CHAPTER 2- PURCHASING MANAGEMENT

Principles of Supply Chain Management: A Balanced Approach

Learning Objectives
2

You should be able to:

Describe the role of purchasing and understand its impact on an organizations competitive advantage. Have a basic knowledge of manual purchasing and e-procurement. Understand and know how to handle small value purchase orders. Understand sourcing decisions and the factors impacting supplier selection. Understand the pros and cons of single versus multiple sourcing.

Learning Objectives- Cont.

3

Describe

centralized, decentralized, and hybrid purchasing organizations and their advantages. Describe and understand how globalization impacts, purchasing, and describe and understand the opportunities and challenges of global sourcing. Understand total cost of ownership and be able to select suppliers using more than unit price alone.

Chapter Two Outline

4

The Role of Purchasing in an Organization The Purchasing Process Sourcing Decisions: The Make-or-Buy Decision Roles of Supply Base Supplier Selection How Many Suppliers to Use Purchasing Organization: Centralized versus Decentralized Purchasing International Purchasing/Global Sourcing

Introduction
5

What is Purchasing?

Introduction
6

PurchasingObtaining merchandise, capital equipment; raw materials, services, or maintenance, repair, and operating (MRO) supplies in exchange for money or its equivalent.

Definitions
Purchasing, Procurement, Material and Supply Management: The terminologies are interchangeable Obj: Lean purchasing or lean supply management Supply chain management Obj: Minimize costs and times across the supply chain Supply and Logistics Obj: Control materials flows to optimize inbound or outbound transportation

Evolution of Purchasing and Supply Management

Pre 1939 1940-49 1950-69 1970-89 1990-1999

2000-Future

Clerical

World War II

Managerial emphasis

Purchasing strategy

Integration into corporate strategy Integration with supply networks and information technology

Inbound logistic and outbound logistic

Purchasing as an administration function

Why Purchasing : The Number Makes Difference

Cost Drivers

Manufacturing Cost

30 55

SG & A Cost R & D. Corporate Allocation Material Cost

5
4.5

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit 5% Reduction in Material Content 5% Reduction in Manufacturing Cost 5% Increase in Sales

$1.00 ($.50) ($.30) $.20

$1.00 ($0.475) ($.30) $.225

$1.00 ($.50) ($.285) $.215

$1.05 ($.525) ($.315) $.21

?
SG&A RD&E Pretax Profit Profit Improvement

?
($.1)
($.05) $0.075

?
($.1)
($.05) $0.065

?
($.105)
($.0525) $0.0525

($.1)
($.05) $0.05

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A RD&E Pretax Profit Profit Improvement 5% Reduction in Material Content 5% Reduction in Manufacturing Cost 5% Increase in Sales

$1.00 ($.50) ($.30) $.20

$1.00 ($0.475) ($.30) $.225 Increase 12.5%

$1.00 ($.50) ($.285) $.215 Increase 7.5% ($.1) ($.05) $0.065 Increase 30%

$1.05 ($.525) ($.315) $.21 Increase 5% ($.105) ($.0525) $0.0525 Increase 5%

($.1) ($.05) $0.05

($.1) ($.05) $0.075 Increase 50%

Financial Significance Cost and Profit Improvement

Standard Price/Profit Sales Material Labor/OH Gross Profit Gross Profit Improvement SG&A RD&E Pretax Profit Profit Improvement ($10) ($ 5) $5 $100 ($50) ($30) $20 $1 Decrease to Material Content $100 ($49) ($30) $21 Increase 5% ($10) ($ 5) $6 Increase 20% $1 Increase in Sales $101 ($50.5) ($30.3) $20.2 Increase 1% ($10.1) ($ 5.05) $ 5.05 Increase 1%

Purchasing Trend: Lean Purchasing JIT)

Implementation of just-in-time (JIT) tools and techniques to ensure every step in the supply process adds value, inventory are kept at minimum level.

Unreliable Vendors

Work in process inventory level (hides problems) Capacity Imbalances Scrap

Lowering Inventory Reduces Waste

Reducing inventory reveals problems so they can be solved.

Unreliable Vendors

Scrap

WIP Capacity Imbalances

Types of Buyers
15

Merchant Buyerswholesalers and retailers who purchase for resale.

Industrial Buyerspurchase raw materials for conversion, services, capital equipment, & MRO supplies.

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The Role of Purchasing in an organization

The primary goals of purchasing are:
1.
2. 3.

Ensure uninterrupted flows of raw materials at the lowest total cost,

Improve quality of the finished goods produced, and Optimize customer satisfaction.

Purchasing contributes to these objectives by:

Actively seeking better materials and reliable suppliers, Work closely with strategic suppliers to improve quality materials, and Involving suppliers and purchasing personnel in new product design and development efforts.

Decision Making At Purchasing Dept.?

Decision Making

Make or buy? Keep inventory and how much? What price to pay? Where, when and what size to place orders? How long is the lead time and when to expect orders What is the best alternative? What transportation mode to choose? Long or short term suppliers? Should we cancel ord Who will form the negotiation team and what is the strategy in negotiation? Should we use bidding or reverse auction?

The Purchasing Process

19

Manual Purchasing-Older system, prone to duplication of

effort and error
Step 1-Material Requisition/Purchase Requisition- stating product, quantity, and delivery due date are clearly.

Step 2- The Request for Quotation (RFQ)- Buyer identifies suppliers & issues a request for quotation (RFQ).
Step 3- The Purchase Order (PO)- The purchase order is the buyers offer & becomes a binding contract when accepted by supplier.

The Purchasing Process- Cont.

20

Electronic Procurement (e-Procurement)

Step 1- Material user inputs a materials requisition- relevant information such as quantity and date needed. Step 2- Materials requisition submitted to buyer- at purchasing department (hardcopy or electronically). Step 3- Buyer assigns qualified suppliers to bid- Product description, closing date, & conditions are given. Step 4- Buyer reviews closed bids & selects a supplier

The Purchasing Process- Cont.

Advantages for the e-Procurement System?

21

The Purchasing Process- Cont.

Advantages for the e-Procurement System
Time

savings Cost savings Accuracy Real time Mobility Trackability Management Benefits to the suppliers
22

Small Value Purchase Orders

23

Processing costs can be substantial. Small value purchases should be minimized through:

Procurement Credit Card/Corporate Purchasing Card Blank Check Purchase Orders Blanket or Open-End Purchase Orders Stockless Buying or System Contracting Petty Cash Accumulating Small Orders to Create a Large Order Using a Fixed Order Interval

24

Sourcing Decisions: The Make-orBuy Decision

Outsourcing -buying materials and components

from suppliers instead of making them in-house. The trend has moved toward outsourcing.

Backward integration refers to acquiring

sources of supply

Forward integration refers to acquiring

customers operations.

The Make or Buy decision is a strategic decision.

25

Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Buying or Outsourcing ?

26

Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Buying or Outsourcing

Cost advantage: Especially for components that are non-vital to the organizations operations. Insufficient capacity: A firm may be at or near capacity. Lack of expertise: Firm may not have the necessary technology and expertise. Quality: Suppliers have better technology, process, skilled labor, and the advantage of economy of scale.

Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Making ?

27

Sourcing Decisions: The Make-orBuy Decision- Cont.

Reasons for Making

Protect proprietary technology No competent supplier Better quality control Use existing idle capacity Control of logistics- lead-time transportation, and warehousing cost Lower cost
28

Sourcing Decisions: The Make-or-Buy Decision- Cont.

The Make-or-Buy Break-Even Analysis

29

Roles of Supply Base

30

Supply Base- suppliers that a firm uses to acquire its materials, services, supplies, and equipment. Firms emphasize long-term strategic supplier alliances consolidating volume into one or fewer suppliers, resulting in a smaller supply base. Preferred suppliers provide:

Early supplier involvement- Information on the latest trends in materials, processes, or designs Information on the supply market Capacity for meeting unexpected demand Cost efficiency due to economies of scale

Supplier Selection
31

The process of selecting suppliers, is complex and should be based on multiple criteria:

Selection Criteria ?

Supplier Selection
32

The process of selecting suppliers, is complex and should be based on multiple criteria:
Product

and

Order

process technologies Willingness to share technologies and information Quality Cost Reliability

System and cycle time Capacity Communication capability Location Service

How Many Suppliers to Use

33

Single-sourcing- a risky proposition. Although trends favor fewer sources, avoid single source.

Reasons Favoring a Single Supplier ?

Reasons Favoring More than One Supplier ?

How Many Suppliers to Use

34

Single-sourcing- a risky proposition. Although trends favor fewer sources, avoid single source.

Reasons Favoring a Single Supplier

Reasons Favoring More than One Supplier

To establish a good relationship Less quality variability Lower cost Transportation economies Proprietary product or process Volume too small to split

Need capacity Spread risk of supply interruption Create competition Information Dealing with special

Purchasing: Centralized vs. Decentralized

Purchasing Organization dependent on many factors, such as market conditions & types of materials required. Centralized Purchasing- purchasing department located at the firms corporate office makes all the purchasing decisions.
Decentralized

Purchasing- individual, local purchasing departments, such as plant level, make their own purchasing35

36

Purchasing: Centralized vs. Decentralized

AdvantagesCentralization ?

AdvantagesDecentralization ?

37

Purchasing: Centralized vs. Decentralized

AdvantagesCentralization

Concentrated volumeleveraging purchase volume Avoid duplication Specialization Lower transportation costs No competition within units Common supply base

AdvantagesDecentralization
Closer knowledge of requirements Local sourcing Less bureaucracy

A hybrid purchasing organization- both decentralized at the corporate level and centralized at the business unit level may be warranted.

38

International Purchasing/Global Sourcing

Global sourcing Opportunity

to improve quality, cost, and delivery performance. Requires additional skills and knowledge to deal with international suppliers, logistics, communication, political environment, and other issues.

Import broker or sales agent- performs service for a fee.

Import merchant- buys and takes title to the goods. Trading company- imports & carries wide variety of goods.

Total Cost of Ownership Concept

Total cost of ownership is more than just the purchase price; other qualitative and quantitative factors, including
freight

and inventory costs, tooling, tariffs and duties, currency exchange fees and fluctuations, payment terms, maintenance, and non-performance costs
Firms can use total cost analysis as a negotiation tool to inform suppliers regarding areas where they need to improve.

Total Cost of Ownership Concept

An Example of Total Cost Analysis Outdoor Inc., assembles five different models of all terrain vehicles (ATV) from various ready-made components to serve the Las Vegas, Nevada market. The company uses the same engine for all its ATVs. The purchasing manager, Ms. Henderson, needs to choose a supplier for engines for the coming year. Due to the size of the warehouse and other administrative restrictions, she must order the engines in lot sizes of 1,000 each. The unique characteristics of the standardized engine require special tooling to be used during the manufacturing process. Outdoor Inc agrees to reimburse the supplier for the tooling. This is a critical purchase, since late delivery of engines would disrupt production, and cause 50% lost sales and 50% backorders of the ATVs. Ms. Henderson has obtained quotes from two reliable suppliers,

An example of Total Cost of Ownership - continued

Demand & Cost Information
Requirements (annual forecast) Weight per engine Order processing cost Inventory carrying rate 12,000 units 22 pounds $125/order
3000 + units/order $490.00 $22,000 2/10, net 30 125 miles 2% 1% $488.00 $20,000 1/10, net 30 100 miles 3% 2%

Two qualified suppliers have submitted the following quotations:

Unit Price 1 to 999 units/order 1000to2999 units/order Supplier 1 $510.00 $500.00 Supplier 2 $505.00 $498.00

20% per year

Tooling Cost

Cost of working capital

Profit margin Price of finished ATV Backorder cost

10% per year

Terms

18% $4,500 $15 per unit

Distance Supplier Quality Rating Supplier Delivery Rating

Ms. Henderson also obtained the following freight rates from her carrier: Truckload (TL M40M or 40,000 lbs): $0.80 per ton-mile Less-Than-Truckload (LTL): $1.20 per ton-mile Note: per ton-mile 2,000 lbs per mile

Which supplier is more cost effective?

Description 1. Total Engine Cost 2. Cash Discount n/30 1/10 2/10 Largest discount 3. Tooling Cost 4. Transportation Cost (22,000 lb LTL) 5. Ordering Cost 6. Carying Cost 7. Quality Cost 8. Delivery Rating Backorder (50% ) Lost Sales (50% ) TOTAL COST 12,000 x 1% x 50% x $15 12,000 x 1% x 50% x $4,500 x 18% $6,000,000 x 10% x 30/360 N/A $6,000,000(10% x10/360+2% ) $ $ 12,000 units x $500

Supplier 1 $ 6,000,000.00 12,000 units x $498

Supplier 2 $ 5,976,000.00

50,000.00 136,666.67 $ $ (136,666.67) 22,000.00

$5,976,000 x 10% x 30/360 N/A

49,800.00 76,360.00 $ $ (76,360.00) 20,000.00

$5,976,000(10% x10/360+1% ) $

125miles x 12,000units x 22lbs x $1.20/2000 12,000 / 1,000 x $125 1,000 / 2 x $500 x 20% $6,000,000 x 2%

$ $ $ $

19,800.00 100miles x 12,000units x 22lbs x $1.20/2000 1,500.00 12,000 / 1,000 x $125 50,000.00 1,000 / 2 x $498 x 20% 120,000.00 $5,976,000 x 3%

$ $ $ $

15,840.00 1,500.00 49,800.00 179,280.00

$ $ $

900.00 12,000 x 2% x 50% x $15 48,600.00 12,000 x 2% x 50% x $4,500 x 18% 6,126,133.33

$ $ $

1,800.00 97,200.00 6,265,060.00

An example of Total Cost of Ownership - Solution