Chapter Three: Purchasing PDF

Chapter Three PURCHASING  MEANING OF PUCHASING  Purchasing: a major function of an organization that is responsible for acquisition of required materials, services, and equipment.  The activity of acquiring goods / services to accomplish the goals of an organization.  The purchase...

Chapter Three PURCHASING  MEANING OF PUCHASING  Purchasing: a major function of an organization that is responsible for acquisition of required materials, services, and equipment.  The activity of acquiring goods / services to accomplish the goals of an organization.  The purchase cycle begins in the Inventory Control department when inventory levels drop to re-order levels. 2  The Role of Purchasing  The purchasing dep’t plays very important role in SCM(Supply chain management )and is responsible for: Selecting suppliers Negotiating and administering long-term contracts Monitoring supplier performance Placing orders to suppliers Developing a responsible supplier base Maintaining good supplier relations 3  Points to remember while purchasing Proper specification of order Comparison of offers based on basic price, freight & insurance, taxes and levies Quantity & payment discounts Payment terms Delivery period, guarantee Vendor reputation (Reliability, Technical capabilities, Convenience, Availability, After-sales service) Short listing for better negotiation terms Seek order acknowledgement 4  OBJECTIVE OF PURCHASING The major objectives of purchasing are to (1) maintain the quality and value of a company's products, (2) Minimize cash tied-up in inventory, (3) maintain the flow of inputs to maintain the flow of outputs, and (4) strengthen the organization's competitive position Purchasing may also involve (a) development and review of the product specifications, (b) receipt and processing of requisitions, (c)advertising for bids, (d) bid evaluation, (e) award of supply contracts, (f) inspection of good received, and (g) their appropriate storage and release. 5  Purchasing cycle and procedure The purchasing department of the company is responsible for the purchase of all the raw materials as well as dealing with the requirements. The following steps are followed in the purchasing cycle. 1) Recognition of need and receipt of requisition: The requisition includes the following information:- - Name - Quality and quantity specifications - Date by which material is required - Place at which material is to be delivered 6 2) Selection of potential sources of supply 3) Making request for quotation (RFQ) RFQ:- Document used in soliciting price and delivery quotations that meet minimum quality specifications for a specific quantity of specific goods and/or services. 4) Receipt and analysis of quotations - material specifications and quality - price of the material - taxes - terms of payment - place of delivery - delivery period - guarantee period 7 5) Selection of right source of supply 6) Issuing the purchase order 7) Follow-up of the order 8) Receipt of materials, reports and analysis 9) Checking and approving of vendor’s invoice for payment 10) Closing of completed order 11) Maintenance of record and file 8  MAKE or BUY Decisions  It is the act of making a strategic choice between producing an item internally (in-house) and buying it externally (from an outside supplier).  A firm’s Make-or-Buy choices should be based on the following considerations: Strategic impact Available capacity Expertise Quality considerations Speed Cost (FC+VC) Make = (FC+VC) Buy 9  Categories of purchasing needs  Low volume, infrequent purchase of small monetary value  One time infrequent purchase of significant monetary value  High volume purchases used over time or in multiple locations  Make/Buy Considerations Reasons for Making Reasons for Buying  lower production cost  lower acquisition cost  unsuitable suppliers  preserve supplier  assure adequate supply commitment  utilize surplus labor and  inadequate capacity make a marginal  reduce inventory costs contribution  ensure flexibility and  obtain desired quantity alternate source of supply  remove supplier collusion  product improvements may  obtain a unique item that be difficulty because it is a would entail a prohibitive sideline commitment from the supplier 11  Decision Problems The materials manager in any organization has to decide on the right quality of material, the right price, the right quantity, the right source, and the right time for the purchase. In this process, he can make use of decision analysis, for analyzing the various classes of decisions. The essential feature of all purchase decision making problems are: Recognition of the existence of several possibilities, Prediction of the pay-off of each one of the strategies, Assessment of the order of preference of the strategies. Cont’d... Depending upon the information available, the decision problems can be classified as certainty, risk and uncertainty. Decision making under certainty conditions deals with a situation which arises when the buyer knows clearly what outcome will occur definitely. Decision Making Under Risk This situation occurs when there are a number of states or nature of alternatives and the decision maker can predict the probability of occurrence of these. It is possible for him to quantity the pay-offs for the alternative courses of action.  For example, let us take a critical spare part those consumption is zero per week in 10 percent of cases, one per week in 50 percent cases, two per week in 30 percent cases and three per week in the remaining 10 percent of the cases. These percentages obtained from past data are called the probability of occurrence. If past data is not available, an expedition cost of $ 1000 per unit is incurred. If a part is kept unit per week, we have to find the optimum buying strategy.The states of nature are that, the requirements can be zero or one, two or three units in a week, respective probabilities. The strategies are as follows: Stock zero, requirement is zero, without any cost; Stock zero but the requirement is two, then expenditure of $ 2000 is incurred. If stock one, requirement zero then we incurred an expenditure of Rs. The following Matrix gives the variation of expected total cost by the weighted average of probabilities with the cost. A strategy of stocking two spares giving minimum cost is obtained. cont’d.... Payoff Table Cont’d.... Standard deviation is a statistical measure to obtain the risk, particularly for regularly consuming items. It is defined as the square root mean squares of the individual's deviation from the average deviation, which is useful to measure risks, fix up the consumption norms and to determine safety stocks in inventory policies.  Decisions under Uncertainty When the buyer is unable to predict the probabilities of occurrence of the different alternatives, the uncertainty situation is faced. This may further be compounded and turned into a conflict situation, if there is an opponent to defeat the buyer. The uncertainty situation should not be confused with a total ignorant view, as the buyer will always have someknowledge, which is not sufficient to calculate their probabilities. Analytical tools are available to take care of the idiosyncrasies of the decision maker and the culture of the organization. Let us now illustrate the buying under uncertainty with an example. Pay-off table The necessity for a special kind of new apparatus is expected to continue either for four or five years, but the probabilities cannot be estimated, as due to technological advancement, the machine will be replaced after four or five years. Two types of apparatus "A" and "B" are available, these consist of an important part and this part will need a complete overhaul Cont’d.... Types of cost Apparatus A Apparatus B Under two conditions of requirements Capital cost $ 50,000 $ 75,000 and overhauling uncertainties the Operating problem is to decide as to which machine cost should be purchased. For simplicity, we per year $ 10,000 $5,000 have omitted factors such as salvage Maintenance P1 P2 P3 P4 values, depreciation, present value, cost expenses ($) of capital, etc. and this example may be year 1 2000 2000 2000 1000 modified suitably if they are given. Year 2 20,000 2000 1000 1000 Year 3 3000 3000 1500 1500 Year 4 7000 3000 10,000 2000 Year 5 2000 7000 1000 10,000  Cont’d... Life in years 4 5 4 5 4 5 4 5 For apparatus "A" life 4 years and overhauling 4 years, the initial cost is Maintenance P1 P1 P2 P2 P1 P2 P1 P2 A Rs. 50,000. Operating cost for 4 years is Maintenance P3 P3 P4 P4 P3 P3 P4 P4 Rs. 40,000 Maintenance expense is Rs. B Average cost 26,000 23,000 25,000 23,400 26,000 23,200 25,000 23.400 2000, Rs 2000 Rs. 7000 or Rs. 14,000. A Total cost Rs. 1,04.000 and average cost Average cost 27,130 22,900 27,130 22,900 25,130 23,100 25,150 23,100 B per year is 26,000. The cost table for all Difference A 0 300 0 500 870 100 0 300 combination P1 with p3 and P4 P2 with P3 and P4, P2 with P3 andp4 etc, is made in B 1130 0 2230 0 0 0 150 0 the below Table.  Value Analysis Definition:- It is a systematic study of every element for its cost in a part, material or service to make certain that it performs its function at the lowest possible cost. Value Analysis is defined as a cross-functional objective evaluation used to improve and analyze the value of a product, system or service. The overriding goal of a Value Analysis program is to decrease cost while improving performance and/or quality. Value Analysis is effective because it is the analysis of both function and cost. 20 Benefits of value analysis:- i. Decrease in existing cost of the product or service. ii. Unnecessary expenditure is identified and eliminated. iii. Product value improves for new materials and processes. iv. More profits. 21  GLOBAL SOURCING  Strategic sourcing: the development and management of supplier relationships to acquire goods and services in a way that aids in achieving the immediate needs of the business  In the past, sourcing was another name for purchasing  But, as a result of globalization, sourcing implies a more complex process suitable for products that are strategically important Outsourcing;- is defined as the act of moving a firm’s internal activities and decision responsibility to outside providers ’International purchasing– international buying as needed or as part of purchasing strategy ’ Global sourcing – Integration and coordination of international purchasing strategy 22  ’ Drivers of Global Sourcing  Cost benefits - Lower labor costs, less costly materials ’  Superior quality ’  Access to more advanced technology ’  Shortage of domestic source – E.g.) A manufacturer of heavy machinery in Netherlands will need to find a foreign source of steel 23  TYPES OF SOURCING Multiple Sourcing Items can be purchased from a variety suppliers, including Manufacturers, Distributors, Retailers, and “e-tailers” Single Sourcing While many suppliers are capable and qualified for particular items, ONE is chosen to provide all spend volume “Short List” Sourcing From a list of qualified (and interchangeable) sources, a small number of Suppliers compete for volume Sole Sourcing Critical items that require a specific technical capability and Performance must be supplied by ONLY ONE source 24  It has to do with creating or making new vendors (and not selecting out of the already established ones in the market).l  This is a continual and an important activity of the purchasing manager.  Traditionally one of the reasons for developing new vendors is to build more competition in the supply market (eliminating monopoly or oligopoly).  The company can then buy materials from a number of sources.  Another traditional reason for such multiple source buying (and, therefore, also for vendor development) is to spread the risk of non-availability of shortage of input materials over a number suppliers. In case, one of the supplier's employees go on strike (or if there is an explosion or fire in the supplying company), the other supplier's can be relied upon to compensate for the shortage.  Vendor development involves helping or building up the vendor by various means such as:  Lending money for part of his capital equipment, working capital requirement, etc  Lending technical help by making company engineers and technicians available problem  Help in R & D, by again lending technical help to not only to establish the company, but also to help improve its products and services on a continuous basis  Guaranteeing him a certain amount of business (this is particularly needed during initial stages of setting up the vendor  Vendor Rating It is a method to evaluate a vendor against certain parameters, related to his supplies. Factors considered: – Vendors are assessed on the basis of a wide variety of factors or criteria which might include but not limited to: – Price – Discounts received – Maintenance of specifications  Vendor Rating Cont’d... Promptness of delivery Freight and delivery charges Service Market information Co-operation Management competence Credit terms Cost reduction suggestions Inventory plans Financial position  Rating Techniques Categorical plan – Personnel from different division maintain informal evaluation records – Purchasing , engineering, quality control, receiving and inspection. – For each supplier , each person prepares a list of performance factors important to him. At a monthly meeting, each major supplier is evaluated against the list and assigned an overall group evaluation, like “preferred”, “neutral”, or “unsatisfactory”.  Weighted point plan The performance factors to be evaluated are given “weights”, for example quality might be weighted 25, delivery 20, price 30 and service 25. Weights selected represent buyer’s judgement about the relative importance of the respective factors. Quantitative terms  Critical incidents Method Record of events related to buyer vendor relationships is maintained in each vendor’s file. They reflect positive and negative aspect of actual performance. This kind of documentation useful in discussing ways and means of improving performance, acknowledging the existence of good relationships, determining the competence of a vendor, and if necessary considering termination.  Checklist system A simple checklist is used to evaluate the vendors. Check list may be something like – Reliability, technical capability, after sales service, availability, buying convenience etc.   Ethics in purchasing Many decisions remain largely a matter of personal judgement. Purchase manager is the custodian of company funds, responsible for their conservation and w spending. Because of his contacts, he is the custodian of company’s reputation for courtesy and fair dealing A high ethical standard of conduct is essential. They are subjected to more temptations Since they spend millions, they yield tremendous power and are the objects of considerab attention from suppliers. They are in an excellent position to be dishonest if they want to. But they have to be ethical