Purchasing & Strategic Sourcing PDF

PURCHASING AND STRATEGIC SOURCING TABLE OF CONTENTS BLOCK NO.I PURCHASING OPERATIONS AND STRUCTURE UNIT 1. The Purchasing and Supply Process ….. 3 UNIT 2 Purchasing Policies and Procedures...

PURCHASING AND STRATEGIC SOURCING TABLE OF CONTENTS BLOCK NO.I PURCHASING OPERATIONS AND STRUCTURE UNIT 1. The Purchasing and Supply Process ….. 3 UNIT 2 Purchasing Policies and Procedures ….. 21 UNIT 3 Supply Management Integration for Competitive Advantage ….. 25 BLOCK NO.II STRATEGIC SOURCING – I (ANALYSIS) UNIT 4 Purchaging and Supply Oranization ….. 33 UNIT 5 Supply Management and Commodity strategy ….. 44 UNIT 6. Supplier Evauation and selection ….. 55 UNIT 7. Purchasing Analysis: Tools and Techniques.… 60 BLOCK NO.III STRATEGIC SOURCING – II (QUALITY) UNIT 8. Supplier Quality Management …. 68 UNIT 9. Supplier Management and Development ….. 76 BLOCK NO.IV STRATEGIC SOURCING – II (PROCESS) UNIT 10. Strategic Cost Management …. 86 UNIT 11. Negotiation …. 94 UNIT 12. Contracting ….. 99 1 PURCHASING AND STRATEGIC SOURCING BLOCK I: PURCHASING OPERATIONS AND STRUCTURE Unit 1: The Purchasing and Supply Process This unit deals with thevarious processes associated with purchasing.Purchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise. Though there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations. Buyers need the ability to select products that consumers will want to buy, so they need to understand trends as well as economic conditions that affect consumer buying decisions. Unit 2: Purchasing Policies and Procedures In this unit we discuss about the various purchasing policies and procedures Policy refers to the set of purposes, principles, and rules of action that guide an organization. Rules of action refer to standard operating procedures along with any rules and regulations. Purchasing management develops policies to provide guidance and support to the professional purchasing and support staff. Unit 3: Integrated Purchasing – Supply Management Integration for Competitive Advantage This unit discusses the various issues associated with supply management integration. Whatever the appeal and promise of integrated supply management, achieving integration is a challenge. In firms with conventionally organized sub functions, supply managers are primarily concerned with satisfying their own sub functional objective. Purchasing managers minimize purchasing costs; marketing managers minimize distribution costs; and so on. Unit 4: Purchasing and Supply Organization In this unit the purchasing organization issues are addressed – what are the prerequisites for such organization and what should be considered beforehand, what are possible solutions and which attributes are there to differentiate between various configurations. In addition, attention is drawn to few key elements that should be considered within any certain structure. UNIT 1 THE PURCHASING AND SUPPLY PROCESS Objectives Understand the differences between purchasing and supply management Understand the differences between supply chains and value chains Identify the activities that are part of supply chain management Appreciate the importance of supply chain enablers 2  PURCHASING AND STRATEGIC SOURCING Identify the historical stages of purchasing evolution Structure: 1.0 Introduction to purchasing and SCM 1.1 Strategic supply management roles and responsibilities 1.2 Improving the procure to pay process 1.3 Approval, contract and purchase order preparation 1.4 Types of purchases 1.0 What is Purchasing Management? Purchasing management directs the flow of goods and services in a company and handles all data relating to contact with suppliers. Effective purchasing management requires knowledge of the supply chain, business and tax laws, invoice and inventory procedures, and transportation and logistics issues. Although a strong knowledge of the products and services to be purchased is essential, purchasing management professionals must also be able to plan, execute, and oversee purchasing strategies that are conducive to company profitability. Sourcing reliable suppliers is a crucial part of purchasing management. Purchasing managers, agents, and buyers usually learn about new products and services from Internet searches, trade shows, and conferences. They meet with potential suppliers in their plants whenever possible. Skills in foreign languages may be helpful for sourcing suppliers in other countries. Purchasing management professionals must always assess potential suppliers in terms of the supplier's ability to deliver quality merchandise at a suitable price on time. 3 PURCHASING AND STRATEGIC SOURCING Fig. 1.1 Purchasing Management Overview 1.2 Defining Supply Management Purchasing management professionals must be good negotiators, understand technical product information, have good mathematical ability, understand spreadsheet software, understand marketing methodology, and be outstanding decision makers. Increased responsibilities in purchasing management require good leadership skills, and higher positions often require a master's degree in a business related subject. Entry level purchasing management positions such as junior buyers, assistant buyers, and purchasing clerks, often require a college degree and some product knowledge. Larger distributors may require a bachelor's degree for entry level purchasing management positions. Training and learning typically start in sales, then supervision, and invoice and stock monitoring. Professional purchasing management designations include Certified Professional in 4  PURCHASING AND STRATEGIC SOURCING Supply Management (CPSM) in the United States, and Certified Professional Purchaser (CPP) in Canada. Purchasing managers, buyers, and materials managers control budgets, manage staff, and may analyze procurement methods as well as negotiate supplier contracts. Purchasing management professionals must understand tax laws, purchasing trends, ethics, and global outsourcing issues. Buyers and purchasing agents usually deal specifically with purchasing tasks, while purchasing managers usually supervise others, including purchasing agents. However, titles and duties vary greatly between industries and employers. Buyers often have assistants to place orders and keep track of delivery details. Buyers need the ability to select products that consumers will want to buy, so they need to understand trends as well as economic conditions that affect consumer buying decisions. Buyers employed in small stores may be responsible for purchasing the store's entire inventory, while buyers working for larger operations may focus on a few product lines. Purchasing Purchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise. Though there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations. Typically the word “purchasing” is not used interchangeably with the word “procurement”, since procurement typically includes Expediting, Supplier Quality, and Traffic and Logistics (T&L) in addition to Purchasing. 1.1 Strategic supply management roles and responsibilities Purchasing managers/directors, and procurement managers/directors guide the organization’s acquisition procedures and standards. Most organizations use a three-way check as the foundation of their purchasing programs. This involves three departments in the organization completing separate parts of the acquisition process. The three departments do not all report to the same senior manager to prevent unethical practices and lend credibility to the process. These departments can be purchasing, receiving; and accounts payable or engineering, purchasing and accounts payable; or a plant manager, purchasing and accounts payable. Combinations can vary significantly, but a purchasing department and accounts payable are usually two of the three departments involved. Historically, the purchasing department issued Purchase Orders for supplies, services, equipment, and raw materials. Then, in an effort to decrease the administrative costs associated with the repetitive ordering of basic consumable items, "Blanket" or "Master" Agreements were put into place. These types of agreements typically have a longer duration and increased scope to maximize 5 PURCHASING AND STRATEGIC SOURCING the Quantities of Scale concept. When additional supplies are required, a simple release would be issued to the supplier to provide the goods or services. Fig. 1.3 Four pillars of purchasing and supply chain excellence We need to recognize the differences between purchasing and supply management. Purchasing is a functional group (i.e., a formal entity on the organizational chart) as well as a functional activity (i.e., buying goods and services). The purchasing group performs many activities to ensure it delivers maximum value to the organization. Examples include supplier identification and selection, buying, negotiation and contracting, supply market research, supplier measurement and improvement, and purchasing systems development. Purchasing has been referred to as doing “the five rights”: getting the right quality, in the right quantity, at the right time, for the right price, from the right source. In this text we will interchange the terms “purchasing” and “procurement.” Supply management is not just a new name for purchasing but a more inclusive concept. We feel supply management is a strategic approach to planning for and acquiring the organization’s current and future needs through effectively managing the supply base, utilizing a process orientation in conjunction with cross-functional teams (CFTs) to achieve the organizational mission. Similar to our definition, the Institute for Supply Management defines supply management as the identification, acquisition, access, positioning, and management of resources and related capabilities an organization needs or potentially needs in the attainment of its strategic objectives. 6  PURCHASING AND STRATEGIC SOURCING Fig 1.4 A cereal Manufacturer’s Supply Chain A supply chain orientation is a higher-level recognition of the strategic value of managing operational activities and flows within and across a supply chain. A supply chain is a set of three or more organizations linked directly by one or more of the upstream or downstream flows of products, services, finances, and information from a source to a customer. Supply chain management, then, endorses a supply chain orientation and involves proactively managing the two-way movement and coordination of goods, services, information, and funds (i.e., the various flows) from raw material through end user. According to this definition, supply chain management requires the coordination of activities and flows that extend across boundaries. Organizations that endorse a supply chain orientation are likely to emphasize supply chain management. Regardless of the definition or supply chain perspective used, we should recognize that supply chains are composed of interrelated activities that are internal and external to a firm. These activities are diverse in their scope; the participants who support them are often located across geographic boundaries and often come from diverse cultures. Although many activities are part of supply chain management (which a later section discusses), an improved perspective visualizes supply chains as composed of processes rather than discrete, often poorly aligned activities and tasks. A process consists of a set of interrelated tasks or activities designed to achieve a specific objective or outcome. New-product development (NPD), customer-order fulfillment, supplier evaluation and selection, and demand and supply planning are examples of critical organizational processes that are part of supply chain management. 7 PURCHASING AND STRATEGIC SOURCING Strategic Purchasing Strategic purchasing is the process of planning, implementing, evaluating, and controlling strategic and operating purchasing decisions for directing all activities of the purchasing function toward opportunities consistent with the firm's capabilities to achieve its long‐term goals”. In the supplier selection process companies use a selection of criteria in order to determine whether the supplier lives up to the standard or not. The most important supplier selections criteria’s is quality that consistently is on the top of the list of important supplier assessment criteria. Delivery precision is often mentioned as another important. Price is often considered to be an important selection criteria (Kannan, et al., 2002) although some studies indicates that it is becoming less important because of, among other reasons, closer supplier‐customer relationships and less multiple sourcing (Simpson, et al., 2002). Other selection criteria that are considered important are capability, commitment to continuous improvements, customer service and flexibility Fig. 1.5 The supply chain of an automotive manufacturer showing the components and parts supplier, manufacturers and dealers 8  PURCHASING AND STRATEGIC SOURCING A world-class purchasing staff must continuously work to improve the efficiency and effectiveness of what we call the purchasing process. This is the process used to identify user requirements, evaluate the need effectively and efficiently, identify suppliers, ensure payment occurs promptly, ascertain that the need was effectively met, and drive continuous improvement. The challenges in ensuring that this process occurs effectively and efficiently are the theme of this unit. Until an organization can streamline the day-to-day purchasing process, it will continually delay implementing other important strategic activities that help their organization become more competitive. We introduce the following topics and ideas associated with purchasing in multiple industries: Purchasing objectives Purchasing responsibilities E-procurement and the procure to pay process Types of purchases Purchasing process improvements Purchasing Objectives The objectives of a world-class purchasing organization move far beyond the traditional belief that purchasing primary role is to obtain goods and services in response to internal needs. To understand how this role is changing, we must understand what purchasing is all about, starting with the primary objectives of a world-class purchasing organization Objective 1: Supply Continuity Purchasing must perform a number of activities to satisfy the operational requirements of internal customers, which is the traditional role of the purchasing function. More often than not, purchasing supports the needs of operations through the purchase of raw materials, components, subassemblies, repair and maintenance items, and services. Purchasing may also support the requirements of physical distribution centers responsible for storing and delivering replacement parts or finished products to end customers. Purchasing also supports engineering and technical groups, particularly during new-product development and outsourcing of key processes. With the dramatic increase in outsourcing, enterprises are relying increasingly on external suppliers to provide not just materials and products, but information technology, services, and design activities. As a greater proportion of the responsibility for managing key business processes shifts to suppliers, purchasing must support this strategy by providing an uninterrupted flow of high-quality goods and services that internal customers require. Supporting this flow requires purchasing to do the following: 9 PURCHASING AND STRATEGIC SOURCING 1. Buy products and services at the right price 2. Buy them from the right source 3. Buy them at the right specification that meets users’ needs 4. Buy them in the right quantity 5. Arrange for delivery at the right time 6. Require delivery to the right internal customer Purchasing must be responsive to the materials and support needs of its internal users (sometimes also called internal customers). Failing to respond to the needs of internal customers will diminish the confidence these users have in purchasing, and they may try to negotiate contracts themselves (a practice known as backdoor buying). Objective 2: Manage the Purchasing Process Efficiently and Effectively Purchasing must manage its internal operations efficiently and effectively, by performing the following: Determining staffing levels Developing and adhering to administrative budgets Providing professional training and growth opportunities for employees Introducing procure to pay systems that lead to improved spending visibility, efficient invoicing and payment, and user satisfaction Purchasing management has limited resources available to manage the purchasing process and must continuously work toward improved utilization of these resources. Limited resources include employees working within the department, budgeted funds, time, information, and knowledge. Organizations are therefore constantly looking for people who have developed the skills necessary to deal with the wide variety of tasks faced by purchasing. Procurement people must be focused on continuously improving transactional-level work through efficient purchasing systems that keep suppliers satisfied, which makes life easier for internal users. Objective 3: Develop Supply Base Management One of the most important objectives of the purchasing function is the selection, development, and maintenance of supply, a process that is sometimes described as supply base management. Purchasing must keep abreast of current conditions in supply markets to ensure that purchasing (1) selects suppliers that are competitive, (2) identifies new suppliers that have the potential for excellent performance and develops closer relationships with these suppliers, (3) improves existing suppliers, and (4) develops new suppliers that are not competitive. In so doing, purchasing can select and manage a supply base capable of providing performance advantages in product cost, quality, technology, delivery, and new-product development. Supply base management requires that purchasing pursue better relationships with external suppliers and develop reliable, high- quality supply sources. This objective also requires that purchasing work directly with suppliers to 10  PURCHASING AND STRATEGIC SOURCING improve existing capabilities and develop new capabilities. A good part of this text focuses on how purchasing can effectively meet this objective Objective 4: Develop Aligned Goals with Internal Functional Stakeholders U.S. industry has traditionally maintained organizational structures that have resulted in limited cross-functional interaction and cross-boundary communication. During the 1990s, the need for closer relationships between functions became clear. Purchasing must communicate closely with other functional groups, which are purchasing internal customers. These are sometimes called stakeholders, in that they have a significant stake in the effectiveness of purchasing performance! If a supplier’s components are defective and causing problems for manufacturing, then purchasing must work closely with the supplier to improve its quality. Similarly, marketing may spend a great deal on advertising and promotion, so purchasing must ensure that the pricing is competitive and that service-level agreements are being met. In order to achieve this objective, purchasing must develop positive relationships and interact closely with other functional groups, including marketing, manufacturing, engineering, technology, and finance. Objective 5: Support Organizational Goals and Objectives Perhaps the single most important purchasing objective is to support organizational goals and objectives. Although this sounds easy, it is not always the case that purchasing goals match organizational goals. This objective implies that purchasing can directly affect (positively or negatively) total performance and that purchasing must concern themselves with organizational directives. For example, let’s assume an organization has an objective of reducing the amount of inventory across its supply chain. Purchasing can work with suppliers to deliver smaller quantities more frequently, leading to inventory reductions. Such policies will show up as improved performance on the firm’s balance sheet and income statements. In so doing, purchasing can be recognized as a strategic asset that provides a powerful competitive advantage in the marketplace. Objective 6: Develop Integrated Purchasing Strategies That Support Organizational Strategies Far too often the purchasing function fails to develop strategies and plans that align with or support organizational strategies or the plans of other business functions. There are a number of reasons why purchasing may fail to integrate their plans with company plans. First, purchasing personnel have not historically participated in senior-level corporate planning meetings, because they were often viewed as slow to recognize the benefits that a world-class purchasing function can provide. As these two conditions are rapidly changing, purchasing is being integrated within the strategic planning process in multiple industries. A purchasing department actively involved within the 11 PURCHASING AND STRATEGIC SOURCING corporate planning process can provide supply market intelligence that contributes to strategic planning. Effective supply market intelligence involves the following: Monitoring supply markets and trends (e.g., material price increases, shortages, changes in suppliers) and interpreting the impact of these trends on company strategies Identifying the critical materials and services required to support company strategies in key performance areas, particularly during new-product development Developing supply options and contingency plans that support company plans Supporting the organization’s need for a diverse and globally competitive supply base Purchasing Responsibilities Functional groups carry out certain duties on behalf of the organization. We refer to this as a function’s responsibility or span of control. Purchasing must have the legitimate authority to make decisions that fall within their span of control. Span of control is established through senior management policies and support. Although internal customers influence many important decisions, final authority for certain matters must ultimately be assigned to the purchasing department. This section details those decision areas that are rightfully part of purchasing’s operating authority in most organizations Evaluate and Select Suppliers Perhaps the most important duty of purchasing is the right to evaluate and select suppliers—this is what purchasing personnel are trained to do. It is important to retain this right to avoid maverick buying and selling—a situation that occurs when sellers contact and attempt to sell directly to end users (purchasing’s internal customers). Of course, this right does not mean that purchasing should not request assistance when identifying or evaluating potential suppliers. Engineering, for example, can support supplier selection by evaluating supplier product and process performance capabilities. The right to evaluate and select suppliers also does not mean that sales representatives are not allowed to talk with non-purchasing personnel. However, non-purchasing personnel cannot make commitments to the seller or enter into contractual agreements without purchasing’s involvement. A trend that is affecting purchasing’s right to select suppliers is the use of sourcing teams with purchasing and non-purchasing representation. The selection decision in sourcing teams requires that the members reach a consensus in selecting suppliers. Review Specifications The authority to review material specifications is also within purchasing’s span of control, although engineering sometimes disputes this right. Purchasing personnel work hard to develop knowledge and expertise about a wide variety of materials but must also make this knowledge 12  PURCHASING AND STRATEGIC SOURCING work to an organization’s benefit. The right to question allows purchasing to review specifications where required. For example, purchasing may question whether a lower-cost material can still meet an engineer’s stress tolerances. The right to question material specifications also helps avoid developing material specifications that only a user’s favorite supplier can satisfy. A review of different requisitions may also reveal that different users actually require the same material. By combining purchase requirements, purchasing can often achieve a lower total cost. Act as the Primary Contact with Suppliers Purchasing departments historically have maintained a policy that suppliers have contact only with purchasing personnel. Although this makes sense from a control standpoint, some firms today are beginning to relax this policy. Today, we recognize that purchasing must act as the primary contact with suppliers, but that other functions should be able to interact directly with suppliers as needed. Involving multiple people enables the communication process between internal customers, purchasing, sales, and the suppliers’ internal functions to be more efficient and accurate. Although purchasing must retain the right to be the primary contact with suppliers, involving other people can improve the transfer of information and knowledge between buying and selling organizations. Determine the Method of Awarding Purchase Contracts An important area of control is that purchasing has the right to determine how to award purchase contracts. Will purchasing award a contract based on competitive bidding, negotiation, or a combination of the two approaches? If purchasing takes a competitive bidding approach, how many suppliers will it request to bid? Purchasing should also lead or coordinate negotiations with suppliers. Again, this does not mean that purchasing should not use personnel from other functions to support the negotiation process. It means that purchasing retains the right to control the overall process, act as an agent to commit an organization to a legal agreement, and negotiate a purchase price. 1.2 Improving the Procure to Pay Process E-Procurement and the Procure to Pay Process In this section, we examine in detail the purchasing process, which includes all the steps that must be completed when someone within the organization requires some product, material, or service. Purchasing is a process made up of all activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance. These activities, or steps, are highlighted in Fig; this is often referred to as the procure to pay cycle. This term includes all of the steps required, from the initial identification of requirements, to the 13 PURCHASING AND STRATEGIC SOURCING procurement/purchasing of the item, through the receipt of the goods, and finally, to the payment of the supplier once the goods are received. Fig. 1.6 The Purchasing Process There are two things to keep in mind as we describe the purchasing process. First, how much effort a company spends on these activities will differ greatly from one situation to the next. The purchasing process leading to a $30 billion contract for military jets is very different from that for a routine purchase of office supplies! Second, as you look at the steps in the procure to pay cycle shown in Fig, recognize that companies can often gain a competitive advantage by performing these activities better than their competitors. Many organizations, for example, use information systems to automate routine purchase order preparation, whereas others use sourcing management teams to improve the outcome of supplier evaluation and selection efforts. This section presents the purchasing process as a cycle consisting of six major stages: 1. Forecast and plan requirement 2. Need clarification (requisition) 3. Supplier identification/selection 4. Contract/purchase order generation 5. Receipt of material or service and documents 6. Settlement, payment, and measurement of performance These stages may vary in different organizations, depending on whether purchasing is sourcing a new or a repetitively purchased item, and also whether there is a detailed approval process for purchases that exceed a specific dollar amount. New items require that purchasing spend much more time up front evaluating potential sources. 14  PURCHASING AND STRATEGIC SOURCING Repeat items usually have approved sources already available. Fig illustrates a typical purchasing process used in many enterprises, with some typical contingency elements shown. The process flow shown in Fig is often called the procure to pay process, as it documents all of the stages from the initiation of a need, through to the payment element. A document flow accompanies the movement of orders and material throughout the procure to pay process. Historically, preparing and managing the proper purchasing documents has been a time-consuming process. Most firms have streamlined the document flow process to reduce the paperwork and handling required for each purchase. The suite of tools used to achieve efficiency in purchasing transactions is broadly defined as e-procurement. Companies are using e-procurement tools to manage the flow of documents by (1) automating the document generation process and (2) electronically transmitting purchase documents to suppliers. The benefits of electronically generating and transmitting purchasing-related documents include the following: 1. A virtual elimination of paperwork and paperwork handling 2. A reduction in the time between need recognition and the release and receipt of an order 3. Improved communication both within the company and with suppliers 4. A reduction in errors 5. A reduction in overhead costs in the purchasing area 6. A reduction in the time spent by purchasing personnel on processing purchase orders and invoices, and more time spent on strategic value-added purchasing activities The electronic documents often used in the process are represented in the figures which we shall now discuss. Forecast and Plan Requirement The purchasing cycle begins with the identification of a need (a requirement). In most cases, procurement personnel have an annual or biannual planning process, whereby they will review the spending pattern for the organization and prepare a forecast of what will be purchased. In some cases, there may be a whole set of new requirements that have not been planned for (such as for new product introductions). In such cases, purchasing personnel meet with internal customers to discuss their needs for the coming year. In many firms today, purchasing is the primary vehicle for obtaining external inputs (products or services) from suppliers, so that means that purchasing personnel have to work with a large number of internal customers, which will often include marketing, operations, finance, information technology, and other internal customers. Through a structured dialogue, purchasing will understand and plan for what these customers will be buying and translate this into a forecast that is shared with suppliers. 15 PURCHASING AND STRATEGIC SOURCING Fig. 1.7 Request for Quotation Fig. 1.8 A purchase requisition 16  PURCHASING AND STRATEGIC SOURCING 1.3 Approval, Contract, and Purchase Order Preparation After the supplier is selected or a requisition for a standard item is received, purchasing grant an approval to purchase the product or service. This is accomplished through several different approaches, depending on the type of system in place. Purchase Order The drafting of a purchase order, sometimes called a purchase agreement, takes place after supplier selection is complete. Purchasing must take great care when wording a purchase agreement because it is a legally binding document. Almost all purchase orders include on the reverse side of the agreement the standard legal conditions that the order (i.e., the contract) is subject to. The purchase order details critical information about the purchase: quantity, material specification, quality requirements, price, delivery date, method of delivery, ship-to address, purchase order number, and order due date. This information, plus the name and address of the purchasing company, appears on the front side of the order. Approximately seven to nine copies typically accompany the purchase order. In computerized environments, a file containing a copy of the PO is sent to each department’s computer mailbox. The supplier receives the original copy of the purchase order along with a file copy. The supplier signs the original and sends it back to the buyer. This acknowledges that the supplier has received the purchase order and agrees with its contents. In legal terms, the transmittal of the purchase order constitutes a contractual offer, whereas the acknowledgment by the supplier constitutes a contractual acceptance. Offer and acceptance are two critical elements of a legally binding agreement. Purchasing forwards a copy of the purchase order (either electronically or manually) to accounting (accounts payable), the requesting department, receiving, and traffic. Purchasing usually keeps several copies for its records. There are good reasons for allowing other departments to view purchase of Purchase Order The drafting of a purchase order, sometimes called a purchase agreement, takes place after supplier selection is complete. Purchasing must take great care when wording a purchase agreement because it is a legally binding document. Almost all purchase orders include on the reverse side of the agreement the standard legal conditions that the order (i.e., the contract) is subject to. The purchase order details critical information about the purchase: quantity, material specification, quality requirements, price, delivery date, method of delivery, ship-to address, purchase order number, and order due date. This information, plus the name and address of the purchasing company, appears on the front side of the order. Fig 1.9 presents an example of a purchase order, and Fig 1.9 illustrates a typical set of conditions and instructions. 17 PURCHASING AND STRATEGIC SOURCING Companies with an older paper system have a cumbersome process (see Exhibit 2.3). Approximately seven to nine copies typically accompany the purchase order. In computerized environments, a file containing a copy of the PO is sent to each department’s computer mailbox. The supplier receives the original copy of the purchase order along with a file copy. The supplier signs the original and sends it back to the buyer. This acknowledges that the supplier has received the purchase order and agrees with its contents. In legal terms, the transmittal of the purchase order constitutes a contractual offer, whereas the acknowledgment by the supplier constitutes a contractual acceptance. Offer and acceptance are two critical elements of a legally binding agreement. Purchasing forwards a copy of the purchase order (either electronically or manually) to accounting (accounts payable), the requesting department, receiving, and traffic. Purchasing usually keeps several copies for its records. There are good reasons for allowing other departments to view purchase orders and incoming receipts: The accounting department gains visibility to future accounts payable obligations. It also has an order against which to match a receipt for payment when the material arrives. The purchase order provides the requesting department with an order number to include in its records. The requestor can refer to the purchase order number when inquiring into the status of an order. Receiving has a record of the order to match against the receipt of the material. Receiving also can use outstanding purchase orders to help forecast its inbound workload. Traffic becomes aware of inbound delivery requirements and can make arrangements with carriers or use the company’s own vehicles to schedule material delivery. Purchasing use their copies of the purchase order for follow-up and monitoring open orders. Orders remain active in all departments until the buying company acknowledges receipt of the order and that it meets quantity and quality requirements. Note that firms are increasingly using computerized databases to perform these processes and are moving toward a paperless office. 18  PURCHASING AND STRATEGIC SOURCING Fig. 1.9 Purchase Order 1.4 Conclusion This unit provided an overview of purchasing and the purchasing process, including the objectives of a world-class purchasing function, purchasing’s span of control, the purchasing cycle, and the documents used to manage the purchasing process. These topics provide the foundation from which to introduce the tools, techniques, and strategies used by purchasing organizations in a competitive market. This unit also points out the many different categories of purchases. In addition to buying production material and items, purchasing can be responsible for buying transportation, services, packing supplies, MRO items, capital equipment, and even the corporate jet! There is no one system or approach that applies to all purchase situations. Purchases can vary according to type, importance, impact on quality, time frame for delivery, and dollar volume. We rarely find purchasing personnel who are experts in all the different types of purchases, which is why so many purchasing departments have specialized personnel. These personnel all have one 19 PURCHASING AND STRATEGIC SOURCING thing in common, however: the opportunity to manage large amounts of resources through the purchasing process. Review Questions 1. Why are more top managers recognizing the importance of purchasing/supply management? 2. What is the difference between purchasing and supply management? What is the difference between a supply chain orientation and supply chain management? 3. What is the difference between a supply chain and a value chain? 4. Do you think organizational purchasers should behave like entrepreneurs? Why or why not? 5. What are some of the factors that might influence how important purchasing is to the success of an organization? 6. What knowledge and skills do you feel are required for a purchasing professional? 7. What challenges do organizations face as they attempt to integrate different activities and organizations across the supply chain? 8. What performance areas do you think will benefit most from purchasing involvement in the future? 9. Discuss the four enablers of purchasing and supply chain excellence. 10. What is the relationship between the growth in worldwide competition and the evolution of the supply chain concept? 11. Briefly discuss each of the seven periods in the evolution of purchasing and supply management. What do you forecast for the future? 20  PURCHASING AND STRATEGIC SOURCING UNIT 2: PURCHASING POLICIES AND PROCEDURES Objectives: Understand the key objectives of any purchasing function Understand the responsibilities of the purchasing function Understand the purchasing process and the role of e-procurement tools in the process Understand the different types of purchases made by organizations Understand how organizations are seeking to improve the purchasing process Structure: 2.0 Introduction 2.1 Policy overview 2.2 Purchasing policies 2.3 Purchasing procedures 2.1 Policy Overview The term policy includes all the directives, both explicit and implied, that designate the aims and ends of an organization and the appropriate means used in their accomplishment. Policy refers to the set of purposes, principles, and rules of action that guide an organization. Rules of action refer to standard operating procedures along with any rules and regulations. Although policies are usually documented in writing, unwritten or informal policies can also exist. Informal policies are understood over time and eventually become part of an organization’s culture. Advantages and Disadvantages of Policies Having written and implied policies is an opportunity to define and clarify top management objectives. Policy statements are a means for executive management to communicate its leadership and views. Executive management should develop a series of high-level policy statements that provide guidance to employees at all levels. Another advantage is that policies provide a framework for consistent decision making and action. In fact, one of the primary objectives of a policy is to ensure that personnel act in a manner consistent with executive or functional management’s expectations. Finally, an effective policy provides an additional advantage by defining the rules and procedures that apply to all employees. There are also potential disadvantages to policy development. First, a policy is often difficult to communicate throughout large organizations. Second, employees might view policies as a substitute for effective management. Policy statements are guidelines that outline management’s belief or position on a 21 PURCHASING AND STRATEGIC SOURCING topic. They are not a set of how-to instructions designed to provide specific answers for every business decision Third, policy development can also restrict innovation and flexibility. Too many policies accompanied by cumbersome procedures can become an organization’s worst enemy. What Makes for an Effective Policy? Several characteristics of a policy render it effective. Effective policies are action-oriented guidelines that provide guidance. They provide enough detail to direct behavior toward a specific goal or objective but are not so detailed that they discourage personnel from following the policy. An effective policy is relevant (avoiding trivial or unimportant issues) and concise (stating a position with a minimum number of words). An effective policy is unambiguous, allowing personnel little doubt as to how to interpret the policy’s intent and direction. Policies that are subject to different interpretations will, over a period of time, result in several possible outcomes. This can lead to inconsistent behavior, as people will simply ignore the policy because it is so difficult to interpret. 2.2 Purchasing Policies—Providing Guidance and Direction Purchasing management develops policies to provide guidance and support to the professional purchasing and support staff. These policies are general outlines clarifying purchasing management’s position on a subject. Although many purchasing policies exist, most fall into one of five categories: Policies defining the role of purchasing Policies defining the conduct of purchasing personnel Policies defining social and minority business objectives Policies defining buyer-seller relationships Policies defining operational issues The following discussion does not include all possible purchasing policies. Organizations will also develop policies to meet unique operational requirements. Policies Defining the Role of Purchasing This set of policies defines purchasing’s authority. It usually addresses the objectives of the purchasing function and defines the responsibilities of the various buying levels. These policies often serve as a general or broad policy statement from which more detailed or specific policies evolve. 22  PURCHASING AND STRATEGIC SOURCING Origin and Scope of Purchasing Authority Personnel at all levels must be aware of purchasing’s authority to conduct business and to represent organizational interests. An executive committee usually grants this authority and develops this policy. This policy may also detail the authority of purchasing to delegate certain tasks or assignments to other departments or functions. An important section of this policy describes the areas where purchasing authority does or does not exist. The policy may exclude the purchasing function from any responsibility for purchasing real estate, medical insurance policies, or other areas where purchasing may not have direct expertise. (However, purchasing is increasingly becoming involved in all types of purchases, including these nontraditional areas.) This policy outlines the overall authority of purchasing as granted by the executive committee while describing the limits to that authority. Policies Defining Buyer-Seller Relationships The policies that are part of buyer-seller relationships cover a wide range of topics. Each topic, however, relates to some issue involving the supply base. Supplier Relations The principles that guide relations with suppliers are often contained in a policy stating that buyer- seller relationships are essential for economic success. Furthermore, relationships based on mutual trust and respect must underlie the purchasing effort.This policy often describes a number of principles that support positive relationships, including the following: Treating suppliers fairly and with integrity Supporting and developing those suppliers that work to improve quality, delivery, cost, or other performance criteria Providing prompt payment to suppliers Encouraging suppliers to submit innovative ideas with joint sharing of benefits Developing open communication channels Informing suppliers as to why they did not receive a purchase contract Establishing a fair process to award purchase contracts Qualification and Supplier Selection Buyers may require guidance regarding the performance criteria used to evaluate potential sources of supply or to evaluate an existing supplier for an item not traditionally provided by suppliers. Management wants to make sure that supplier selection occurs only after purchasing thoroughly reviews all criteria. Supplier selection criteria include the following: 23 PURCHASING AND STRATEGIC SOURCING Price/cost competitiveness Product quality Delivery performance Financial condition Engineering and manufacturing technical competence Management of its own suppliers Management capability Ability to work with the customer Potential for innovation This policy may also outline management’s position on single and multiple sourcing or the use of longer-term purchase agreements. It may also acknowledge purchasing’s need to rely on non- purchasing personnel to evaluate technical or financial criteria during the supplier selection process. 2.3 Purchasing Procedures The various purchasing procedures are given below. Principles and Guidelines for Awarding Purchase Contracts The process for selecting and awarding purchase contracts is central to effective purchasing. This policy covers a number of critical topics:\ Buyer’s authority to award a contract within a certain dollar limit Conditions where the competitive bid process is and is not acceptable 2.3 Conclusion Understanding policies and procedures is essential for understanding how organizations operate and work. Policy is based on the idea that guidelines are documented and applicable to all the internal and external relations of an organization. A policy prescribes methods of accomplishment in terms broad enough for decision makers to exercise discretion while allowing employees to render judgment on an issue. Well formulated policies and procedures support efficient, effective, and consistent purchasing operations. On the other hand, policies and procedures that are out of date, require unnecessary actions, or do not address current issues or topics will not support effective purchasing operations. As organizations expand their global sourcing activity, they are increasingly revisiting their purchasing policies and procedures, to ensure that they are keeping up with the rapid set of changes their professional associates are facing in their work lives. Review Questions 24  PURCHASING AND STRATEGIC SOURCING 1. Write a brief policy statement that presents a position on the need for utilizing more diverse suppliers. What are the features or characteristics that your policy statement should have? 2. Why is it important to include a policy that outlines the origin and scope of purchasing authority? What might happen if such a policy did not exist? 3. Why should management periodically review its purchasing policies and procedures? 4. What are the potential consequences if management does not review policies and procedures? How often do you think it should go through a minor or major set of rewrites? 5. What are the benefits associated with a comprehensive policy and procedure manual? 6. Is there a downside to the manual’s being too comprehensive? 7. Discuss the concept of ethics. Why is the purchasing profession particularly sensitive to this topic? 8. Describe a potential ethical dilemma that a purchasing professional might encounter in day- to-day activities. 9. Describe a potential situation in which a purchasing professional might be guilty of conflict of interest. 10. What are the risks associated with backdoor (maverick) buying and selling? Why is purchasing interested in controlling this business practice? 11. Consider the elements of the code of conduct developed by Caterpillar in Sourcing Snapshot: Caterpillar’s Code of Conduct. What are some specific examples of purchasing behavior that would violate elements of this code of conduct? UNIT 3 INTEGRATED PURCHASING – SUPPLY MANAGEMENT INTEGRATION FOR COMPETITIVE ADVANTAGE Objectives: Understand why integration is important and the role that supply management plays in internal and external integration Understand the role of cross-functional teams in promoting integration Understand how supply management can work with engineering and suppliers to develop new products and services Structure 3.1 Integrated Supply Management (ISM) 3.2 Purchasing Process 3.3 Purchasing Management Process 3.4 Procurement 3.5 Overview 25 PURCHASING AND STRATEGIC SOURCING 3.6 Direct Procurement and Indirect Procurement 3.1 Integrated Supply Management (ISM) Whatever the appeal and promise of integrated supply management, achieving integration is a challenge. In firms with conventionally organized subfunctions, supply managers are primarily concerned with satisfying their own subfunctional objective. Purchasing managers minimize purchasing costs; marketing managers minimize distribution costs; and so on. These objectives are local, not systemwide. The decisions of a production-inventory control (PIC) manager may maximize utilization of production equipment, yet poorly serve the requirements of the marketing manager. The decision of the purchasing manager affects not only the purchasing function but other materials functions. It is the objective of ISM to manage the related considerations. Purchasing should consider the nonpurchasing consequences of its decisions. Suppose a purchasing manager must decide the order quantity for a material with an annual requirement of 200,000 units. The material is consumed by manufacturing at a constant rate. The unit cost of the material is $1. For transportation purposes, 50,000 units are considered a truckload (TL). Shipments less than 50,000 units are charged at a less-than-truckload (LTL) rate, that is higher per unit. Asked to state their objectives, the subfunctional managers might respond by saying: Purchasing manager: “Minimize annual ordering cost.” PIC manager: “Minimize work-in-process inventory.” Traffic manager: “Minimize transportation cost.” 3.2 Purchasing Process includes as usual 8 main stages as follows: 1) Requisitioning 2) Approving 3) Studying Market 4) Making Purchase Decision 5) Placing Orders 6) Receipting Goods and Services Received 7) Accounting Goods and Services 8) Receiving Invoices and Making Payment 3.3 Purchasing Management Process 26  PURCHASING AND STRATEGIC SOURCING Purchasing Management Process consists usually of 3 stages: 1) Purchasing Planning 2) Purchasing Tracking 3) Purchasing Reporting Purchasing Planning Purchasing Planning may include steps as follows: ❖ Creating purchasing projects and tasks ❖ Providing related information (files, links, notes etc.) ❖ Assigning purchasing tasks to employees ❖ Setting task priorities, start/finish dates etc. ❖ Assigning supervisors ❖ Setting reminders Purchasing Tracking Purchasing Tracking consists of: Checking task's status and/or history of changes Receiving status notifications Sorting, grouping or filtering tasks by current status Highlighting overdue tasks Purchasing Reporting Purchasing Reporting includes: Comparing actual and estimated values Calculating purchasing task and project statistics Sorting, grouping or filtering tasks by attributes Creating charts to visualize key statistics andkips 3.4 Procurement 27 PURCHASING AND STRATEGIC SOURCING Procurement is the acquisition of goods and/or services at the best possible total cost of ownership, in the right quantity and quality, at the right time, in the right place and from the right source for the direct benefit or use of corporations, or individuals, generally via a contract. Simple procurement may involve nothing more than repeat purchasing. Complex procurement could involve finding long term partners – or even 'co-destiny' suppliers that might fundamentally commit one organization to another. SAP Business One offers best-practice functionality to support your procurement, integrating the entire purchasing process from order creation through goods receipt to invoice payment. Special processes such as returns and special charges are fully supported. Purchase orders are created in a few easy steps and fully integrate vendor and item master data. They support multiple currencies and item categories, such as raw materials, trading goods, and services. You can define price lists for different vendor and item categories, such as distributor and retail prices, and implement various discount models, such as volume and special discounts. Price lists are automatically selected, and discounts are applied when a purchase order item is entered. Special one-time discounts can manually be added to the document. Shipping and billing information, including delivery date and address, shipping type, payment terms, and buyer contacts, can be entered into the document, giving your vendor all necessary data to process your order in a timely manner. Depending on shipping location, taxes are calculated and applied at both the header and the item level, eliminating the need for manual tax computations. Inbound shipments are recorded with goods receipts and are immediately recognized by the corresponding warehouse. Goods receipt documents can be stand-alone (that is, replacing a purchase order in a cash purchase) or based on purchase orders or other procurement documents. Accounts payable (AP) plays a key role in SAP Business One purchasing management. Upon receipt of a vendor invoice, you can make all necessary entries in SAP Business One to recognize the liability on your books. AP invoices can be created both with and without reference to purchase orders. Enter all information manually, or reference a purchase order or goods receipt to automatically insert vendor and item information into the invoice. In addition to basic accounting information, SAP Business One supports multiple payment methods, such as check, credit card, cash, and bank transfer. By adding payment terms from the vendor or item master, you can automatically calculate a due date in SAP Business One. This allows you to effectively manage your cash on hand using liability SAP Business One aging reports. Items or services that have been delivered in an unsatisfactory condition can be returned to the vendor using the goods return function. When you link the goods return to a goods receipt, SAP Business One will immediately make the necessary adjustments to your inventory and AP balance with the corresponding vendor. Notes and text fields are available at the header and item 28  PURCHASING AND STRATEGIC SOURCING level so you can give your vendor detailed information about why items are being returned. Once your supplier receives the return and recognizes its validity, you can create an AP credit memo in SAP Business One to correct your outstanding balance with the vendor. 3.5 Overview Almost all purchasing decisions include factors such as delivery and handling, marginal benefit, and price fluctuations. Procurement generally involves making buying decisions under conditions of scarcity. If good data are available, it is good practice to make use of economic analysis methods such as cost-benefit analysis or cost-utility analysis. An important distinction is made between analysis without risk and those with risk. Where risk is involved, either in the costs or the benefits, the concept of expected value may be employed. 3.6 Direct Procurement and Indirect Procurement DIRECT PROCUREMENT AND INDIRECT PROCUREMENT TYPES DIRECT PROCURE INDIRECT PROCUREMENT RAW MATERIAL AND MAINTENANCE, CAPITAL PRODUCTION GOODS REPAIR AND GOODS AND OPERATING (MRO) SERVICES SUPPLIES FEATURES LARGE LOW LOW QUANTITY FREQUENCY HIGH RELATIVE HIGH LOW VALUE INDUSTRY SPECIFIC LOW HIGH NATURE OPERATIONAL TACTICAL STRATEGIC CRUDE OIL IN PETROLEUM LUBRICANTS, SPARE MACHINERY, EXAMPLES INDUSTRY PARTS COMPUTERS Table 1 29 PURCHASING AND STRATEGIC SOURCING Based on the consumption purposes of the acquired goods and services, procurement activities are often split into two distinct categories. The first category being direct, production-related procurement and the second being indirect, non-production-related procurement. Direct procurement occurs in manufacturing settings only. It encompasses all items that are part of finished products, such as raw material, components and parts. Direct procurement, which is the focus in supply chain management, directly affects the production process of manufacturing firms. In contrast, indirect procurement activities concern “operating resources” that a company purchases to enable its operations. It comprises a wide variety of goods and services, from standardized low value items like office supplies and machine lubricants to complex and costly products and services like heavy equipment and consulting services. 3.7 Procure to Pay (P2P) Procure to pay (p2p) is the new generation procurement methodology pioneered by IBM. Other big names in this industry are IBM, Accenture, Infosys etc...Using this service facility, an organization can outsource the end to end procurement operations to them and make use of their global vendor contacts and procurement expertise. 3.8 Acquisition Process The Revised Acquisition Process For Major Systems In Industry And Defense Is shown in the next figure. The process is defined by a series of phases during which technology is defined and matured into viable concepts, which are subsequently developed and readied for production, after which the systems produced are supported in the field. The process allows for a given system to enter the process at any of the development phases. For example, a system using unproven technology would enter at the beginning stages of the process and would proceed through a lengthy period of technology maturation, while a system based on mature and proven technologies might enter directly into engineering development or, conceivably, even production. The process itself includes four phases of development: Concept and Technology Development: is intended to explore alternative concepts based on assessments of operational needs, technology readiness, risk, and affordability. Concept and Technology Development phase begins with concept exploration. During this stage, concept studies are undertaken to define alternative concepts and to provide information about capability and risk that would permit an objective comparison of competing concepts. 30  PURCHASING AND STRATEGIC SOURCING System Development and Demonstration phase. This phase could be entered directly as a result of a technological opportunity and urgent user need, as well as having come through concept and technology development. The last, and longest, phase is the Sustainment and Disposal phase of the program. During this phase all necessary activities are accomplished to maintain and sustain the system in the field in the most cost-effective manner possible. 3.9 Procurement Systems Another common procurement issue is the 'timing' of purchases. Just In Time is a system (commonly used by Japanese companies but widely adopted by many global manufacturers from the 1990s onwards) of timing the purchases of consumables so as to keep inventory costs low. Shared Services In order to achieve greater economies of scale, an organization’s procurement functions may be joined into shared services. This combines several small procurement agents into one centralized procurement system. 3. 10 Procurement Process Procurement may also involve a bidding process i.e, Tendering. A company may want to purchase a given product or service. If the cost for that product/service is over the threshold that has been established (eg: Company X policy: "any product/service desired that is over $1,000 requires a bidding process"), depending on policy or legal requirements, Company X is required to state the product/service desired and make the contract open to the bidding process. Company X may have ten submitters that state the cost of the product/service they are willing to provide. Then, Company X will usually select the lowest bidder. If the lowest bidder is deemed incompetent to provide the desired product/service, Company X will then select the submitter who has the next best price, and is competent to provide the product/service. In the European Union there are strict rules on procurement processes that must be followed by public bodies, with contract value thresholds dictating what processes should be observed (relating to advertising the contract, the actual process etc). Procurement Steps Procurement life cycle in modern businesses usually consists of seven steps: 31 PURCHASING AND STRATEGIC SOURCING 1) Information Gathering: If the potential customer does not already have an established relationship with sales/ marketing functions of suppliers of needed products and services (P/S), it is necessary to search for suppliers who can satisfy the requirements. 2) Supplier Contact: When one or more suitable suppliers have been identified, Requests for Quotation (RFQ), Requests for Proposals (RFP), Requests for Information (RFI) or Requests for Tender (RFT or ITT) may be advertised, or direct contact may be made with the suppliers. 3) Background Review: References for product/service quality are consulted, and any requirements for follow-up services including installation, maintenance, and warranty are investigated. Samples of the P/S being considered may be examined or trials undertaken. 4) Negotiation: Negotiations are undertaken, and price, availability, and customization possibilities are established. Delivery schedules are negotiated, and a contract to acquire the P/S is completed. 5) Fulfillment: Supplier preparation, shipment, delivery, and payment for the P/S are completed, based on contract terms. Installation and training may also be included. 6) Consumption, Maintenance and Disposal: During this phase the company evaluates the performance of the P/S and any accompanying service support, as they are consumed. 7) Renewal: When the P/S has been consumed and/or disposed of, the contract expires, or the product or service is to be re-ordered, company experience with the P/S is reviewed. If the P/S is to be re-ordered, the company determines whether to consider other suppliers or to continue with the same supplier 3.12Conclusion This unit discussed the need for supply management to develop closer relations with internal and external groups. To accomplish this, supply management professionals must develop a working knowledge of the principles of engineering, manufacturing, cost-based accounting, quality 32  PURCHASING AND STRATEGIC SOURCING assurance, and team dynamics. The days are over when supply management could operate in a confined area with only an occasional visit to a supplier. Firms are using the team approach to streamline and improve the product development process. This directly affects firms that rely on innovative new products for their continued success. Supply management has a key role to play on these teams. In its role, supply management helps select suppliers for inclusion in the process, advises engineering personnel of suppliers’ capabilities, and helps negotiate contracts once the product team has selected a supplier. Supply management also acts as a liaison throughout this process, in facilitating supplier participation at team meetings and helping to resolve conflicts between the supplier and the team when they occur. Supply management may also be involved in developing a target price for the supplier to aim at while planning the component or system, and helping the supplier to analyze costs and identify ways of meeting this target price. Finally, supply management may also be involved in developing nondisclosure and confidentiality agreements in cases where technology sharing occurs. Part of the increased interaction between supply management and other functions is due to the need to compete in an environment driven by reduced product cycle times. Supply management supports this effort by developing closer internal and external relationships and by participating on cross-functional teams. Those interested in the supply management profession should learn as much as they can about what it takes to compete in today’s markets, including expanding their knowledge about the team approach as well as understanding how firms compete on cost, quality, and time. The need to interact effectively with different groups plays a major role in how well supply management can accomplish its tasks. UNIT 4 PURCHASING AND SUPPLY ORGANIZATION Objectives: Recognize the role of organizational design in enabling purchasing and supply chain success Understand the factors that influence organizational design in purchasing and supply chain Recognize the differences between centralized, decentralized, and hybrid forms of the purchasing organization Understand the team concept and its influence and roadblocks to adoption in purchasing and supply chain Identify features of the supply organization of the future Structure 4.1 Introduction 4.2 P/SM organizational structure 33 PURCHASING AND STRATEGIC SOURCING 4.3 Centralization 4.4 Formalization 4.5 Dynamics 4.6 Other Organizational Factors 4.7 Conclusion 4.1 Introduction In this unit the purchasing organization issues are addressed – what are the prerequisites for such organization and what should be considered beforehand, what are possible solutions and which attributes are there to differentiate between various configurations. In addition, attention is drawn to few key elements that should be considered within any certain structure. The unit focuses mainly on manufacturing companies, which leaves service providers as well as public sector organizations out of scope. However, as structural design is an issue in any organization, the underlying principles for the supply department can be applied outside the scope discussed in the unit. 4.2 Purchasing Organization Structure Having identified the goals and requirements for the organization, the appropriate structure for the organization can be considered. Designing an organization refers to “the process of assessing and selecting the structure and formal system of communication, division of labor, coordination, control, authority and responsibility required to achieve an organization’s goals”. (Trent, et al., 2005) As goals are different, the actual balance between those factors is highly dependent on the specific company and its surrounding environment. However, despite of numerous possible solutions, only a discrete subset of different organizational configurations has been found to be adopted in practice. (Wood, 2005) The main attributes differentiating organization structures are considered to be centralization and formalization. (Wood, 2005) In our case of purchasing organization, the first one implies whether the procurement activities of different business units of a company are handled by one central function (centralized) or is every single location/site responsible for its own purchasing decisions (decentralized) (Gadde, et al., 2001). Formalization of the organization expresses the extent to which the procedures, instructions, communication patterns, etc are documented in the company and how are they followed. “It is the existence and prevalence of written documentation”.(Wood, 2005)Those two attributes are commonly chosen for adjustment for reasons that they are managerially easily applicable as well as they involve both the formal and informal structure of the company. (Wood, 2005) 34  PURCHASING AND STRATEGIC SOURCING 4.3 Centralization Centralized purchasing organization can be found applicable in case of similarities between multiple company locations e.g. in used technology, market conditions, purchasing problems, item demand, etc. It is more common to occur in companies offering the same product or service in multiple locations. (Quayle, 2006)In addition, centralized control is found to be prevailing configuration also for single site and relatively small size company where there are no feasible criteria for division of control and thus decentralization would provide no benefits. However, decentralized purchasing solution is seen beneficial when substantial differences exist between various sites of one company. In such case centralized control would be inefficient as each unit operates in its own area (Gadde, et al., 2001); (Quayle, 2006). Table 1 provides comparative overview of benefits and downsides of both described solutions. Centralized Decentralized Increased professionalism of buyers Purchasing department’s More efficient allocation of purchasing better contact with local budget organization Integration with other functions; buyers are Higher bargaining power often located together with Less orders and bigger quantities – savings engineering or manufacturing Ad through administrative costs and economies specialists va of scale nt Ability to focus on local Direct and single‐point contact with conditions and adjust ag suppliers Avoidance of competitive buying purchasing activities es by parallel departments accordingly Increased efficiency through development of common standards and procedures Higher role of purchasing in corporate hierarchy Indirect contact between supplier and actual Coordination difficulties user of the component/product between different sites Di sa Increased specialization can limit No clear overview of inbound dv purchasing function integration with other material flow leading to an department, losing the overall coherence inefficiency ta requirement Reduced specialization and ge High buying power can be abused by the bargaining power due to s chase of lower prices resulting in smaller scale and scope of the 35 PURCHASING AND STRATEGIC SOURCING bankruptcy of supplier and changers in function market structure Table 4.1 ‐ Advantages and disadvantages of different centralization configurations. Based on Gadde, et al. (2001), Quayle (2006), Van Weele (2005) It can be noted that total centralization and total decentralization are both extreme values of centralization continuum. The majority of companies lie somewhere between these two extremes to utilise advantages of both configurations (Johnson, et al., 2004). In such hybrid structures responsibilities and control between head office and local organization are divided with accordance to business environment. Even though the exact division is highly individual among companies, the tasks often allocated to head office can include: ▪ development of purchasing strategies, policies and standards ▪ negotiations for common, widely used items ▪ stock management between sites ▪ purchase of plant equipment and other strategic items ▪ training ▪ legal matters ▪ research and information service Gadde, et al. (2001), Quayle (2006) The responsibility for local purchasing organizations would thus be: placing orders for common items negotiating and contracting locally used items Gadde, et al. (2001), Quayle (2006) 4.4 Formalization The issue of formalization in purchasing organizations is not much addressed in prevailing literature which implies its relatively small effect on supply performance of companies. However, 36  PURCHASING AND STRATEGIC SOURCING its combinations with centralization decision help to describe four essentially different organization types which are also suitable for defining different purchasing function’s characteristics. Those include machine bureaucracy‐, entrepreneurial‐, professional‐, and adhocracy types (Wood, 2005) (see Fig. 9). Fig. 4.1‐ Different organizational configurations. Based on Mintzberg (1989) Machine bureaucracy type organizations contain both high levels of formality as well as centralization. This results in an organization with many formal rules, regulations, and controls where a large part of communication existing in written form. To be able to control that regulations are followed, the decision‐making is centralized with very clear and hierarchical division of power(Wood, 2005). Large multisite manufacturing firms that drive for efficiency can be good representatives of such supply organization type. In the entrepreneurial organization little of its activities are formalized. Control as well as decision making is agglomerated to the manager which leaves little or no reasons why to formalize the operational communication too much (Wood, 2005).An example of purchasing organization like this can be single site manufacturing company with centralized control and relatively simple procedures. The configuration can also be applied by more complex companies with a small number of central suppliers where local units are responsible only for call‐offs from those contracts which require no extensive formalities. 37 PURCHASING AND STRATEGIC SOURCING Professional organization type contains high level of formalization with the purpose of facilitating complex procedures that need certain level of formalized control. However, as the formalization is designed to achieve the desired outcome from its members, all professionals share decision‐making authority in this configuration. In general, it is considered to be suitable setting for hospitals and universities. (Wood, 2005)In our case of purchasing organization, it fits to a development intense multi site MTO type of company with heterogeneous supply demand where contracts are done autonomously at different locations due to different or changing characters of the product. Also, such configuration is suitable to describe the head office layer of centralized or hybrid supply organization – corporate buyers with high specialization and autonomous decision‐making power (Van Weele, 2005). Adhocracy structure is low in formalization and with decentralized decision‐making. (Wood, 2005)As all previous types, there are environments where such design can be considered an appropriate solution. It facilitates fast response and flexibility in the processes. However, it is rather difficult state to control due to tendency for anarchy and poor coordination. It might be suitable for R&D intense development organizations where purchasing activities can be complex and unconventional. This clustering allows general positioning of the organization. As also hinted in the description of professional organization type, different types can be exist in different levels of centralized or hybrid purchase organizations i.e. head office and local units. Such classification might not be particularly useful to know for buying company itself as more important is the actual alignment with the rest of organization and not which cluster it falls in. On the other hand, it might prove to be great value for selling companies where such grouping can give useful insight how decision‐making and power is divided in purchasing function and thus allows “to push the right buttons” by focusing sales effort to right positions (Wood, 2005). There is no checklist available concerning decisions for designing most appropriate purchasing organization i.e. in which square to be on that graph. The solution is highly context dependent and the context is highly volatile which leads to continuous need to monitor and configure the organizational structure (Gadde, et al., 2001); (Johnson, et al., 2004). 4.5 Dynamics An organizational structure must be able to change in order to cope with outside pressures. However, there are several views on the dynamics of organizational structure. It is suggested as being progressive with different organizational types evolving over time. Also cyclical and oscillating patterns between discrete numbers of configurations have been described. But the bottom line of all of those views is that managers reform the organization in order to enhance the performance and despite the fact whether such configuration has been used before. (Wood, 2005) 38  PURCHASING AND STRATEGIC SOURCING According to Johnson, et al. (2001) and Wood (2005), it is not proven that CPOs restructure or design the organization driven by and based on an analysis of available alternative. Such reforms are initiated by pressures created by changes in external environment which influence corporate strategy. That in turn necessitates adjustments in corporate structure which inevitably brings along changes in supply organization to maintain coherence throughout the entire company. Such hierarchy of events leads to two important considerations regarding the design of purchase organization. First, as adjustments to organizational issues are done with the purpose of improving cost structure, even when changing back to setting that has been previously used. That means no perfect organizational design exists but the usefulness is determined by external conditions. Second, as changes are not triggered by managers, but rather external pressures, internal problems, or combination of the two, there is a certain lifetime for one organizational structure(Johnson, et al., 2001).It is just a matter of time before the current configuration is outdated again. Coming back to the model of four organization types, those two conclusions imply that companies are not determined to be in the matching “square” for eternity. The position changes over time. As companies grow, they can, for example, move from entrepreneurial towards machine bureaucracy due to simple increase in people and volumes. By changing strategy or developing supplier relations, companies can become more development centred with professional‐type structure or even downgrade to adhocracy type. Companies can apply several models in different layers of their supply organizations enabling even more directions for a change. The movements in the graph don’t necessarily have to cross category borders but also shifts towards certain direction can indicate an important change for the company. Expressing the ongoing trends of increasing centralization and reducing the number of suppliers in the light of this matrix, the shift to right side of the graph – towards centralization – could probably be detected in all clusters. The change in terms of formality is probably multifold, especially in hybrid structures, and shifts in graph would express various directions depending on business environment making it difficult to detect any clear pattern except for the fact of change itself. However, it is important to differentiate between the essential drivers behind the shift towards another configuration. As described previously, it can be the result of already changed external factors. In that case, the management of purchasing organization deals with consequences by just trying to avoid further damages with fast reacting. It resembles driving a car through the rear window where upcoming curves on the road are recognized when the ride is already very bumpy. In our view it would be highly welcomed if the dynamics of the organization could be more controlled in terms timing and planning the change according to future forecasts. In that way minor adjustments in organizational design can keep the processes well on track and can avoid costly restructurings of the entire organization. Despite the seeming lack of research on that topic, the issues seems to come in focus of practitioners as stated by the study of Johnson (2004) that coping and prospering despite and, perhaps, because of change, may be the CPO’s ultimate test. As 39 PURCHASING AND STRATEGIC SOURCING change management regarding external and internal factors becomes recognized part of Purchasing Management, the improvements towards controlled dynamics may be underway. 4.6 Other Organizational Factors Once the organization’s structural model has been decided, the frame for working conditions and formal communication has been set. It defines the shape and orientation of the function but not what’s inside. Therefore the next step in organizational design is “filling” the structure, which also adds few critical decisions to the overall design process. Previously outlined trends in purchasing practice indicate the increasing strategic role in corporate policy. Along with that comes the need for higher alignment in corporate hierarchy which in turn results in higher reporting level of the CPO. This trend needs to be taken into consideration when designing a structure. Studies by Johnson, et al. (1998) and Johnson, et al. (2004) note that in order to achieve the capabilities of strategic planning and responsibility, an organization must have some kind of centralized control over its processes and prove that purchasing organizations classified as centralized, and also hybrid, have higher rate of participation in major corporate activities than decentralized supply departments. Thus the seemingly external factor of purchasing positioning inside the company correlates to structural design decisions in a very good way – increased centralization facilitates the higher reporting level of a CPO. The same study indicates another factor which, in terms of organizational structure, might seem irrelevant at first glance – the background and characteristics of the CPO. Managers with higher corporate positions and those with relevant work experience demonstrated wider use of various purchasing techniques, e.g. cross‐functional teams, supplier and customer involvement teams, colocation of buyers with other functions. Those methods can significantly determine the actual formal as well as informal communication structure in the purchasing organization along with division of labour and control. Therefore the question how managing positions in purchasing function are staffed must also be considered in the design process. Among other decisions affecting the way in which a purchasing organization works is the question of division of work. As outlined in the beginning of this unit, the ongoing trend is formalising buying groups around end items rather than commodities. However, the bottom line is that this division should be done on logical bases, whether it is based on commodities, geographical location, or other factors(Quayle, 2006). As specialization on one category alters the efficiency of the others, the division should be made with considerations to: practical and technical feasibility of dividing the line of work; and sub‐tasks should not seriously impact the values of other sub‐tasks. (de Boer, et al., 2003) 40  PURCHASING AND STRATEGIC SOURCING In purchasing organization that can be interpreted as, for example, grouping around end items should be easily supported by the organizational structure. The benefits of such a configuration should overweight the negative impact of changes in commodity and geographical level, i.e. it does not alter functionality of supplying. For example, (Van Weele, 2005)suggests a division of tasks between the following functions. Function Responsibility Corporate procurement Developing corporate purchasing strategies, systems, reporting. officer (CPO) Strategic commodities – large volumes, high investment projects and Corporate services. Responsible for developing sourcing strategy for key buyer commodities. Long planning horizon. New materials and components. New suppliers. Discussing spec.‐s, market Purchasing research, selection of suppliers, negotiations. Work on decentralized level. engineer Liaisons between purchasing and R&D. Project Similar to purchasing engineer but focus on equipment and services. buyer Materials planning and ordering, order handling – ensuring material Material supply, calling off materials against annual agreements. Vendor rating ‐ planners monitor and control suppliers quality and delivery performance. MRO supplies – management of the entire assortment of MRO items with MRO buyer regard to overall performance rather than just price focused. Table 4.2 ‐ Buyer profiles and division of responsibilities. Based on Van Weele (2005) As for the organizational structure, it is difficult to state the correct division. It can vary through different strategic levels of the organization (de Boer, et al., 2003)or be uniform for the entire department. The overall principle is that the solution must provide satisfactory profit and align with corporate values and policy. The literature has also implied the increasing level of integration of purchasing function to external as well as internal environment, i.e. to suppliers and customers, and other departments of the company, accordingly (Trent, 2004).Common methods of facilitating such interaction are cross‐functional teams including various counterparts related to end product, co‐location of buyers and other specialists (engineering and manufacturing), supply councils, etc. The study by Johnson, 41 PURCHASING AND STRATEGIC SOURCING et al. (1998) also indicates the influence of centralization decisions on the use of those tools. Their conclusion is that in centralized and hybrid structures the implementation of those methods is more common than in decentralized organizations. However, the connection between organizational structure and the tactics of carrying out the tasks exists. The idea described in this unit about organizational configuration of supply function is simple – structural design affects the performance of purchasing to substantial extent and should be paid consideration by decision‐makers in the company. It must have a good fit to the rest of the company structure and facilitate the activities necessary for competitive purchasing. More important, the changing character of the “best fit” necessitates the understanding and consideration of ongoing trends in supply function. However, the solution in this matter is not simple. One can, and should, consider, among other factors, attributes like centralization, work division, or formalization to achieve better alignment with surrounding environment. Nevertheless, as repeatedly stated in the text, there is no uniform configuration or checklist available to download and implement in all situations. The organization must be continuously adjusted in accordance with external forces and corporate policy. As purchasing has gained strategic value rather recently, the management still seems to be seeing business dynamics through sort of a back window, reacting only when the changes has already occurred and coping with consequences. In terms of organizational design there seems to be a long way to go to “control” the surrounding environment as being able to predict the dynamics, prepare the structure and processes in the organization, and synchronize the changes in organization with changes in external environment. However, as the studies have revealed the understanding of the importance of change management in business practice and along with increasingly strategic role and closer collaboration with suppliers, we can hope to see improvements in that front in sooner future. 4.7 Conclusion Just as having the right people, systems, and performance measures in place is critical to purchasing success, so too is having a properly designed organizational structure. Careful attention to assessing and selecting the structure and formal systems of communication, division of labor, coordination, control, authority, and responsibility will make the attainment of supply management objectives more likely. Without question, the kinds of organizational design features that a firm selects often relate to the size of the firm. Larger firms differ from smaller firms in terms of scope, complexity, and available resources. They tend to have operations that are worldwide (scope), more organizational levels covering a wider array of businesses and product lines (complexity), and more resources that support the use of certain design features. As firm size increases, many of the design features put 42  PURCHASING AND STRATEGIC SOURCING in place help coordinate and integrate a globally diverse and large organization. Whatever the size of the firm, progressive supply managers recognize the important relationship between organizational design and supply management effectiveness. Future organizational structures will need to be more flexible and responsive regardless of whether they are centralized, decentralized, or hybrid. Review Questions 1. Do you feel that choosing an organizational design is simple? If so, explain why firms would change their supply management organization structure. 2. Why is a function’s placement in the organizational hierarchy important? 3. What factors contribute to the increasing importance of purchasing within the organizational hierarchy? 4. Why would you believe that the importance of purchasing diminishes when a firm organizes under a supply chain management structure? 5. Discuss the two or three most important benefits to centralized purchasing authority. 6. Justify your choices. Discuss the two most important benefits to decentralized purchasing authority. Justify your choices. 7. What are some of the factors that would influence whether a firm centralizes or decentralizes its supply management organization? 8. What is the difference between strategic and operational purchasing? Provide some examples of strategic and operational tasks. 9. Discuss the logic behind physically separating strategic and operational buyers. 10. Discuss the role of a purchasing research staff. 11. You are the chief purchasing officer for a company with worldwide production and buying locations. Design an organizational structure that allows you to compete effectively. Describe the reporting structure, the physical placement of personnel, the placement of purchasing authority, and the coordination of activities with other functional groups. 12. Discuss the advantages of using a cross-functional team to evaluate and select suppliers. 13. Compare a vertical and horizontal organizational structure. What is the logic behind a vertical structure? What is the logic behind a horizontal structure? 14. What are some of the barriers to using teams in purchasing and supply chain management? 15. What is the logic behind co-locating purchasing personnel with internal customers? BLOCK II STRATEGIC SOURCING – I(ANALYSIS) 43 PURCHASING AND STRATEGIC SOURCING BLOCK II: STRATEGIC SOURCING – I (ANALYSIS) Unit 5 Supply Management and Commodity Strategy Development In this unit we discuss the category strategy management. Category management is perhaps one of the most important ways that supply managers create value for their stakeholders. Category teams must effectively scan the market environment, conduct research on suppliers and cost drivers, analyze internal spend characteristics, and establish appropriate strategies for managing these relationships. Unit 6: Supplier Evaluation and Selection In this unit the most popular factors for supplier selection is discussed and thereafter the conclusions about how the ISO standards can be used in the supplier selection process are pr