The replenishment cycle is similar to the customer order cycle except that the retailer is now the customer. The objective of the replenishment cycle is to replenish inventories at the retailer at the minimum cost while providing high product availability. The processes involved in the replenishment cycle include: - Retail order trigger - Retail order entry - Retail order fulfillment - Retail order receiving **Retail Order Trigger**: As the retailer fills customer demand, inventory is depleted and must be replenished to meet future demand. A key activity that the retailer performs during the replenishment cycle is to devise a replenishment or ordering policy that triggers an order from the previous stage. The objective when setting replenishment order triggers is to maximize profitability by ensuring economies of scale and balancing product availability and the cost of holding inventory. The outcome of the retail order trigger process is the generation of a replenishment order that is ready to be passed on to the distributor or manufacturer. **Retail Order Entry:** This process is similar to customer order entry at the retailer. The only difference is that the retailer is now the customer placing the order that is conveyed to the distributor. This may be done electronically or by some other medium. Inventory or production is then allocated to the retail order. The objective of the retail order entry process is that an order be entered accurately and conveyed quickly to all supply chain processes affected by the order. **Retail Order Fulfillment**: This process is very similar to customer order fulfilment except that it takes place at the distributor. A key difference is the size of each order as the customer orders tend to be much smaller than replenishment orders. The objective of the retail order fulfilment is to get the replenishment order to the retailer on time while minimizing costs. **Retail Order Receiving**: Once the replenishment order arrives at a retailer, the retailer must receive it physically update all inventory records. This process involves product flow from the distributor to the retailer as well as information updates at the retailer and the flow of funds from the retailer to the distributer. The objective of the retail order receiving process is to update inventories and displays quickly and accurately at the lowest possible cost. **Manufacturing Cycle** The manufacturing cycle typically occurs at the distributor/manufacturer (or retailer/manufacturer) interface and includes all processes involved in replenishing distributor or retailer inventory. The manufacturing cycle triggered by customer orders, replenishment orders from a retailer or distributor or by a forecast of customer demand and the current product availability in manufacturer's finished-goods warehouse. One extreme in a manufacturing cycle is an integrated collection of orders that enable the manufacturer to produce in large quantities. In this case, the manufacturing cycle is reacting to customer demand (refer to as pull process). Another extreme is a firm must produce consumer products in anticipation of demand. In this case, the manufacturing cycle is anticipating customer demand (referred to as a push process). The process involved in the manufacturing cycle include: - Order arrival from the finished-goods warehouse, distributor, retailer, or customer - Production scheduling - Manufacturing and shipping - Receiving at the distributor, retailer, or customer **Order Arrival**: During this process, a finished-goods warehouse or distributor sets a replenishment order trigger based on the forecast of future demand and current product inventories. The resulting order is then conveyed to the manufacturer. In some cases the customer or retailer may be ordering directly from the manufacturer. In other cases a manufacturer may be producing to stock a finished-products warehouse. In the latter situation, the order is triggered based on product availability and a forecast of future demand. This process is similar to the retail order trigger process in the replenishment cycle. **Production Scheduling**: This process is similar to the order entry process in the replenishment cycle where inventory is allocated to an order. During the production scheduling process, orders (or forecasted orders) are allocated to a production plan. Given the desired production quantities for each product, the manufacturer must decide on the precise production sequence. If there are multiple lines, the manufacturer must also decide which products to allocate to each line. The objective of the production scheduling process is to maximize the proportion of orders filled on time while keeping costs down. **Manufacturing and Shipping**: This process is equivalent to the order fulfillment process described in the replenishment cycle. During the manufacturing phase of the process, the manufacturer produces to the production Schedule. During the shipping phase of this process, the product is shipped to the customer, retailer, distributor, or finished-product warehouse. The objective of the manufacturing and shipping process is to create and ship the product by the promised due date while meeting quality requirements and keeping costs down. **Receiving:-** In this process, the product is received at the distributor, finished-goods warehouse, retailer, or customer and inventory records are updated. Other processes related to storage and fund transfers also take place. **Procurement Cycle** The procurement cycle occurs at the manufacture/supplier interface and includes all processes necessary to ensure that materials are available for manufacturing to occur according to schedule. During the procurement cycle, the manufacturer orders components from suppliers that replenish the component inventories. The relationship is quite similar to that between a distributor and a manufacturer with one significant difference. Whereas retailer/distributer orders are triggered by **uncertain customer demand**, component orders can be determined precisely once the manufacturer has decided what the production schedule will be. Component orders depend on the production schedule. Thus, it is important that suppliers be linked to the manufacturer's production schedule. Of course, if a supplier's lead times are long, the supplier has to produce to forecast because the manufacturer's production schedule may not be fixed that far in advance. **Push/pull View of Supply Chain Processes** All processes in a supply chain fall into one of two categories depending on the timing of their execution relative to end customer demand. With pull processes, execution is initiated in response to a customer order. With push processes, execution is initiated in anticipation of customer orders. Therefore, at the time of execution of a pull process, customer demand is known with certainty whereas at the time of execution of a push process, demand is not known and must be forecasted. Pull processes may also be referred to as reactive processes because they react to customer demand. Push processes may also referred to as speculative processes because they respond to speculated (or forecasted) rather than actual demand. The push/pull boundary in a supply chain separates push processes from pull processes. A push/pull view of the supply chain is very useful when considering strategic decisions relating to supply chain design. This view forces a more global consideration of supply chain processes as they relate to a customer order. Such a view may, for instance, result in responsibility for certain processes being passed on to a different stage of the supply chain if making this transfer allows a push process to become a pull process. **Drivers of Supply Chain Performance** To understand how a company can improve supply chain performance in terms of responsiveness and efficiency, we must examine the four drivers of supply chain performance: **facilities,** **inventory**, **transportation**, **and information**. These drivers, not only determine the supply chain's performance in terms of responsiveness and efficiency, they also determine whether strategic fit is achieved across the supply chain. 1. **Facilities**: are the places in the supply chain network where product is fabricated, assembled and stored. The two major types of facilities are production sites and storage sites. Whatever the function of the facility decisions regarding location, **capacity and flexibility** of facilities have a significant impact on the supply chain's performance. - **Location**: Deciding where a company will locate its facilities constitutes a large part of the design of a supply chain. A basic **trade-off** here is whether to centralize to gain economies of scale or decentralize to become more responsive by being closer to the customer. Companies must also consider a host of issues related to the various characteristics of the local area in which the facility may be situated. These include **macro-economic factors**, **quality of workers**, **cost of workers**, **cost of facility**, **availability of infrastructure**, **proximity to customers** **and the rest of network, tax effects and other strategic factors.** - **Capacity**: Companies must also decide the capacity of its facility to perform its intended function or functions will be. A large amount of **excess capacity** allows the facility to be very flexible and to respond to wide swings in the demands placed on it. Excess capacity, however, costs money and therefore can decrease efficiency. A facility with **little excess capacity** will likely to be more efficient per unit of product it produces than one with a lot of **unused capacity**. Therefore, a company must make a trade-off to determine the right amount of capacity to have at each of its facilities. - **Operations Methodology**: Companies must make a major decision regarding the operations methodology that a facility will use. They must decide whether to design a facility with **a product focus** or **functional focus**. A product-focused facility performs many different functions (e.g., fabrication and assembly) in producing **a single type** of product. A functional focused facility performs few functions (e.g., only fabrication or only assembly) **on many types** of products. A product focus tends to result more expertise about a particular type of product at the expense of the functional expertise that comes from a functional methodology. Firms must decide which type of expertise will best enable them to meet customer needs. - **Warehousing Methodology**: As with manufacturing, there are a variety of methodologies from which companies can choose when designing a warehouse facility. Some of these methodologies include: - **Sock keeping unit (SKU) storage**: a traditional warehouse that stores **all of one type of product together.** This is a fairly efficient way to use store products. - **Job lot storage**: a methodology in which all the different types of products needed to perform a particular job or satisfy a particular type of customer are stored together. This generally requires more storage space but can create a more efficient picking and packing environment. - **Cross-docking**: a methodology in which goods are not actually warehoused in a facility. Instead, trucks carry from supplier, each carrying a different type of product, deliver goods to a facility. There, the inventory is broken into smaller lots and quickly loaded onto store-bound trucks that carry a variety of products, some from each of the supplier trucks. - **The overall Trade**-**Off: Responsiveness versus Efficiency**: The fundamental trade-off manager's face when making facilities decisions is between the cost of the number, location, and type of facilities (efficiency) and the level of responsiveness that these facilities provide to the company's customers. 2. **Inventory**: includes all raw materials, work in process, and finished goods within a supply chain. Inventory is an important supply chain driver because changing inventory policies can dramatically alter the supply chain's efficiency and responsiveness. For example, a clothing retailer can make itself more responsive by stocking large amounts of inventory. With a large inventory, the likelihood is high that the retailer can immediately satisfy customer demand with cloths from its floor. A large inventory, however, will increase the retailer's cost, thereby making it less efficient. Reducing inventory will make the retailer more efficient but will hurt its responsiveness. Components of inventory decisions are: **Cycle inventory**, **Safety inventory**, **seasonal inventory** and **sourcing**. - **Cycle Inventory**: Cycle inventory is the **average** amount of inventory used to satisfy demand between receipts of supplier shipments. The size of the cycle inventory is a result of the production or purchase of material in large lots. Companies produce or purchase in large lots to exploit economies of scale in the production, transportation, or purchasing process. With the increase in lot size, however, also comes an increase in carrying costs. The basic trade-off supply chain manager face is the cost of holding large lots of inventory (when cycle inventory is high) versus the cost of ordering product frequently (when cycle inventory is low). - **Safety Inventory**: This is inventory held in case **demand exceeds expectation**; it is held to counter uncertainty. If the world were perfectly predictable, only cycle inventory would be needed. Because demand is uncertain and may exceed expectations, however, companies hold safety inventory to satisfy unexpectedly high demand. Managers face a key decision when determining how much safety inventory to hold. Therefore, choosing safety inventory involves making a trade-off between the costs of having too much inventory and the costs of losing sales due to not having enough inventory. - **Seasonal Inventory**: This inventory is inventory that is built up to counter predictable variability in demand. Companies using seasonal inventory will build up inventory in periods of low demand and store it for periods of high demand when they will not have the capacity to produce all that is demanded. Managers face key decisions in determining whether to build seasonal inventory, and if they do build it, in deciding how much to build. If a company can rapidly change the rate of its production system at very low cost, then it may not need seasonal inventory because the production system can adjust to a period of high demand without incurring large costs. However, if changing the rate of production is expensive (e.g., when workers must be hired or fired), then a company would be wise to have a smooth production rate and build up its inventory during periods of low demand. Therefore, the basic trade-off supply chain managers face in determining how much seasonal inventory to build is the cost of carrying the additional seasonal inventory versus the cost of having a more flexible production rate. - **Sourcing:** sourcing is the set of business processes required to purchase goods and services. Managers must first decide the tasks that will be outsourced and those that will be performed within the firm. For each task, the manager must decide whether to source from a single supplier or a portfolio of suppliers. If a portfolio of multiple suppliers is to be carried, the role of each supplier in the portfolio must be clarified. The next step is to identify the set of criterion that will be used to select suppliers and measure their performance. Managers then select suppliers and negotiate contracts with them. Contracts should be structured to improve supply chain performance and minimize information distortion from one stage to the next. Contracts also clearly define the role of each supply source. Sourcing decisions are crucial for a firm because they affect all other inventory decisions and the level of efficiency and responsiveness the supply chain can achieve. **Overall Trade-Off**: **Responsiveness versus Efficiency**: The fundamental trade-off manager's face when making inventory decisions is between responsiveness and efficiency. Increasing inventory will generally make the supply chain more responsive to the customer. This choice, however, comes at a cost as the added inventory decreases efficiency. Therefore, a supply chain manager can use inventory as one of the drivers for reaching the level of responsiveness and efficiency the competitive strategy targets. **3. Transportation**: transportation entails moving inventory from point to point in supply chain. Transportation can take the form of many combinations of modes and routes, each with its own performance characteristics. Transportation choices have a large impact on supply chain responsiveness and efficiency. A company can use a faster mode of transportation like airways to ship products, thus making their supply chain more responsive but also less efficient given the high costs associated with air transport. Or the company can use slower but cheaper water or ground transportation to ship the product, making supply chain efficient but limiting its responsiveness. Components of transportation are: **mode of transportation**, **route and network selection**, and in **house or outsourcing**. **Mode of Transportation**: it is the manner in which a product is moved from one location in supply chain network to another. Companies have six basic modes from which to choose. - **Air**: The fastest and most expensive mode - **Truck:** A relatively quick and inexpensive mode with high levels of flexibility - **Rail:** An inexpensive mode used for large quantities. - **Ship:** The slowest mode but often the only economical choice for large overseas shipments. - **Pipeline:** Used primarily to transport oil and gas - **Electronic transportation**: The newest mode that" transports" goods such as music, previously sent solely by physical modes, electronically via the internet. Each mode has different characteristics with respect to the speed, size of shipments, cost of shipping, and flexibility that lead companies to choose one particular mode over the other. **Route and network selection**: Another major decision managers must make is the route and network along which products are shipped. A route is the path along which a product is shipped and a network is the connection of locations and routes along which a product can be shipped. For example, a company needs to decide whether to ship products directly to customers or to use series of distribution channels. **Inhouse or Outsource**: Traditionally, much of the transportation function has been performed inhouse. Today, however, much of transportation (and even entire logistics systems) outsourced. Having to choose between bringing parts of transportation inhouse or outsourcing leads to another dimension of complexity when companies are designing their transportation systems. **Overall Trade-Off:** **Responsiveness versus Efficiency**: The fundamental **trade-off** for transportation is between the cost of transporting a given product (efficiency) and the speed with which that product is transported (responsiveness). The transportation choice influences other drivers such as inventory and facilities. When supply chain managers think about making transportation decisions, they frame the decision in terms of this trade-off. 4**. Information**: it consists of data analysis concerning facilities, inventory, transportation, and customers throughout the supply chain. Information is potentially the biggest driver of performance in the supply chain as it directly affects each of the other drivers. Information presents management with the opportunity to make supply chains more responsive and efficient. **Components of information decisions are**: push versus pull, coordination and information sharing, forecasting and aggregate planning, pricing and resource management and enabling technologies' versus Pull: When designing pieces of supply chain, managers must determine whether these pieces are part of the push or pull phase in the chain. Push systems generally require information in the form of elaborate Material Requirments Planning systems to take the master production schedule and roll it back, creating schedules for suppliers with part types, quantities and delivery dates. Pull systems require information on actual demand to be transmitted extremely quickly throughout the entire chain so that production and distribution of parts and products may accurately reflect the real demand. **Coordination and Information** **Sharing**: Supply chain coordination occurs when all the different stages of a supply chain work toward the objective of maximizing total supply chain profitability rather than each stage devoting itself to its own profitability without considering total supply chain profit. Lack of coordination can result in a significant loss of supply chain profit. Managers must decide how to create this coordination in the supply chain and what information must be shared in order to accomplish this goal. Coordination between different stages in supply chain requires each stage to share appropriate information with other stages. For example, if a supplier is to produce the right parts in a timely manner for a manufacturer in a push system, the manufacturer must share demand and production information with the supplier. Information sharing is thus crucial to the success of a supply chain. **Forecasting and Aggregate Planning:** Forecasting is the art and science of making projection about what future demand and conditions will be. Obtaining forecasting information frequently means using sophisticated techniques to estimate future sales or market conditions. Managers must decide companies often use forecasts both on a tactical level to schedule production and on strategic level to determine whether to build new plans or even whether to enter a new market. Once a company creates a forecast, the company needs a plan to act on this forecast. Aggregate planning transforms forecasts into plans of activity to satisfy the projected demand. A key decision manager's face is how to collaborate on aggregate planning throughout supply chain. The aggregate plan becomes a critical pieces of information to be shared across the supply chain because it affects both the demand on a firm's suppliers and the supply to its customers. **Pricing and Revenue Management**: Pricing is the process by which a firm decides how much to charge customers for its goods and services. Demand and supply information is a fundamental input into the pricing decisions. A firm must understand the impact of price and competition on demand and the cost of supply when deciding whether to run a price promotion. Information on the availability of supply chain assets and the demand for these assets is needed for a firm to decide the best pricing strategy. Revenue management is the use of different pricing over time or customer segments to maximize profits from a limited set of supply chain assets. For effective revenue management, the supply chain must have good information on asset availability, customer demand, and customer behavior when faced with differential pricing. **Enabling Technologies**: Many technologies exist that share and analyze information in the supply chain. Managers must decide which technologies to use and how to integrate these technologies into their companies and their partner's companies. The consequences of these decisions are becoming more and more important as the capabilities of these technologies grow. Some of these technologies include: 1. Electronic Data Interchange (EDI) allows companies to place **instantaneous** paperless purchase orders with suppliers. EDI is not only efficient, but it also decreases the time needed to get products to customers as transactions can occur more quickly and accurately than when they are paper based. 2. The Internet has critical advantages over EDI with respect to information sharing. The Internet conveys much more information and therefore offers much more visibility than EDI. Better visibility enables stages in the supply chain to make better decisions. Internet communication between stages in the supply chain is also easier because a standard infrastructure (the World Wide Web) already exists. Thanks to the Internet, e-commerce has become a major force in the supply chain. 3. Enterprise Resource Planning (ERP) systems provide the transactional tracking and global visibility of information from any part of a company and its supply chain that allows intelligent decisions to be made. This real time information helps a supply chain to improve the quality of its operational decisions. ERP systems keep track of the information, whereas the Internet provides one method with which to view this information 4. Supply Chain Management (SCM) software adds a higher layer to ERP systems. This software provides analytical decision in addition to the visibility of information. ERP systems show a company what is going on while SCM systems help a company decide what it should do. **Chapter Three: procurement procedures** **3.1 Introduction** The procurement management requires some standard operation procedures to be performed in the normal daily tasks. The purchasing activity involves expenditure of large amount of money. This requires: - an objectivity of being economical and effective when dealings with suppliers - Establishing an efficient system that protects the purchasing material from waste and theft and handles purchasing and inventory information. Therefore, in view of the above point, this unit deals with the steps followed in purchasing and materials management activity A purchasing department buys many different types of materials and services and the procedures used in completing a total transaction normally vary among the different types of purchases. However, the general cycle of activities in operating purchasing, materials and suppliers are fairly standardized. The following steps constitute the typical purchasing cycle. 1\. Recognition of need 2\. Describing the need with accurate and clear statements 3\. Determining and analyzing possible source of supply 4\. Assessing the prices and terms 5\. Preparing and planning of the purchase order 6\. Follow-up (expediting) or (de-expediting) the order. 7\. Receiving and inspecting goods 8\. Clearing invoice and payment 9\. Maintaining purchasing and inventory records **3.2 Steps in Procurement procedures** **1. Recognition, definition and description of the need** The need for a purchase typically originates in one of a firm's operating departments or in its inventory control section. The purchasing department is usually notified of the need by one of the basic methods. i\) Standard purchase requisition or ii\) A material requirements planning (MRP) schedule. If the need is one-time purchase, then an engineering bill of materials is sometimes used. **a. Standard Purchase Requisition** **The purchase requisition is an internal document, in contrast with the purchase order, which is basically an external document. Most companies used a standard, serially numbered purchase requisition form for requests originating in the operating departments. The user generally makes a minimum of two copies.** **b. Material Requirements Planning Schedule** **When a design engineer completes the design of a part or an assembly, he or she makes a list of all the materials (and quantity of each) required to manufacture the item. This list is called an engineering bill of materials. In firms using computerized production and inventory planning systems such as an MRP system, the engineering bill of materials is first reconfigured into a structured multilevel bill of materials. This structured bill of materials for each item being manufactured can then be used in determining specific material requirements for a given production schedule during a specific time period.** **c. Engineering Bill of Material** **In firm's that do custom manufacturing work, or for various reasons are involved in unique one-time projects, a similar but less sophisticated approach can be used. When purchase of the required materials is a one-time affair, the engineering bill of materials along with the production department's need for materials. The buyer then obtains total requirements simply by manually extending the bill of materials for the production quantity scheduled. Thus, communications are simplified and the need for purchase requisitions is eliminated.** **d. Definitions and Description of the need** **Regardless of the form of transmission used, material requirements must be defined effectively and the most appropriate methods of description should be selected for the situation at hand. The point to be understood here is that clear, complete, appropriate definition and description is a joint responsibility of the user and the buyer. One of the reasons why every purchase authorization document should be approved by designated departmental supervisors is to ensure that qualified individuals initially review it and subsequently comes to procurement in correct form.** **e. The stock check** **Some companies route all requisitions for tools, supplies and production type materials to inventory control before they are sent to procurement. If a sizeable percentage of a firm's requisitions involve stores-type items, this procedure expedites the supply process and reduces clerical work in the procurement department.** **2. Supplier selection and preparation of the purchase order** **The procurement of a new or a high value item, on the other hand, may require a lengthy investigation of potential suppliers. If the item to be procured is complex or highly technical, the firm may utilize across functional sourcing team, first to qualify potential suppliers and perhaps eventually to make a team decision about the most desirable supplier.** **A) Sources of Supply** **While purchasing and supply management has the ultimate responsibility for selecting the "right" source, the process is handled in many ways. Procedurally, the simplest approach is when the buyer alone conducts the analysis and makes the selection. A second common approach calls for the use of a cross-functional team consisting of representatives of purchasing and supply management, design engineering, operations, quality and finance. The third common approach is the use of a commodity teams.** **B) Commodity Teams** **Commodity teams frequently consist of buyers, materials, engineers and production planners. Large commodity teams include a commodity manager (normally from purchasing and supply management) and representatives of materials, design and manufacturing engineering, quality and finance. Commodity teams are essentially a type of cross-functional team. The principal difference between them is that commodity teams tend to be fairly permanent, while cross-functional teams tend to be one-time assignment.** **C) Evaluating a Potential Supplier** **After developing a comprehensive list of potential suppliers, the buyer's next step is to evaluate each prospective supplier individually. A process of elimination develops a selected list of potential suppliers with whom the buying company may be willing to do business.** **d) Type of Evaluation Needed** **The type of evaluation needed required determining supplier capability varies with the nature, criticality, complexity and dollar value of the purchase to be made.** **i. Preliminary surveys** **If an examination of existing data indicates that a firm appears to be an attractive supplier for existing or anticipated requirements, a telephone or mail survey should be conducted to obtain additional information. Such a survey should provide sufficient knowledge of the supplier to make a decision to include or exclude the firm from further consideration. Clearly, this sound precedes any plant visits.** **ii. Financial condition** **Preliminary investigation of a potential supplier's financial conditions often can avoid the expense of further study. A qualified buyer or professional from the finance department conducts these investigations. A review of financial statements and credit ratings can reveal whether a supplier is clearly incapable of performing satisfactorily.** **iii. Quality Capability** **A critical factor to examine is the firm's quality capability. If the prospective supplier's process capability is less than the buying firm's incoming quality requirements, the suppliers typically is not worthy of further investigation. An obvious exception is the case in which no supplier possesses the required capability** **vi. Plant Visit** **By visiting a supplier's plant or distribution facility, the sourcing team can obtain firsthand information concerning the adequacy of the firm's technological capabilities, manufacturing or distribution capabilities and its management's technical know-how and orientation. Depending on the importance of the visit, the company may send representatives from only procurement and engineering or it may also include some combination of representation from finance, operations, quality assurance, marketing and industrial relations.** **3. Preparation and placement of the purchase order** **The evaluation of bid results in the selection of a supplier. Once the supplier is selected, purchase order must be prepared by purchasing clerk. Sometimes there is an urgent need, an order can be placed using a telephone and telegraph. However, telephone order is to be confirmed in written order later.** **All proper contracts must be included in the purchase order to avoid any legal complications later. Sometimes, it is important also to consider how to make compromise when the seller wants to enforce his own provision or when he is not willing to accept the provision stated in the purchase order. This is because it is natural for any organization to protect itself from entering into any legal obligations that may endanger his business operation later.** **The form of purchase orders varies from organization to organization depending on the type of business it is conducting. Purchase order of a service giving organization may not be similar with purchase order of manufacturing organization because their nature of business and operation are different. However, any purchase order form should contain the serial numbers, date of issue, the name and address of the firm receiving the order, quantity and description of the items ordered, date of delivery required, shipping direction, price, terms of payment and conditions governing the order. Based on their activities, different organizations may follow different principles on the number of purchase order copies to be distributed. In a typical organization for example, the original copy with additional copy is sent to the supplier (the supplier uses the additional copy to confirm acceptance of the order). One copy to accounting, one copy to the using department, one copy to the store, one copy to the receiving department (if receiving and store are two separate departments), and one copy remains in the purchasing department for follow up purpose. In addition, the purchasing clerk should not forget to link the purchase order to the requisition as a reminder to show that a purchase order is already done for that particular requisition.** **4. Acknowledgement and follow-up of the order** **In most cases, the original copy of the purchase order, which is sent to the supplier, constitutes a legal "offer" to buy. No purchase "Contract" exists, however, until the seller "Accepts" the buyer's offer. The seller's acceptance can take one of the two forms.** **i) Performance of the contract or** **ii) Formal notification that the offer is accepted.** **The purpose of sending the supplier an acknowledgement form along with the purchase order is twofold. First, it is a form that can be completed conveniently and returned to the buyer, acknowledging acceptance of the order. At the same time, the supplier can indicate whether or not it is able to meet the desired delivery date. If a supplier ships the ordered item immediately from stock, it frequently disregards the acknowledgement form.** **In some firms, the buyer handling the order conducts follow-up procedures. In others, a separate expediting group conducts follow-up activities. Although relatively few in number, some firms maintain a force of follow-up personnel in the field such firms typically purchase a great deal of critical material or major equipment on very tight schedules. To ensure that all materials are available when needed, these firms track critical purchases by having traveling follow-up representatives personally visits suppliers' plants. In some situations these field personnel have the additional responsibility of attempting to speed up (expedite) or even delay (de-expedite) delivery as the buyer's timing requirement undergo unexpected changes.** **5. Receipt and Inspection** **The next step in the traditional procurement cycle is receipt and inspection of the order. When a supplier ships material, it includes in the shipping container a packing list which itemizes and describes the contents of the shipment. The receiving clerk uses this packing list in conjunction with his/ her copy of the purchase order to verify that the correct material has been received. After a shipment has been inspected for quality and for general condition of the material, the receiving clerk issues a receiving report. In some cases, the report is prepared on separate receiving department forms. However, the trend in most companies today is to reduce the clerical work by using an online computer based system, coupled with bar code order identification or by preparing a receiving report form during the same typing or printing operation that prepares the purchase order.** **5. Settling invoices or effecting payment** **After the store (receiving) department confirms, it is the accounting section that clears invoices by effecting payments. There is no uniform procedure in all organizations for settling payments. Checking invoices and continuing receipt will be part of the function of procurement department and sore (receiving) department. After getting all the justifications for payment, the accounting section makes prompt payment by taking into account the advantages that the organization may get from discounting or establishing a good relationship with the supplier. Sometimes invoices may arrive to the accounting section a head of the arrival of the items. However, whether the intent is clearing invoice or paying cash, payment must be effected after accounting section gets receiving copy from store (receiving) department and approval from procurement section.** **6. Maintenance of records and files** **After going all the steps described above, the last step is to maintain the purchase order files, inventory files and supplier files. Recording the information is a routing task but an essential activity of an organization. Recording and keeping procurement and inventory data has the following three major purposes.** 1. **To control the material flow within an organization** 2. **To prepare procurement and inventory reports to management** 3. **To make future procurement decisions** **However, judgments are required for how certain information needs to be kept in the organization. In recent years, computers have become useful instruments for organization for maintaining and processing procurement and inventory data.** **The files of a procurement department contain an endless flow of operating data. Despite its huge volume, much of this information can be useless in daily operations unless it is organized in a manner, which makes it readily accessible. The following basic records are essential for the effective operation of most procurement departments.** **1. Record of Open Orders** **All buyers need immediate access to information concerning the status of their outstanding orders. The record system can be maintained on a computer, in hard copy form, or as a combination of the two.** **2. Record of Closed Orders** **The closed order file provides a historical record of all completed procurements. It frequently serves as a useful reference when questions arise concerning past orders and when certain historical data are needed to guide future decisions.** **3. Purchase Log** **Every purchasing department should maintain an ongoing record in numerical sequence, of all purchase orders issued. The record not be elaborated, but it should contain the purchase order number, the status of the order, the supplier's name, a brief description of the material purchased and the total value of the order. Such a record summarizes the commitments for which the procurement executive is responsible.** **4. Commodity Records** **The file of commodity records constitutes a vast reservoir of materials data that makes efficient "mass production purchasing" possible. A commodity record card or computer file should be maintained for each major material and service that is purchased repetitively. Typically included in the record is a complete description of the material or service, with full reference to necessary engineering drawings and specification, which might be filled elsewhere.** **5. Supplier Record** **To provide quick access to information about suppliers, most companies centralize such information in a single record file. A separate card or computer record is maintained for each major supplier. In this record is recorded the address, telephone number and the names of personnel to contact on a specific matters of inquiry.** **6. Blueprint and specification record:** - In metalworking and similar industries, many items are purchased by blueprint specification. Such specifications often are very detailed and cannot be reproduced on the purchase order. Even if they could be, there would be risk of errors in transcribing from the master copy. Such items are ordered by writing a brief description of the part on the purchase order with a reference to blueprints and specifications that are enclosed with and made a legal part of the order. To facilitate the forwarding of such specifications a procurement department may maintain a file of blueprints and specifications covering all parts in current use. Generally, blueprints and specifications are kept in separate files, with an index showing their location and where the copies have been sent. Thus, for repeated orders to old suppliers, it is not necessary to send a new copies of the specifications. The record is also helpful in mailing corrected copies when a change is made in a blueprint or specification. Certain goods may be bout under a term contract: if so, the procurement department must maintain a record of such contracts. This record is specially, important if the contract is an open one, against which orders may be placed within the contract quantity. **7. Purchase order journal**: - A few procurement department maintain a daily journal where all purchase orders placed during the day are entered. The name of the vendor and the amount of money value of the order are entered. This records has a dual purpose: It is useful to the purchasing officer in preparing reports on the activity of his/her department and it is sometimes used by the finance department as indication of the amount of expenditure to which the company is being committed. The record is especially useful in a procurement department that is operated on a budget. It can be used to show whether purchases comply with the budget figures. **8. Contract Record:** - Today most firms are purchasing an increasing number of items on a long-term contractual basis. In such cases, it is usually convenient to consolidate all contracts in a separate file. In addition to providing immediate access to all contract documents, this file also apprises all buying personnel of the materials that are purchased in this manner. If the number of contracts is large, it is desirable also to list them in summary form to provide a bird's eye view of all contract procurements and their expectation dates **3.3 Handling order problems** **The small order problem** Small orders are a serious problem in every organization. Clearly no manager wants to devote more buying and clerical effort to the expenditure of less than 10 percent of his/ her funds than to the expenditure of the other 90 percent. The very nature of business requires the procurement of many low-value items. Nevertheless, small orders are costly to buyer and seller alike. The various methods used by procurement manager to deviate the small order problem can be as illustrated below. **1. Centralized Store System** A stores system is the first approach typically used to reduce the volume of small-order procurement activity. When expenditure shows that the same supply items are ordered in small quantities time after time, the logical solution is to order these items in larger quantities and place them in a centralized inventory for withdraws as needed. **2. Blanket Order System** A store system solves the small-order problem only for items that are used repetitively. A blanket order system helps solve the problem for the thousands of items a firm cannot carry in inventory, as well as some that it does carry. Briefly, the general procedure used for this type of purchase is as follows. On the basis of an analysis of past procurements, the buyer determines which materials should be handled in this manner. After bidding or negotiation, the buyer selects a supplier for each item, or family of items, and issues a blanket order to each supplier. The order includes a description of each item, a unit price for each item when possible, and the other customary contract provisions. However, no specific order quantities are noted. The blanket order typically indicates only an estimated usage during the period of coverage (usually one to three years). It also states that all requirements are to be delivered up on receipt of a release from the buyer or other authorized person. On receiving a requisition for one of the materials, the buyer merely sends a brief release form to the supplier. On the release form are noted the blanket order number, the item number, and the quantity to be delivered. Receiving reports are filed with the original order, and at the end of the month are checked against the suppliers' monthly invoice. At the end of the period, the order may be reviewed or placed with another firm, depending on the suppliers' performance record. The blanket order system offers six important benefits: - It requires fewer purchase orders and reduces clerical work in procurement, accounting and receiving. - It releases buyers from routine work, giving them more time to concentrate on major problems. - It permits volume pricing by consolidating and grouping requirements. - It can improve the flow of feedback information, because of the grouping of materials and suppliers. - Because of some suppliers will stock material for prompt delivery, this system may reduce the buyer's lead times and inventory levels. - It develops longer-term and improved buyer supplier relationships. To function effectively in the long run, however, any blankets order systems must provide adequate internal control. Absence of the control encourages petty fraud and poor supplier performance. **3. Systems Contracting** A system contracting is simply an extension and more sophisticated development of the blanket order procurement concept. Some firms call it "stockless" procurement. As its name implies, systems contracting involves the development of a corporate wide agreement, often a one-to five year requirements contract with a supplier to purchase a large group or "family" of related materials. The items to be purchased are usually described in detail as "catalog" that belongs part of the contract. Estimated usage usually is included along with a fixed price for each item and an agreement by the supplier to carry a stock of each item adequate to meet the buyer's needs. Various types of supplies and commonly used operating items, typically purchased from distributors are the materials most often covered by these types of agreement. **4. Telephone/Fax Order Systems** Most companies now use a telephone or fax ordering system to reduce the paperwork associated with small-order procurement. Under this system, when the procurement department receives a requisition, it does not prepare a formal purchase order. Instead, the order is placed by telephone or fax, and the requisition is used in the receiving procedure. **5. Petty Cash** Most firms today use a petty cash fund for making small one-time purchases. For this purpose, many firms define "small" as under \$ 1000. It is often less expensive for an individual user to buy minor items personally and pay for them from a petty cash fund than it is to buy them through the conventional purchasing system. 6\. **Supplier Stores/Consignment System** If a purchaser buys a large enough volume of certain materials from a single supplier, the supplier sometimes can afford to start a small "store" at the purchaser's plant and operate it on a consignment basis. Users then simply go to the store and sign for their purchases. At the end of the month the company is billed for its purchases just as if the user had "gone downtown" to buy the material. **7. Supplier Delivery System** The supplier delivery system is somewhat similar to a supplier stores system, but it is more feasible for firms with a smaller volume of purchases. Many suppliers who are not willing to set up a store at the buyer's plant are willing to stock numerous miscellaneous materials and make daily or semiweekly deliveries. The buyer typically reviews and accumulates purchase requisitions for such materials. The various methods used by purchasing manager to deviate small order problems are: centralized store system, blanket order system, system contracting, telephone/fax order system, petty cash system, and supplier delivery system. **3.4 Review questions** 1\. List the purchasing cycle in their order 2\. How can the purchasing department be notified about the needs? 3\. Explain about supplier selection and preparation of purchase order 4\. What are criteria for evaluating suppliers? 5\. How the buyer can confirm the seller's acceptance? 6\. What are the purposes of recording and keeping purchasing and inventory? 7\. Explain the different types of purchase records 8\. Discuss the various types of order problems **Chapter four: Suppliers Evaluation and selection** **4.1 Introduction** Purchasers usually evaluate potential suppliers across a number of performance categories before making a final selection decision. Firms that perform supplier evaluation usually have their own performance and selection criteria. For example, a firm that requires consistent delivery performance to support its just-in- time manufacturing system may emphasize a supplier's scheduling and production systems, which directly impact a supplier's delivery performance. A higher technology buyer may emphasize a supplier's process and technological capabilities. Initially, procurement manager will evaluate suppliers on three primary criteria: **Price, quality, and delivery elements.** These three elements of performance are generally the most critical areas that will affect the purchasing company. The supplier's price must be in line with the price quoted by other suppliers, and must also meet the purchasing manager's expectations in terms of value. Before determining the sources of supply and supplier evaluation, management should decide whether the required materials can be made within the organization or can be bought from outside sources 4**.2 Make or buy decisions** How does a make or buy decision originate? This decision may originate in any of the following events i. When we are planning to produce a new product or modify the existing product ii. When the current performance of supplier is unsatisfactory iii. Changing demand in the external environment (increase or decrease of demand) Now before buying or making the parts the cost should be evaluated. The relevant cost of buying is; purchase cost of the parts, transportation costs and receiving and inspection costs. The costs of making includes; In general, - Delivered raw material cost - Direct labor cost - Incremental managerial cost - Inventory carrying cost - Cost of capital and - Opportunity cost In order to make a sound managerial decision, we should have to consider the factors specifying favoring the making or buying decisions **Factors that specifically favor the making decisions** i. When the cost to make substantially lower or less than the cost to buy ii. When the demand for the product is stable &at the higher value so t

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