Professional Documents
Culture Documents
COURSE - I
PURCHASING MANAGEMENT
SYLLABUS
LESSON -1
LESSON -2
LESSON -3
LESSON -4
LESSON -5
LESSON -6
LESSON -7
LESSON -8
Buying
practices
in
fluctuating
markets
volume
timing
of
Purchasing
under
uncertainty-Statistical
criteria-Illustrative
examples.
LESSON-10
LESSON-11
LESSON-12
Value
analysis
-Importance
as
a cost
reduction technique-
LESSON-14
LESSON-15
performance appraisal.
1
LESSON 1
PURCHASING FUNCTION
OBJECTIVES
1. To know about materials management
2. To know the scope of Materials management
3. To know the objectives and scope of purchasing
4. To know the Role of purchase manager
5. To know about organizational structure for purchasing
CONTENT
1.0 Introduction
1.1
1.2
1.3
1.4
Objectives of Purchasing
1.5
Scope of Purchasing
1.6
1.7
1.8
Revision Points
1.9
Intext Questions
1.10 Summary
1.11 Terminal Exercises
1.12 Suggested Reading/Reference Books/Set Books
1.13 Key words
1.0 INTRODUCTION
Materials Management was recognised during the World Wars and its utmost
importance was very keenly felt in the defense and military operations. The concepts
of planning, sequencing, programming, production, inspection, storage, transport
and delivery were very carefully thought of and an awareness was created.
Consequent to such a need for proper supply of materials, equipment, spare parts
etc. the total Materials Management was evolved. The Materials Management
embraces in its field, essentially the material planning till its end use, like the
concept of 'cradle to cremation'. Therefore, in its sphere, material planning,
procurement, inspection. Transport, storage issue and accounting etc. are all
covered.
The Material Management therefore is grouped broadly as under:
Material planning, indenting, budgeting, material proerurement, purchase and
delivery, inspection, storage, preservation, stock verification, material accountingnumerical and value, bills, payments.
Further for the purpose of studies and in-depth knowledge, it could be
classified as below:
-Material planning and control
-Purchase management
-Stores management
Purchase management is the key area of the materials management. It is
looked up very critically by the management of the Company/Organisation, as it is
this area wherein about 60 to 70% of the company's finances are ploughed. In fact in
many companies, public enterprises, State enterprises. This area is very critically
and closely followed and monitored. The Purchase Management has to face lot of
opposing divergent forces from different internal departments like production, stores
and finance but yet to show good results. Great amount of skill, strategy are needed
in this vital department so that it serves all these internal departments without any
friction or production loss. Again it is this part which faces the suppliers and
expected
to
solve
their
problems
carefully
maintaining
good
rapport
and
followed in the industries. Within the ambit of materials management, the Purchase
Management is one of the basic functions and forms a major part of it. The moment
the purchaser places an order he commits a substantial part of the funds of the
Company thereby working capital and cash flow are to be regulated. The purchase
department is associated with commercial and finance departments, closely tied up
with purchase actions. If purchase commitments are chosen wrongly, the Company
may end up with losses and even turn out to be its burial. Proper policy of the
company on the purchase are to be formulated and then goals/objectives of the
purchase department duly drawn out with reference to the company's end product,
its acceptability in the market. Carefully drawn out procedures, policy and deploying
the right Executive in the purchase department shall prove to be a most successful
organisation.
1.1 MATERIALS MANAGEMENT AN INTRODUCTION
Materials management a comparatively new concept at has now been
recognised as a part of the total management of any Company in order to achieve
best results and best return on investments. Terms such as purchasing, storing,
transport, preservation, legalistic supports known in a very elementary and vague
manner have all now being accepted as a major element that plays a key and vital
role in the' integrated Materials Management. Like advanced countries of the west
Japan in the east who have made giant strides in the successful use of material
management techniques, India has also emerged as one to adopt such techniques.
Indian Institute of Materials Management and its functions are similar to American
Materials Management Association and Japan Materials Management Association.
The Material Management in a fast developing country like India is quite unique and
with peculiar problems of its own. Materials are the largest single expenditure in any
Company and the other areas of expenditures are establishment including salaries,
allowances, perks, traveling, contribution to pension fund, leave travel concessions,
bonus, incentive, extratia payments expenditure due to auditing, payments to
statutes etc. While the materials account for 60 to 70% of the sale in value of the
product, the others shall range between 30 to 40% only. It will be very difficult to
make any change or alternatives in the area other than materials as all these involve
human and industrial relations point which is very sensitive as men speak and
claim
their
rights
while
machines/materials
do
not
speak.
Under
these
reducing the cost of the material will go a long way in improving the profitability and
the rate of return on the investment.
Materials management offers a wide scope for reducing costs, savings in foreign
exchange, conserving scarce raw materials. Improving productivity and increasing
profits. It will be much easier to reduce the materials cost than the cost in the other
areas as narrated above as materials cost predominate in the total cost of a product.
1.2 OBJECTIVES OF MATERIALS MANAGEMENT
a.
b.
c.
Purchasing the right quality, right quantity at a light price from a right
source and at right delivery.
d.
e.
f.
g.
h.
(i)
Materials planning and control: Materials planning and control are action
based on sales forecast and production planning. This involves estimating
the individual requirements of parts, preparing material budget, forecasting
in the level of inventories, scheduling the orders, monitoring, follow up and
expediting.
(ii)
(iii) Stores and inventory control: include receipt, storage, preservation and
issue
of
materials,
accounting,
efficient
handling,
declaring
accounting,
finance,
budget
and
Management
reports:
such a delicate/sensitive area and job, person of very high caliber, integrity, honesty,
determined to save the Company funds, high quality, character beyond any
temptation shall be entrusted with this function.
Every organisation or company, be it a public sector enterprise, state sector
enterprise, private sector, partnership firm or family concern of any industry such
as agricultural, power, chemicals, textiles, agro, heavy machineries, roadways,
telephones, rubber etc. needs raw materials of some kind/variety or other,
depending upon the plant/factory design and end product, consumables like
building materials, timber, paints and varnishes, oils, lubricants, petrol, hardware,
steel, structurals etc., tools, spare parts as needed for the machineries installed,
supplies and services of others. Services from others are needed as no single
company can make all the products due to its own economies, skills, technologies
etc. Procurement of articles is therefore a basic need for every company and its
timely and scientific action shall meet the objectives of the Company.
The objectives of purchasing can be stated as below:
to maintain continuity of production,
to contribute to the competitiveness of the end product.
to contribute towards higher productivity.
target will be discussed jointly by all the heads of various departments specifying
their portion as well as their inputs needed. For example, the production head may
say that machines are of such condition that they cannot deliver beyond certain
quantity per day or per month.
position is such that to meet the sales target envisaged by the Sales department,
they may need to borrow or float shares or over draft from Banks and so on. On the
basis of the viewpoints by various departments in their function, a reasonable target
is fixed which is achievable, marketable and fetch returns and profits.
On the basis of the target fixed materials of various items, spare parts
consumable, tools are prepared based on engineering norms or standards or on the
basis of observed data or earlier experience. These are listed out on the basis of the
codification of materials. Such a list will show details as under: Description of the material, total quantity required Quantity on time basis like
monthly, quarterly based on the production schedule and storage position, technical
specification of the material required, supported by drawings, if any.
Such a list is sent to Material Controller, who in turn raises the demand on the
purchase department. While sending the list, The Material Controller takes into
account the stock on hand, goods in transit. The Material Controller converts such a
list into a Purchase requisition to the Purchase department. Upto this activity it can
be said as Pre-purchase.
SALES
PRODUCTION
FINANCE
FORECASTS
CAPACITY OF THE
MACHINES
FUNDS
AVAILABILITY
(BUDGET)
DISCUSSION
TARGETS FIXED
STOCK
INCOMING
GOODS
MATERIAL
PLANNING
FINALISED
ITEM QTY
MATERIAL
PLANNING
10
11
ii.
iii.
iv.
v.
Single Tender
vi.
vii.
Repeat Order
viii.
Negotiation
ix.
Local purchase
The mode of tender enquiry depends upon the item to be procured, its
estimated value, quantity, time at which it is required, availability in the market etc.
However,
in
any
method
adopted,
there
is
necessity
to
have
detailed
(ii)
12
opening of the tenders can be kept less as this type of tendering is resorted
to only standard products.
suppliers whose performance rating has been assessed and such suppliers
listed for that item.
(iv) Single Tender enquiry is resorted to in the case of items which are
proprietary nature and there is only one source available for this item. For
example for Petrol, Diesel, Steel etc. generally the tender enquiry shall
contain all the clauses. Terms and conditions except Liquidated Damages
clause.
(v)
13
suppliers sources are already prepared and kept ready under Rate
Contract (RC).
(vi) Repeat Order is resorted to in case there is already a supply order which is
under execution and suddenly a demand is received for the same item. In
such cases in the same current order the quantity is increased by a Repeat
Order while all other terms and conditions including prices are same.
Except the quantity. This type will help and vasten the supply.
(vii) Negotiations: For very urgent requirements for any item, a known, reliable
and dependable firm is called for negotiations on price, terms and
conditions and supply order issued after due agreement on all the issues.
Care must be exercised in selecting the firm in this case to avoid any
failure.
(viii) Local Purchase For emergency needs, purchases are made locally in the
market without resorting to any tendering procedure, this will be on the
basis of 'cash and carry' but involves risk as rates are not obtained on
competitive basis and no guarantees are made.
Under any system of tendering, the bids/offers submitted in due stipulated
time are opened in the presence of those bidders or their representatives and
important technical and commercial parameters are openly read out. Care should be
taken to see that no discussions are encouraged, as it is not 'negotiation' but only
'tender opening', Proper records and documentations are carried out so that any
bidder raises any issue, it can be duly answered.
A Tender Committee will examine all the offers, facts, technical suitability and
evaluate them taking into account all costs involved in getting the material to the
stores of the firm, Generally lowest technically suitable offer is recommended for
purchase and in few cases it could be negotiated also, On the basis of the Tender
Committee's recommendations and with the approval of the competent authority
delegated with such powers, supply /purchase order is placed.
1.5.4 Supply/ Purchase Order
A
supply/purchase
order
is
prepared
on
the
basis
of
tender
as
it
makes
lot
of
commitments
on
both
sides,
namely
14
and without any ambiguity and shall not lead to different interpretations. It shall
contain:
Name and address of the buyer.
Name and address of the supplier.
Quantity to be supplied.
Place per unit.
Payment.
Delivery -rate of delivery -terms like F.O.R. Ex.Works etc.
Time schedule.
Time guaranteed by way of liquidated damages.
Excise duty.
Sales Tax.
Octroi and other taxes. If any.
Inspection and acceptance.
Insurance during transit.
Force Majored.
Settlement of disputes.
Termination.
In addition to the above clauses, in the case of an order for imported item
against a firm abroad, the following shall also be included.
Currency of payment.
Import license details.
Letter of Credit.
Marine insurance.
Marine transit.
Customs duties
Port handling
15
Such a detailed supply order shall be prepared and get vetted by legal' and
finance departments before release. After release, it must be get signed in one copy
by a representative who has a power' of attorney issued by the management.
Sometimes, to save time, a Letter of Intent is issued so that manufacture can be
started as in many cases it takes sometime to prepare the order and release it. An
order copy is sent to finance, stores and the user department for follow up action in
their respective areas.
Many companies issue supply orders on Ex.Works'basis to avoid Excise Duty on
transport charges and insurance charges payable by the buyer. The buyer enters
into a contract for transport of goods through bank approved transport carrier.
Therefore, the buyer arranges the transport through such transport carrier and pays
it directly. In the case of insurance many companies take an Open Policy on annual
basis and make payment direct to insurance department.
In some cases, even the inspection, expediting, follow up to the receipt of
materials are attended to by the Purchase Executive. It depends upon the policy of
the company. But it is a post-purchase activity and it involves co-ordination with
transport, stores and accounts departments.
1.6 ROLE OF PURCHASE MANAGER
The role of the Purchase Manager in any Company, Public or Private or State
sector, Small scale industry, partnership concern or any is becoming more and more
difficult and complex due to the factor, he has to satisfy various departments
internally and statutory authorities, suppliers, transport agencies, insurance
companies, banking sector and the like.
department looks upon its needs only and is not able to appreciate the problems
faced by the purchase executive. Scarcity of the goods in the market, uncertainty in
the supply of raw materials; frequent changes in the taxes and duties, acts of Good,
acts of Governments, power failure, transport problems industrial relationship, low
productivity etc. have been conquered with and goods procured. There are many
opposing forces. Above all, queries/audit, objections have to be answered.
Purchase Manager is a most key person in the company as it is he who
commits on behalf of the company to outside forms. Since he makes a
financial commitment he has a very great responsibility. He has to interact
with the production department so that the production needs are met with in
respect of quality and quantity by timely supplies. He has to interact with the
finance department in respect of budget allocation, payment of bills. He has
to, interact with the stores department so that incoming goods are properly
organised and inventory is held at the desired level.
16
The Purchase Manager shall maintain good rapport with the suppliers. He is,
to some extent, Public Relation Officer (PRO). He must visit the factories as
often as possible to acquaint himself of the development taken place.
Sometimes, reciprocal buying is also adopted. That means against what is
sold,
some
other
items
required
are
purchased.
Good co-operation,
see
of
authority
adequate
delegation of
powers,
17
PURCHASE MANAGER
PRIVATE
SECRETARY
APM
RAW
MATERIALS
&
CONSUMABL
ES
APM
APM
PLANT AND
MACHINERY
SPARES AND
TOOLS
APM
OIL
LUBRICANTS
IRON AND
STEEL &
BEARINGS
APM
CO-ORDINATION
MONITORING &
REPORTING
COMPUTER
2.
3.
4.
Explain the relationship between the, Purchase Manager and other Inter
departments Company.
5.
6.
18
7.
1.10 SUMMARY
In this lesson, concept of materials management and their scope are given in
detail.
Scope and objective of purchasing, role of purchase manager and purchasing
organization are explained in detail.
1.11 TERMINAL EXERCISE
1.
2.
Define purchasing?
3.
4.
2.
Management,
purchasing,
material
Planning,
Make-or-Buy
19
LESSON-2
2.
3.
4.
CONTENT
2.0.
Introduction
2.1.
Concept of Quality
2.2.
Right Quality
2.3.
2.4.
2.5.
2.6.
2.7.
2.8.
Determining quality-inspection
2.9.
Revision Points
2.10.
Intext Questions
2.11.
Summary
2.12.
Terminal Exercises
2.13.
2.14.
Key words
2.0 INTRODUCTION
In the Industry, today, there are number of products, end products, semifinished products developed which are needed for various uses and functions. The
products are manufactured depending upon the use from different raw materials,
additives, different process technology adopted. The products are used in the
various sectors like domestic appliances, agricultural sector, mining, chemical
industry, power generation, utilities, heavy machineries, railways, ship building,
aviation sector, automobile industry, office equipment tele communication sector,
transport and handling sector and so on. In each of this sector, different end
20
functions are called upon and the product has to meet and match with. These
products are to withstand dynamic loading, stress and strain, temperature,
pressure, impact, shocks and other engineering characteristics. Failure in anyone
area by any product/ component may end up in a break down which will cause loss
of production and affect the profits. But a quality product shall function and
perform well and shall not cause a failure and help the industry in its operation.
Quality is a function of use and shall meet the technical specification and
requirement.
The need for the quality in any product need not be emphasized. It is the
quality that makes the product to perform very well to the desired level and such
products of quality will have a great demand in the market. Once the quality of a
product is proven. The Company's name is well established in the market and many
time people demand that product only.
maintain its quality, many manufacturing firm have created a quality control
department. The Quality Control department functions independently and has full
authority and powers. In recent management principles, even a Quality Circle is
created. This Quality Circle consists of executives from different departments like
production planning, quality control and inspection. The executives meet frequently
and discuss the production methods. And methodology, standards, order, quality
control checks and measures and inspection procedure to ensure quality. Areas
where there is weakness and improvement called for, remedial measures are
suggested and carried out.
2.1 CONCEPT OF QUALITY
Towards
departments
the
manufacture
prepare
design
of
and
any
product,
drawings.
The
Planning
and
department
Engineering
also
prepares
materials/components required for the manufacture of the product and draws out
technical specification for these items. These include chemical and physical
properties and other parameters. These details shall act as a guidance in deciding
and procuring these materials/components. To produce the good quality material
and components of right quality as per technical and engineering specification are to
be procured and used. Also the correct process of manufacturing is to be adopted so
that quality can be maintained in the end product. The machines installed in the
manufacture, consumables used in the manufacture, tools, jigs, vices etc., used in
the manufacture shall also be of good quality so that the end product and storage
and preservation of the product certain quality standards are to be adhered to, so
that they are kept in the quality as manufactured without any deterioration. The
Supervisors, Foremen, Skilled workers engaged in the manufacture of the product
21
shall also of quality conscious people and shall not sacrifice or compromise the
quality in production at any cost.
The systematic control of quality and development of standards had their
inception with the industrial revolution and the production technique that
accompanied it. In earlier days, such quality control was relatively a simple matter
as the variety of products were not there and many usage under different climate
were not envisaged. For example, in the surface transport, we had only bullock carts
or jutkas. These were relatively, small with few parts and were not used for high
speeds with heavy loads. There was also not much risk/damages caused in case of
failure. But today we see lot of buses, lorries, two-wheelers, tractors, etc. moving on
the road at a high speed carrying heavy load of passengers/cargo. In case of any
accident due to any failure of any part, the risk involved is considerable and the
damage to life and property are unexplainable. In these cases. Therefore all the
parts/components shall be of quality product to ensure non-failure at all. Due to
technological revolution all over the world, the old conventional methods are getting
changed to machine methods and also due to the heavy demand. Therefore it means
clear and precise description of products to be manufactured and this led to the use
of samples, brands and specifications. Such description is made in the form of
standard which is an acceptable level of quality design. Standards are evolved as a
result of experience and are widely published and are readily available to any buyer.
Such standards are prepared and Indian Standards Institute (ISI) publishes them.
2.2 RIGHT QUALITY
The design and engineering department generally specifies the quality of the
material needed for the manufacture of the product. This quality will always have
some tolerances and allowances. Such specifications of the quality means that the
quality should be just enough and right to meet the specification requirements. It
shall be neither too high or too low. Such a quality standard is called the 'right
quality'. It is the role of the Purchase Manger to bring it to the notice of the user
department the different qualities available. Wherever possible, the user department
can carryout the shop tests or on-line tests to determine the right quality.
Specification can be really worked out and drawn on the basis of these tests. For
example, where a Galvanised Iron bolts will meet the technical function and
specification requirements, there is no need to use Stainless Steel bolts. When the
purpose can be achieved/ensured by a cardboard case, there is no need to provide a
plastic box or wooden box. Therefore, right quality is the one which meets the
technical specification and can function well and should just right one either too
high or too low. Such a right quality product will definitely be of reasonable and just
price, which will ultimately control the cost, and unit price of the product.
22
23
24
available as per ISI. So, there may not be any difficulty, in meeting the quality
standards. But in practice, there could be no manufacturer at all for a particular
product of a particular design/ specification. But in the market alternative may be
available but it will also meet the end function designed. In such cases, the quality
requirements may be suitably changed with the materials available in the market.
This would be a practical and realistic approach. The other alternative would be to
develop a source for the item so designed and desirable. Where quality standards
cannot be altered, but has to be maintained, then a new source has to be developed.
Many times, it is achieved by a trial order. In few cases, the modifications may not be
acceptable at all. Many companies, through their Sales and Marketing department
personnel, collect data of the available material in the collected data and
informations to the design department and even Production planning department.
The departments may then take care on the design, the available material and fit it
into the designs. This way will be very easy to locate the source for a material of a
particular specification which is really needed.
2.3.4 Development of New Sources
If it becomes necessary that material quality standards cannot be altered and
the material of the same specification is needed and not available in the market.
Then the Purchase department has to procure the material only; a Tender enquiry
has to be issued for this material with specification and special condition to be
carried out. Since it is a new source for this material, there shall be enough
encouragement and motivation to undertake the job. In many cases certain amount
of incentive is also considered like supply of shop drawings, parting with the knowSUPPLIER
how etc. exclusively for this purpose, deletion of penalty clause and advance
payment etc. Many times a clause is added that once the product is found
technically suitable, a long-term contract will be reached between the buyer and
seller for this item. Such
a clause
will ensureREQUIREMENTS
the prospective seller to evince more
SUPPLY
ORDER-QUALITY
interest in developing the product as he may get a long-term business. In the same
CREDIBILITY
GOOD MARKET
& RETURN
way, Even alternate materials can be found, such suitable substitute materials are
put to tests and accepted. Costs also has a role to play. Cost/price being one of the
PROCESS OF
most vital factors, the purchase department
has a large role to play. Once a new
MANUFACTURE
source" and the alternate materials are found and acceptable, and then they can be
put in the list of approved suppliers
2.3.5 Vendor Co-operation
RIGHT
INSPECTION
VendorsRIGHT
co-operation is
very essential RIGHT
in the purchase
of a product/
QUALITY
TECHDURING
SKILLED
machinery/ spare
In the case of purchase
order for MANUthe manufacture of
RAWparts etc. NOLOGY
PERSONAL
MATERIAL
FACTURE
major equipment
like Boilers, Turbines, Transformers, Condensers,
Reactors,
QUALITY
SEND
PRODUCT
INSPECTION
ACCEPTANCE
25
26
27
may like to know about the desired item. The main purpose of the quality.
Description is three-fold: (1) to describe the quality of the item or items in as clear
tenns as possible, (2) to let the vendor know all the factors that he may want to know
about the item ordered, and later on (3) permitting inspection by specified
measurements or quality test which can verify that the material or materials
received are infact the materials described on the purchase order and conform to the
quality requirements of the vendor.
The description may take a variety of form or a combination of forms, but the
general practice is to describe the quality of the purchase order by the following
methods:
1. By brand name or trade name in case of branded products.
2. By commercial standards in case of standardized products, components or
materials.
3. By specification: (a) by specifying physical or chemical characteristics, (b) by
specifying performance characteristics and (c) by specifying materials and
methods of manufacture.
4. By using blueprints of engineering drawings followed by descriptions.
5. By market grades and samples in case of graded commodities.
However, in many cases one of the above methods is quite inadequate to
describe the quality properly and clearly. In such cases, a combination of two or
more of the above methods is used. Each of these, methods is discussed briefly as
below:
2.4.1 Brand Name or Trade Name
A manufacturer in deciding to market a product-market generally decides to
brand it. A brand name or trade name is put on the product in order to identify its
origin, which ultimately creates goodwill for the manufacturer. By branding it, he
protects it against substitutes, gains repeat sales, maintains, price-stability and
simply
competes
with
other
manufacturers
in
the
market.
By
repeated
28
29
(c) Materials and method of manufacture This type includes both materials
used and method of manufacture
requirements exist and the buyer is willing to assume the responsibility for product
performance. There are two distinct advantages; one is securing of competitive bids
and since the item is generally a non-standard one. The supplier cannot charge
arbitrary -price if the costs of materials and manufacture are known to the buyer.
2.4.4 Specifications
Specifications are a detailed description or listing of the characteristics of an
item. Compiling specifications often requires considerable time and may prove costly
by comparison with other methods of communicating to the supplier what is
desired. Nevertheless, buying by specifications is one of the commonest methods.
Since a great majority of business purchases require its use.
(a) Dimensional and Material Specifications: Specifications may take the
form of a listing of the physical or chemical properties desired in the product. These
are sometimes called dimensional specifications because they state the desired
properties in measurable terms. Such commodities as metallic raw materials, oil,
and paint are examples of items for which this type of specifications are frequently
used. Conformity to dimensional and material specifications can usually be checked
quite simply.
Another form of specification is the minute prescribing of both material and
method of manufacture. This method is sometimes used in military purchasing, but
in industry it is rarely used except when unique requirements exist. Ordinarily, if the
vendor knows the use of the 'good, he is in better position than the buyer to
determine what materials and methods of manufacture are necessary. The buyer
assumes a heavy responsibility under this procedure, since he- has no recourse if
the products are unsatisfactory, so long as his specifications were met by the
supplier. The buyer incurs the methods of production with which he may not be
familiar. Also, costly inspection at the vendor's plant may be involved.
(b) Performance Specification Specifications may detail the performance or
use of the purchased item. Here the purchaser indicates his interest in the service
that the product will give, and he tests the end result rather than the product. If the
vendor accepts the specifications, the responsibility for a satisfactory product is' his.
For example, a part may be specified as capable of being bent to a 90-degree angle
and subjected to an 80-degree temperature. These are the least difficult
specifications to formulate. The method is especially suitable for purchase of
machines or tools about which the purchaser has little technical knowledge. It leaves
30
the seller free of restrictive prescriptions of materials and processes, and he may
take advantage of the most up-to-date knowledge to provide the best product at the
lowest cost. Satisfactory use of performance specifications requires securing reliable
suppliers and developing competition. Otherwise the seller's responsibility for results
may cause him to suggest better but more expensive item than is needed.
2.4.5 Blueprints
Use of the blueprint, or dimension sheet is an important corollary of many
specifications. The blueprint usually accompanies some descriptive text in the
purchase order. It is the most precise and probably the most accurate of all forms of
description, and is applicable where close tolerances or a high degree of mechanical
perfection is required. Its use is expensive, not only because of the cost of the
blueprint, but also because it usually describes items of special design that is costly
to manufacture. However, for items such as casting, forgings: tools and fixtures,
purchings, and machine parts, which call for extreme accuracy, it is the most
feasible method of description. Blueprints also provide the basis for an accurate
check on compliance with specifications by the inspection department when
material is received.
It is important to remember that an inspector will be governed only by the
purchase order and any drawing or specifications indicated thereon. He may only
inspect to see that the items comply with the drawing and the written specifications.
Therefore, any verbal agreements that have beep made may become a source of
difficulty when a shipment is received, and care should be taken to make sure that
all special conditions and agreements are made a part of the purchase order.
Specifications should be revised as conditions change. In one instance, in the
purchase of steel, a situation developed in which a purchasing agent and supplier
informally agreed that steel supplied under certain specifications could vary from
the specifications. The specifications called for a thickness tolerance of 0.003. The
informal agreement was that the supplier would aim at this tolerance but that
actual shipments might occasionally vary up to 0.005. The agreement worked
successfully for 8 years, but when a new buyer was apprised of the agreement by the
supplier, he was unable to get the using department to accept the terms of the
informal agreement. After considerable time however, the specifications were
changed because adherence to the stated requirements threatened to raise the cost
so much that the company would have been unable to compete in the sale of the
final product. All this could have been avoided if the informal agreement had been
expressed in revised specifications
31
32
4.
5.
6.
Specification
buying
is
necessary
step
toward
industry-wide
2.
3.
4.
33
5.
34
transportation is great in relation to the value of the goods, final inspection may be
made before shipment in order to avoid return transportation costs in the event of
rejection. Some large companies find it economical to maintain inspectors at or near
the source of subcontracted items, special items such as heavy forgings and
castings, and goods bought in large quantity. Perhaps the most extensive use of
inspection at the source is by the Department of Defense for military purchases.
Few companies have centralised inspection department. The benefits of this
arrangement are described as follows:
1.
Special skills required for proper product inspection involve the training
of fewer people than would be the case if each operating area were to
inspect its own incoming shipments.
2.
3.
4.
5.
For any given value of protection (in respect to both producers and
consumers risks) a smaller sampling ratio is required for the larger size
lots inspected at the source as compared with the smaller size lots
which would be inspected at destination.
6.
7.
In most instances the size and nature of a companys. operations will preclude
the use of such an elaborate system. Where conditions dictate inspection at the
source, independent testing laboratories or inspection agencies can sometimes be
employed. When the cost of securing and maintaining specialized inspection
35
2.
36
Specification,
Description,
Commercial
Standards,
Performance
37
LESSON-3
2.
3.
CONTENT
Introduction
Source of Information of potential suppliers
Need for Evaluation
Factors to be considered in supplier Evaluation
Different methods of Evaluation
Revision points
Intext Questions
Summary
Terminal Exercises
Suggested Reading/Reference Books/ Set Book
Key word
3.0 INTRODUCTION
The main objective of a purchase function is to procure the required material,
component, spare parts from the right source, at the right quality, right quantity,
right price and at right time. If the source is selected properly, naturally all aspects
will be fulfilled. If the supplier is a dependable, reliable, proven and guaranteed the
supplies will meet the technical specification and timely supplies can be ensured. If
the source selected is not so, the supplies made may not be on time, may not meet
the technical specification and if used, may cause damages and thus there will be
loss of production which in turn will adversely affect the financial position of the
company. Such a wrong selection of a source may lead to disastrous consequences.
38
39
Most purchasing departments maintain vendor files which contain the names
and addresses of all vendors with whom the company has delay throughout its
history as well as a notation of the classes of goods that have been purchased from
each vendor. Frequently the files are set up to include additional data on such
things as the reliability of the supplier in meeting commitment dates, willingness to
handle emergency and rush orders and defect or reject ratios on shipments received
in the past.
Some companies expand their vendor files to include information on all
suppliers investigated, as well as the ones with whom the company has done
business. Such information may be useful, provided it is still current enough to be
pertinent.
3.1.2 Interview With Salesman
The salesman who call on purchasing agents are extremely valuable sources of
information about suppliers for particular products. In most cases their information
relates to their own companies and their own products, but often a salesman is also
able to tell the buyer about a source of supply for an item that his company does not
make.
In an attempt to provide visiting salesman with the greatest possible amount of
information about their requirements, many firms display their finished products
and purchased components in reception or special display rooms. The salesman is
then able to determine items he call supply and provide technical assistance.
Supplementary information relating to standards of quality expected are also
provided. The more a salesman knows of his prospective buyer's needs, the better
are his chances of being a good source of supply.
3.1.3 Technical and Description Catalogue
The catalogues published by vendors in which they list and describe the
various items they make for sale constitute a valuable source of Information about
possible suppliers. For standard production items such catalogues frequently are
one of the most effective and efficient sources of potential suppliers. A number of
studies have been made In order to learn the extent to which purchasing agents use
their catalog files. These studies show that almost all buyers make some use of their
catalogues and a substantial percentage of buyers use them extensively.
The usefulness of a catalogue, file depends to a large extent on how up-to-date
it is kept. Many of the larger companies appoint a librarian who maintain the
catalogue file as one of his official duties.
40
A companys
41
42
43
important to analyze in detail the facilities that the various companies have to offer
as a criterion of the service they will supply.
3.3.3 Internal Facilities
The
keeping up with current method are also considerations affecting service. While it
might be argued that a, buyer is interested only in whether a supplier can supply
the quality requested, this is a short-sighted attitude. As improvements and
developments are made by competitors, the buyer is certain to want better products
from his suppliers, and, if their technological capabilities do not enable them to keep
up with competitors, the buyer will suffer from having chosen a technologically
inferior supplier.
The inspection methods and the quality-control standards maintained by the
prospective supplier are also important in evaluating service. Since assurance of
supply means not only that the goods will be delivered, but also that they' will be
usable condition, it is important that these two criteria-inspection and quality
control be carefully checked before the choice of supplier is made. A supplier who is
careless about inspection will ship many items that must eventually be rejected and
returned because they are not satisfactory for the purpose. If such a supplier is also
lack in his production quality control, the problem is aggravated because of some of
these, imperfections which many not be discovered until after the item has been
incorporated into the finished product.
A closely related consideration that bears on supplier service is the
"housekeeping" or plant-maintenance standards carried out by the supplier. A
supplier who is careful and thorough in his plant-maintenance practices is likely to
suffer from a minimum number of production disruptions resulting from machinery
breakdowns and similar mishaps. Since production disruptions frequently lead to
delays in shipments to customers, they decrease the assurance of supply which is
an important consideration in service.
3.3.4 Labour Relations
Another possible interference with the continuity of production in a supplier's
plant may originate with the workers themselves. These stoppage may be in the form
of strikes or slowdowns and are the by-product of the labour relations of the
supplier. To a considerable extent, the possibility of such delays can be determined
by observing the morale of the working force the labour policies as expressed by
general management of the prospective supplier, and the degree of responsibility of
the leadership of the union associated with the plant. The history of past strikes will
reflect the labour management climate. A final important point is to determine the
44
length of time remaining on the present labour contract. The possibility of labour
difficulties can then be assessed taking all these factors into consideration.
An indirect clue to anticipate service may be gained from noting the kind and
form of warranty and service that the supplier offers with his products. One should
consider the willingness of the supplier to give an adequate express warranty with
his products, his offer to install where necessary and to replace where indicated and
his willingness and ability to make available replacement parts as needed.
Assurance of supply means not only that, deliveries are made as promised but also
that the product delivered should be usable throughout its normal life. A supplier
who does not stand behind his product or who is not equipped to service his product
satisfactorily cannot be rated high on the point of service.
The vendor relations of the supplier must also be evaluated in determining his
service rating. A good supplier on this score is one who will meet occasional unusual
requests, such as the need for emergency shipments or a sudden slight change in
specifications. A buyer needs assurance that a supplier will willingly accept such
situations if he can be satisfied that the emergency is a real one and that such
emergencies do not arise with undue frequency. It is as important that the buyer do
not subject the supplier to a succession of emergencies as it is that the supplier
accept an occasional emergency graciously.
A visit to the plants of prospective suppliers is an important means of
evaluation. Plant visitation is also important in the periodic reexamination of
present suppliers. It is quite customary for a representative of the production
department or the engineering department to accompany the buyer on his plant
visitations. This is especially desirable if the supplier makes technical products. By
having a technical expert with him the buyer is able to arrive at a sounder judgment
on the equipment and capabilities of the supplier.
3.3.5 Plant Visitations
Although there is no one list of things to be considered on all plant visitations,
it is possible to generalize somewhat with regard to the things that should be
observed and examined on such visits.
I. Facilities: The examination should include not only production machinery
and plant layout but also such facilities as the receiving room where the supplier
handles his incoming shipments, the shipping room where he prepares his own
products for delivery, the internal materials-handling system, the supply rooms and
tool rooms where he maintains his reserve stocks, and the office facilities where he
processes the necessary paper work and records.
45
contain information on
a supplier's
facilities
where
the
report is
unfavourable, a trip to a suppliers plant can be saved. The reports often given an
insight into the experience and character of a potential vendor. By establishing the
credit character of a potential vendor. By establishing the credit rating of vendor,
the purchasing agent is able to estimate the financial risk of dealing with that
vendor.
purchasing agent some insight into his capabilities. Since the reports show the
vendor's profits, the purchasing agent has a clue to the efficiency of the vendor's
operations.
A supplementary related procedure involves independent analysis of the
vendor's financial statements. Although accounting statements vary with fiscal
periods, and details of accounting procedures, the purchasing official can obtain
46
information regarding the financial stability, pricing cushion, and general operating
efficiency by applying the tools of ratio analysis to the balance sheet and income
statements of the vendor. A short account of the more popular ratios and their uses
are follows.
Current ratio relates current assets to current liabilities. The usual "rule of
thumb" acceptable ratio is 2:. As current assets and liabilities are those that can be
turned into cash within short period of time (one year or less). this ratio measures
the financial ability of the firm continue in the short-run. Acid test ratio is a variant
of the current ratio in that it relates current assets less inventories to current
liabilities. Inventories are omitted from current assets because they often are
difficult to turn into cash readily. A "rule of thumb" acceptable ratio here is 1:1. Like
the current ratio, it is a reflection of the ability of the firm to function in the short
run.
Sales-receivable ratio is determined by dividing sales by accounts receivable; it
indicates whether customers are paying their bills promptly or whether too much of
the vendor's assets are tied up in receivables.
standard terms of payment. For example, if the terms are 90 days, not much more
than this amount of total sales should be in receivables. A firm with sales of $6
million and 90-day terms should not have much more than $1 million in accounts
receivable.
Net profit to sales is an overall measure of the profitability of the firm after all
expenses have been deducted, The size of the profits gives an indication of the
possibility of successful price negotiations.
Cash flow is obtained by adding net profit after taxes to depreciation charges. It
measures the amount of dollars the firm is receiving. Cash flow assists profit
evaluation, as an increase or decrease in profit may be caused by changes In
depreciation accounting.
Inventory turnover ratio is the cost of goods sold divided by average inventory. It
indicates efficiency in inventory management, and freshness and salability of the
inventory. If the ratio is low, the firm is either over inventoried or undersold. A
high turnover ratio is usually preferable to a low one.
3.4 DIFFERENT METHODS OF EVALUATION
The most important measure of a suppliers performance is his record of earlier
supplies of similar items made to various purchasers. Recently increasing attention
is being paid to make the evaluation objectively by standards and procedure. There
are three evaluation techniques developed and they are, the categorical method, the
weighted point method and the cost-ratio method.
47
shipments
Received
Quality
Percentage
Rating
Accepted
(%
30)
Percentage
on
Schedule
Deliver
y
Rating
(% 30)
Parentage of Total
Total
Cost
Reductio
n Rating
(% 20)
48
Vendor
A
Vendor
B
Vendor
C
100
90
36
80
24
20
60
80
32
90
27
20
50
70
28
100
30
60
12
Vendor A
Vendor B
Vendor C
Average
Lowest Price
Price Rating
Price/ Unit
40.00
50.00
60.00
Actual Price
40/40
40/50
40/60
(Price % 10)
10
8
7
Vendor A
Vendor B
Vendor C
Quality
Delivery
(40 points)
(30 points)
36
32
28
24
27
30
Cost
Reduction
(20 points)
4
4
12
Price
Composite
(10 points)
Rating
10
8
7
74
71
77
Among the advantages of the weighted-point plan is the fact that a number of
evaluation factors can be included and they can be assigned relative weights
corresponding to the needs of the firm. Subjective evaluation is minimized. Finally, if
the weighted point plan is used in conjunction with the categorical plan, suppliers
can be evaluated on a quantifiable basis without overlooking the intangible aspects
of service.
3.4.3 The Cost Ratio Method
The third evaluation technique, the cost-ratio method, relates all identifiable
purchasing and receiving costs to the value of shipments received from respective
suppliers. The higher the ratio of costs to shipments, the lower the rating applied to
the supplier.
The choice of cost to be allocated depends somewhat on the specific products
involved. However, quality, delivery, service, and price are the usual categories. Costs
associated with quality usually include costs of visits to vendor's plants and sample
approval, inspection costs of incoming shipments, and costs associated with
defective products such as unusual inspection procedures, rejected parts, and
manufacturing losses attributed to defective parts. The costs associated with routine
qualifying of a supplier and routine inspection tend to be approximately equal for all
vendors of like products. However, the costs associated with defective products will
vary substantially from vendor to vendor.
Quality costs can be tabulated by the quality control department, with the aid
of information from production regarding the possible reworking costs associated
with defective parts. An alternative procedure is to have a specific account
49
established departments forward, for posting to this account, their excess costs
incurred as a result of the defective shipment. In either case, total quality costs are
related to total dollar purchases to determine the quality-cost ration as shown in
Table 3.4.3.1.
Table 3.4.3.1 Quality Cost in Rupees
Vendor
Month of Rs.
200
Sample approval
300
Incoming inspection
75
Manufacturing losses
Reworking costs
425
Other
Total costs
1,000
100,000
1%
Month of Rs.
Telephone calls
300
Telegrams
175
200
Premium shipments
125
Miscellaneous
200
1,000
100,00
Delivery-cost ratio
1%
50
evaluates suppliers above and below the norm in relation to price. The following
procedure is suggested to integrate service into the cost ratio:
1. Determine the subjective service factors that the buying company thinks it
should evaluate, such as research and development facilities, capacity for future
production expansion, field service facilities, stability of labour relations, warranty
provisions, geographical' location, financial stability, inventory-storing service, and
flexibility in providing short lead times.
2. Assign numerical weights to each factor in accordance with its importance to
the buying firm.
3. Establish a premium over quoted price that the total subjective service
"package" is worth. A firm producing highly technical electronic components might
value this "package" at 10% of quoted price, whereas a buyer of standard fasteners
might value it at only 1 %.
4. Determines an acceptable norm. For example, out of a total of 100 possible
service points, 70 might be considered as acceptable.
5. Rate the suppliers according to the service factors.
6. Apply this percentage to the value of the total service package to determine
the cost ratio of service. For example, if the total service package is valued at 10% of
price and total possible points are 100, with 70 being acceptable, a vendor with 90
service points would have a service-cost ratio of -3%, whereas a vendor with 50
points would have a service-cost ratio of + 3%. This final value is obtained by
relating the actual number of service points earned to the acceptable level and
subtracting the result from 100%. In this example 90/70 = 130% -100% = 30% over
norm. This value (30%) multiplied by 10% (the total value of the service package)
equals the service ratio of 3%1 .As the final value is over the average, the serviceratio cost is -3%.
A tabulation chart such as the Table given below could be used.
The quality, delivery, and service cost ratios are now combined with the
vendor's quoted prices to detailing the net cost. Assuming that the rating procedure
already described has been applied to four competing firms, the comparison would
be as shown in the Table 3.4.3.3.
Table 3.4.3.3 Service Rating
Vendor
Month of
51
Maximum point
value
Factors
Rating
20
Financial stability
10
15
10
10
10
10
Labour stability
10
Geographic location
10
Warranty provisions
Inventory-storing service
10
100
20
9
Miscellaneous
10
Total points
90
Delivery
Cost
Ratio%
Service
Cost
Ratio%
Total Cost
Penalty%
Quoted
Price/Unit
Net
Adjusted
Cost
Z Company
-3
-1
87.00
86.13
F Company
+3
+7
83.25
89.08
W Company
+6
+10
85.10
93.61
P Company
+2
+1
+4
85.00
88.40
Part
52
Number
Number
Unit
Supplier
Accepted
Price
7,000
6,700
7.00
0.86
2,500
2,300
6.50
0.97
3,400
2,900
4.50
1.00
Supplier
Commitment
fulfilled
3.7 SUMMARY
All three evaluation techniques designed to aid buyer judgment, and in some
cases quantify what would otherwise be subjective analysis. However, they are
suggested to be used as aids to. and not a replacement, for, buyer judgment.
Important supplier variables such as integrity initiative and ethics are not
quantifiable. In addition many of the quantifiable, variables are dependent initially
on subjective decisions. Properly used these techniques can make supplier selection
more scientific and rational.
53
Trade
Directories,
Trade
journals,
Trade
Fairs,
Supplier
Evaluation, Categorical.
54
LESSON 4
conservative
agencies,
government
departments,
Public
sector
undertakings want the lowest responsible price. At the same time, we should not be
blinded by the idea that the higher we pay, the better will be the quality.
55
considered. As the purchaser has very vital role and responsibility to see that the
goods he buys have best value for the price paid as he, the purchaser, is one who
incures expenditure on behalf of his company gain, knowledge of Law of Contracts,
Sale of Good Act, Excise Duty, Customs Duty, Local rules and regulations. ImportExport policy will help him to carry out his job successfully. His familiarity with the
common law of the land, banking regulations, insurance aspects will be an
advantage since he commits the company's funds by way of a supply/Purchase
order which are legally binding bilateral contracts and the knowledge as above will
help him to have the funds of the company and troublesome litigations.
56
57
may not be the best price according to the buyer. In such a process, naturally, the
buyer exerts pressure on the supplier/seller to recheck his cost and review again the
method adopted and possible reduction in price. To a large extent, by this process,
the buyer induces a low cost and efficient production method and technology.
The pricing process of any product is generally determined by the following
factors which has an influence on it.
Direct cost -On materials on labour & Supervisor, overheads, cost of machines
Indirect cost -Overheads due to other expenses like services, purchase,
marketing, finance, personnel and corporate/Head office expenses.
The seller tries to estimate the unit price of the product as accurately as
possible but many times it becomes very difficult due to various elements and
variables involved.
Profit margin -This is also worked out on assumption basis so as to be
competitive.
(A) DIRECT COST:
This shall be the cost of the materials, raw materia1 consumables, spares,
purchased and used in the process of the manufacture of the product. There are
engineering standards and norms for the product manufactured on which the
quantity of each material, spares and other inputs are specified. On these items the
unit price as purchased and the cost incurred thereon are added and the direct cost
so arrived at. Due allowance are taken into account due to wastage, shrinkage, shell
life, productivity of the labour engaged.
On labour, the cost of the entire skilled, semi skilled labour, technicians is
engaged in the direct product manufacture are calculated and included. But the
labour engaged in the services part like inspection, material handling etc. are not
included.
(B) INDIRECT COST:
The expenses incurred in all the services department are grouped together and
charged on the unit cost as overheads. These include all indirect charges incurred,
establishment, personnel, finance, purchase material management, sales etc. and
also includes payment of statutory levies, maintenance of factory, civil and electrical,
distribution system etc.
4.4 RIGHT PRICE
From the foregoing, it will be very difficult to work out the right price as it
depends upon various factors, conditions and situation. But broadly through cost
58
analysis and value analysis, one can assess the price of an item should cost.
Thereafter, the purchaser's skill in negotiating, his relationship and rapport
developed will determine the actual price. Forecasting is done at + 10% of the
previous price. Sometimes, the prices can be arrived at on the basis of the published
indices for the prices of raw materials and Reserve Bank of India's (RBI) indices for
Labour. There are certain standard formulae available. But here again, the exact/
accurate price cannot be arrived at as only few selected items are taken as subject to
variation.
In deciding what is the right price, the Purchase executive must take a broad
and objective view of the company. He must examine the prices quoted by different
vendors/suppliers and attempt to determine which price in relation with the quality
features. standards of the product and the service aspects by the vendor/supplier
will offer his company the greatest ultimate value. The purchase, executive is
spending a substantial proportion of the funds of the company. As it is known
generally
that
materials
are
about
70%
of
the
total
product
59
60
orders carry less cost on transport, reduction in the handling dealing on all matters
with one buyer only. The buyer must consider the inventory carrying cost with
reference to the discount on large quantity. The economics must be worked out and
compared.
4.6 PRICE ANALYSIS
As earlier mentioned, the right price of a product cannot be easily determined.
There are certain information/ data which will be useful in making a very accurate
price of a product. These are indicative but not definite and final.
The Purchaser has to investigate in the market, the fair and reasonable price of
a product, For standard products the price can be collected through price lists and
catalogues. Such price list and catalogue are to be investigated whether they are the
current list, whether any discount announced later or any Excise/Sales Tax benefits
to be passed on to the buyer and so on. Many times a discussion with the Salesman
will bring forth many useful information on the price of the product. These salesman
are well informed about the product price, changes announced, discounts possible,
For controlled items like Iron & Steel metals the authorities concerned like Steel
Authority of India Ltd, (SAIL) and Minerals & Metals Trading Corporation (MMTC)
publish the prices of various items/materials under their purview periodically so
that the buyer is kept informed of the commodity prices offered. By the Seller such
as trade discount, seasonal discount, quantity discount and cash discount.
4.7 TENDERING SYSTEM
As soon as the purchase demand is received in the form of purchase
requisition, the purchaser should decide the mode of purchasing it in due time
depending upon the type of material, component, spare part machinery etc., time at
which it is needed for the production department, quantity needed, the estimated
cost etc. The purchaser should decide the mode of procurement for this item
whether through direct call or negotiation or repeat order or by tendering. More
often, tendering to the open market is resorted to for high value or critical items of
any raw material, spare, machinery and the like.
While there are many different methods of tendering which we shall discuss
later in this lesson, the steps to be taken on the tendering process are as under: Entry of the purchase Requisition
61
62
Limited tender or Single tender, a notice of the intention of the purchaser must be
prepared, and communication so that the firms/companies manufacture will come
to know the demand and act later. Essentially, the Notice inviting Tender is to draw
the attention of the supplier, the intention of the purchaser. The NIT is broad based
and shall contain the following: Name of the Company, Organisation and address.
Tender number
Scope of work
Cost of tender documents
Sale period of tender document
Earnest Money Deposit/Bid Guarantee
Time and date of submission of bids/offers
Time and date of bid opening
Other details like extension for sale/bid/opening/delays in transit by
post/officer to whom bids to be submitted etc. shall also be there.
In the case of major equipment, terms of even pre-qualification requirements
are mentioned on the Notice Inviting Tenders. Generally standard printed forms are
63
available for easy follow up and proceeding with. In the case of Advertised Tender,
the above NIT is published in the approved Dailies. In the case of Limited Tender
Enquiry (LTE) it is modified slightly and sent to such bidders/vendors in the
approved list.
4.7.4 Terms And Conditions
The Purchaser must specify in the tender document tends and condition under
which he desires to receive the bids. The commercial part of the bid documents shall
contain brief description on the terms and conditions and shall include:
Scope of work
Commissioning/Delivery schedule
Price and price variation
Performance guarantee
Payment terms
Insurance/Transport
Excise Duty/Sales Tax/Customs Duty
Liquidated Damages/Force Major
Delivery basis (For/Ex. Works/CIF/C&F/FOB etc)
Termination/Arbitration Limits of legal jurisdiction.
4.7.5 Submission of Bids and Tender Opening
The intending bidders/suppliers shall purchase the tender documents on
payment of the cost prescribed for it. On going through the tender documents,
clarification, if any, may be sought by the bidder. All such clarification will be
examined by the purchaser and suitable reply/clarification shall be issued to all the
bidders/suppliers who have purchased the tender documents. The intending
bidder/supplier shall carefully prepare the tender document is line with the
instruction of the bidders/suppliers issued by the p-purchaser and submit the
tender document in due time as prescribed. Tenders so submitted by the various
bidders/suppliers are registered and duly accounted. These are opened in public in
the presence of the representatives of the bidders/suppliers. Generally late tenders
are not accepted and rejected. Salient terms and conditions of- the various bidders
are read out for the benefit of the other bidders. Generally a Committee shall open
the tender documents though the custodian is the purchase department.
64
4.7.6 Evaluation
The offers/bids so received are examined and analysed in depth. The
comparative statement on technical aspects and commercial aspects are prepared.
The prices are evaluated taking into amount all elements of cost involved in arriving
at the site cost. The details of calculation, are checked very carefully and placed
before the tender committee. The Tender committee will examine these report and
submit its recommendations. On the basis of the financial delegation of powers the
approval to the recommendations are accorded and supply order placed and
acknowledgement obtained from selected supplier.
4.7.7 Supply Order/Purchase Order
This is a most important document which binds the Purchaser and the
Supplier under certain agreed terms conditions and price. On the basis of this
document only an inter department follows and acts. It is a legal document and
claims, disputes etc. that may arise may have legal bearing on the terms and
conditions set in the supply order. Care should be taken to prepare the supply order
and it shall contain to prepare the supply order and it shall contain mutually agreed
clauses terms and conditions and prices. Generally, it is get checked by Finance
department and vetted by Legal department.
4.8 DIFFERENT METHODS OF TENDERING
The objective of the purchase is to get the material/goods of right quality, right
time, right source, right price. To meet this objective, tendering is resorted to,
4.8.1 Global Tender
For procurement of imported materials /goods, a Global Tender is issued. The
Notice Inviting Tenders are -published through Indian Embassy in, other countries
and other country's Embassy in India besides the press advertisement and
publication in the Indian Trade Journal, a publication widely circulated carrying
only such tender notices.
The documents in the case of Global Tender shall, indicate the Foreign
Exchange details, funding agency and its terms. More time is to be given for
submission of bids as bidders are from outside the country.
4.8.2 Press Tender/Advertised Tender
The
Notice
Inviting
Tenders
are
published
in
Dailies
so
that
many
65
66
4.14 KEYWORDS
Right Price, Administered Price, Trade discount, Seasonal Discount, Quality
discount, Tender notice, Tender documents.
67
LESSON -5
PRICING TOOLS
OBJECTIVES
1. To know about forecasting Techniques in purchase management.
2. To know about concept of Break-even analysis and their mechanism.
3. To understand the learning curve concept.
CONTENT
5.0 Introduction
5.1 Direct material cost
5.2 Direct Labour cost
5.3 Indirect expenses
5.4 Price Forecasting
5.5 Break even analysis
5.6 The learning curve
5.7 Revision Points
5.8 Intext questions
5.9 Summary
5.10 Terminal Exercise
5.11 Suggested reading/reference books /set books
5.12 Key words.
5.0 INTRODUCTION
The pricing process of the supplier is not exact and he does not work rigid cost
estimates. He also has a flexible profit that is determined by the market conditions.
The reason for this is not far to seek. He does not, simply know his exact costs till
such costs are actually incurred, and the supplier's price quotations are based on
further estimates of costs, which may be broken into the following for major cost
components.
1. Direct expenses Direct materials Direct labour
2. Indirect expenses Manufacturing overheads
Selling and administrative overheads
He tries to estimate such elements of cost as accurately as possible, but the
pricing process is less exact because of many variables present in the system, which
are briefly discussed below.
68
69
averages
method,
exponential
smoothing,
regression
analysis,
etc.
Sometimes Delphi techniques are used for long- term forecasts. Basic issues, such
as forecasting technique, forecast time detail, and review frequency must be finalized
in consultation with top management.
Price Forecasting Techniques : One of the important activities in materials
management is the forecasting of prices of materials to be procured. The forecast of
material prices forms the basic of purchase budgeting, product, stocking policies,
etc.
Materials Research provides the basic infrastructure and information for the
forecast of prices, The research activity helps in predicting some sudden changes in
prices due to environmental causes. Executive brain-storming sessions can also help
anticipate
sudden
price
changes.
However,
even
without
any
observable
environmental cause, prices do rise and they need to be forecasted on the basic of
statistical analysis. This statistical analysis for prices and any observable cause for
their variations have to accounted for by applying suitable correction factors to the
statistical forecast.
Thumb Rule for Price Forecasting: A general practice rise in price as a basis
for forecast. This is all right for an economy in the grip of inflation. However, the
prices of some products vary randomly both within one year between years and the
prices of these can be predicted by using statistical methods.
The forecasting techniques can be broadly classified as those based on (1) the
extrapolation of the same price series, and (2) relation with another price series.
Extrapolation of the same Price Series (Time series)
The following two methods conform to the above title:
(1) Moving average methods, and (2) Exponential smoothing. These are
explained by means of an example.
5.4.1 Moving Average
Consider the price of linseed oil in the years 1970, and 1971. The monthly
prices 'of linseed oil per quintal are indicated below:
EXHIBIT 1
70
MONTH
January'
1970
454.0
1971
481.0
February
445.0
456.0
March
440.0
439.0
April
384.0
413.0
May
396.0
406.0
June
414.0
393.0
July
404.0
389.0
August
405.0
401.0
September
432.0
421.0
October
422.0
425.0
November
464.0
432.0
December
469.0
412.0
By using the five month moving average methods, the prices from June 1970
up to December 1971 could have been predicted. This predicted value for June 1970
would be the sum of the actual prices for the months January, February, March,
April and May divided by 5. The predicted price value for July 1970 would be the
sum of the actual prices of February, March, April, May and June divided by 5.
Hence, the predicted price for June 1970 would be: 454+445+440+396/5 which is
Rs.423.80
per
quintal
and
the
predicted
value
for
July
would
be
Predicted Price
Actual Price
June
423.80
414.00
July
415.80
404.00
August
407.60
405.00
September
400.60
432.50
October
410.30
422.00
November
415.50
464.00
December
425.50
469.00
January
438.50
481.00
February
453.70
456.20
March
458.44
439.50
1970
1971
71
April
461.94
413.80
May
451.90
406.00
June
439.70
393.80
July
422.26
389.00
August
408.82
401.70
September
401.26
421.70
October
403.84
425.00
November
407.64
432.50
December
415.38
412.30
In the moving average method, the weightages given to the price of each year is
l/n where n is the number of months over which the average is taken. In the
illustrative example, the number of months was 5 and the weightage given to each of
the last 5 months prices was 1/5 or 0.2.
The moving average method requires a lot of data preservation and this
becomes tedious if the number of months over which the average is taken as large.
Another aspect for consideration is the equal weightages given to all the previous
'month's prices. These two aspects, viz., data preservation and giving equal weights
to previous months' prices, is overcome by using what is known as Exponential
Smoothing Method.
5.4.2 Exponential Smoothing Method
In the exponential Smoothing Method, forecast for the next month is based on
the forecast for the previous month and the actual, price of the previous month. The
weightages given are dependent on the nature of changes in prices. Forecast of
month (m) = 1/n (Actual price in month (m-D) + (l-l/n) (Forecast for month (m-D).
If n=5 (n has to be chosen based on experience) then the forecast for the month
July 1970 = 0.2(414.00) + 0.8 (423.80) = 82.80 + 339.04 =421.84 per quintal.
The Forecast price for August 1970 would be = 0.2 (404) +0.8 (421.84) = 80.80 +
= 337.09 = 417.89/Quintal.
The Forecast values and the actual prices up to December 1971 are shown in
the table below.
EXHIBIT 3
1970
June
Predicted
Actual
423.80
414.00
1971
April
Predicted
Actual
444,52
413.00
72
July
421.84
404.00
May
438.38
406.00
August
417.89
405.00
June
431.90
393.00
September
415.31
432.00
July
24.28
389.00
October
418.75
422.00
August
416.22
401.00
November
419.40
464.00
September
413.32
421.00
December
427.32
469.00
October
414.00
425.00
January
435.66
481.00
November
416.20
432.00
February
444.73
456.00
December
419. 46
412.00
March
447.02
439.00
1971
In the above illustration the weightage given to previous month's is 0.2. The
prior month get weightages (0.2 X 0.8), (0.2X 0.8X O.8); and so on, The weightages
given to months is inversely related to their age.
5.5 BREAK EVEN ANALYSIS
Cost-Volume Relationship and Break-even Chart
A Break-even chart shows profit or loss of any of output. If a series of cost
volume relationship is calculated and plotted on a graph. The resulting point which
shows that costs are equal to revenue, is the break-even point. At this point of
output, revenue exactly covers costs of production, below this there is a loss and
above this there is profit. Thus break-even point is the dividing line between profit
and loss and as such, break-even analysis is often used for planning production,
pricing etc. Break-even point is thus what the term implies, because at this volume
of output the firm's total revenue begins to rise and it makes profit at a progressive
rate is the output increases.
In the following chart break-even point is show although in the chart the lines
are shown as straight lines these may not be so in actual practice. Below the volume
of 3.800 units of production, there is loss, and above it, there is profit. The breakeven chart thus graphically illustrates the relative changes in costs and revenues as
the volume of production changes, However, it may be noted that unit cost of a given
product does not only depend upon the volume of production alone, it is also
affected by the overall efficiency of the producer and by the amount of business he
gets, a point which every purchaser has to note.
73
Figure 5.5.1
5.5.2 Cost-Volume Profit
Analysis helps in finding out the relationship of cost and revenues to output. It
enables the financial manager to study the general effect of the level of output upon
income and expenses and therefore, upon profits. This analysis is usually presented
on a break-even chart. It helps in understanding the behavior of profits in relation to
output. Such an understanding, among other things, is significant in planning the
financial structure of a company. There are two elements to consider the level of the
break-even point and the rapidity (Volatility) with which profits change in relation to
output.
The cost-volume profit analysis is used to answer many of the questions faced
by management. As profits are affected by the interplay of costs, volumes and selling
prices, management must have at its disposal analyses that can allow reasonably
accurate presentation of the effect a change in anyone of these factors would have
on the profit performance. When plans are formulated for a given period, certain
questions of the following type have to be answered. Should emphasis be placed on
increasing sales volume? If so, to which of the may products marketed should it be
74
75
Absorption, or full costing system seeks to allocate the fixed (period) costs to
products. It creates the problem of apportionment and allocation of such costs to
various products. By their very nature, the fixed costs have little relationship to the
volume of production or sale. They are allotted to products on some fair or
equitable basis. But any such decision is bound to be subjective and reliability of
allocated cost is naturally very low. Even if the basis for allocation of fixed expenses
is settled, there is still a problem. The actual total cost is distorted not only by
fluctuation-in volume of production but also by variations in the amount of
expenses incurred at irregular intervals. Allocation of overhead expenses, is usually
fraught with considerable technical and accounting difficulties and apportionment
of fixed costs on an arbitrary basis is of limited value and can even be dangerous.
Variable costs: Variables costs are related to the activity itself rather than to
the physical and administrative framework which makes the activity possible. These
costs expand or contract as the activity rises or falls. For instance, the number of
items produced in a period directly determine the amount of material used in their
production. Similarly, the volume of output establishes the direct workers required
and the hours they must put in as well as the amount of certain supplies and other
direct factory expenses. Over the long run, all costs tend to be variable. But within a
given time span, covering an established level, of capacity, distinction has to be
drawn between costs that are relatively free of the ups and downs of production and
those that vary directly with these changes.
As fixed costs do not change with production, the amount per unit declines as
output rises. On the other hand, variable costs react proportionately with
production
changes.
The
amount
per
unit is
constant
with
output.
The
decomposition of costs into fixed and variable class proves to be a trying task.
Relationships often are not clear-cut or may be obscure by unusual circumstances.
Because of the numerous technological changes in recent years, it is difficult to
establish a static period when output and costs can be measured over time with a
reasonable assurance of accuracy. Decisions may have to be made by executive fiat,
although in most cases satisfactory results are likely to be obtained through a
statistical or engineering analysis.
5.5.4 Mechanics To Break-Even Chart
On a break-even chart, the volume is indicated on the x-axis as number of
units produced and sold.
component (F) plus a variable component (v) times the number of units of volume (x)
i.e. for cost y = F +vx.
76
Rs.
500
Variable cost
Rs. 1 per unit
Selling price
Rs. 2 per unit
Normal Volume 750 units
Figure 5.5.2
Figure.5.5.2
In this situation, total cost (F=vx) at normal volume would be Rs. 500 (fixed
cost) + Rs. 1 x 750 (variable cost) = Rs. 1, 250/=
The revenue (px) by selling 750 units at Rs. 2 per: unit would be Rs. 1, 500.
Thus the profit would be Rs. 1,500 -Rs. 1, 250 = Rs. 250. At the break-even volume
cost is equal to revenue and the break-Even volume is px=F +vx. If we use the above
figures in this equation, the result would be as follows:
77
2x = Rs. 500 + Ix
x = 500 units.
We, therefore, find that the break-even volume is 500 units. These results have
been shown in Figure 5.5.2
Mathematical
formulae:
The
point
of
break-even
can
be
determined
F
F
or
1 Vr
C/S
where, x = Break-even in rupee sales, F = total fixed costs at the present level of
x
sales, Vr = ratio of variable costs (per unit) to selling price (per unit),
C/S = percentage of contribution to sales.
Substituting, x =
Rs.500
= Rs. 1,000
0.5
To get the number of units instead of the sales value at the break-even point,
use the following formula:
F
pv
where, x=number of units at the break-even point, F = total fixed costs at
x=
present level of sales, p = selling price per unit, and v = variable costs per unit.
Substituting, x =
Rs.500
Rs.500
500 units
Rs.2 Re .1
Re .1
The calculation of break-even point thus can take two forms: (1) in terms of
physical volumes and (2) in terms of rupee value of sales. The second calculation
emphasizes the approach of marginal income analysis. The marginal income is the
difference between the selling price per unit and variable cost per unit. If the
objective is to find out the break-even volume in units the formula would be:
F
pv
On the other hand, if the break-even point has to be determined in terms of
x=
F
F
or
1 Vr
C/S
78
The higher the break-even point, the less chances are of operating the business, at a
profit over the years, For example, in managing a hotel, a comfortable position can
be had if the break-even point is at 60 per cent of capacity than if it is at 90 per cent
of capacity, Further, if an undertaking is operated close to the break-even point,
slight changes in business environments are likely to result in losses.
There are four ways in Which profit performance of a business can be improved.
a) by increasing volume.
b) by increasing selling price
c) by decreasing variable costs, and
d) by decreasing fixed cost.
(a) Increasing volume: Considering our original illustration where selling price
and variable costs per unit were set at Rs. 2 and Re. 1 respectively and fixed costs
amounted to Rs. 500, the company had to sell 500 units to break-even. The normal
volume of production for this company had been assumed at 750 units. The amount
of profit at different volumes is shown in Table 4.1.
Table 4.1. Profit at various volume levels
Volume
(units)
previous levels
Volume%
Profit%
500
..
..
600
100
20
Infinite
750
250
25
150
900
400
20
60
1000
500
11
25
It is worth noting that a 25 per cent of sales increase (from 600 units to 750
units) would result in an increase of 150 per cent in operating profits. But the
additional increase of 20 per cent, .i.e. from 750 units to 900 units, would result in
an increase of 60 percent of profits. This shows that as the sales move away from a
break-even point, the percentage increase in profit Is proportionately lower than the
increase near the break- even point.
(b) increasing selling price: Profit performance can be improved by increasing
the selling price. An increase of 10 per cent in selling price (Rs. 2+0.20= Rs. 2.2 per
unit) would add Rs. 150 to revenue and would, therefore, increase profit at current
79
volume of 750 units from Rs.250 to Rs. 400. i.e. increase of 60 per cent. With this
price
500
0
600
100
750
400
900
580
1000
700
(Break-even point= 416.6 units)
previous levels
Volume%
..
20
25
20
11
Profit%
..
120
82
45
21
It may be noted that the break-even point with an: increase in selling price at
10 per cent would be reached at 416.6 units instead of 500 units. However, with an
increase of 25 per cent in volume (from 600 units to 750 units), the percentage of
profits (after an increase of 10 per cent in selling price) would go to 82 as compared
to 150 in the example (a).
(c) Decreasing variable costs: If the company is able , to reduce its variable
costs by 10 per cent (Re. 1-0. 10 = 90 paisa). it would increase "contribution margin"
(selling price-variable cost per unit, i.e. Rs.2-0.90 = Rs.l.10) and the break even
point would decline to 454.5 units and thereby the operating leverage characteristic
would also change. A.25 per cent increase in volume from 600 units to 750 units
would produce a profit increase of 103 per cent as shown in Table 4.3.
Table 4.3. Profit at various volume levels
Volume
(units)
previous levels
Volume%
Profit%
500
61
..
..
600
160
20
220
750
325
25
103
900
490
20
51
1000
600
11
22
80
This increase deserves special notice as there is a common belief that changes
in fixed costs alone can result in a favourable operating leverage. This analysis
demonstrate that changes in the contribution margin due to changes' either in
variable costs or in selling price are very significant.
(d) Decreasing fixed costs: Profits can be improved by reducing fixed costs. A
10'per cent decrease in fixed costs would amount to Rs.50. and break even point
would decline from 500 units to 450 units. A 25 per cent increase in volume from
600 units to 750 units would produce a profit increase of 100 per cent and a 20 per
cent increase from 750 units to 900 units would result in an increase of profit of
only 50 per cent (Table 4.4)
Table 4.4 Profit at various volume levels
Percentage increase from
Volume
previous levels
Profit (Rs.)
(units)
Volume%
Profit%
500
50
..
..
600
150
20
200
750
400
25
100
900
450
20
50
1000
550
11
22
fixed
or
Variable
cost
categories
as
they
possess
the
81
It was assumed that the company sold only one product. In several products
with different marginal incomes were sold, the break-even chart for the whole
company would show the average marginal income for all products and would be
affected by changes in the mix of products. Under such circumstances break-even
charts for each product or for each group of homogeneous products are more useful
for analysis than is the single overall graph. In a company having multi-plants,
management may bring about a reduction of the break even point by increasing
sales of a product with a high profit margin at the expense of a less profitable item.
To get around this condition, the financial manager may have to prepare and
evaluate a number of profit-graphs covering integrated segments of independent
activities.
The break-even analysis assumes that changes in the four factors are not
accompanied by changes in amount of capital employed. If a decrease in variable
costs raised because of the purchase of new machines, effect in the return of
investment is not given by the profit-graph. Partly the effect may be shown by an
increase in the fixed depreciation cost but one can hardly tell from this alone what is
the effect on the overall rate of return.
Break-even chart represents short-run static relationship of costs to output. As
it is based mainly upon historical experience, variations in costs of material and
labour and introduction of new equipment or methods will change these relations.
Firms that are growing rapidly find that break-even charts become obsolete very
quickly. Their situation is too dynamic for a static analysis. .
In many cases, it is difficult to measure output, particularly in a multi product
firm. One way of constructing a break-even chart for such a firm is to measure
output in terms of per cent of capacity. Instead of showing number of units product
on the X- axis of the break-even chart, per cent of capacity ranging from 0 to 100 per
cent can be shown. Alternatively, machine hours or standard labour hours can be
used as measured of output. The aim should be to find out a factor that serves as an
equally satisfactory measure of the level of output of all product. The relations
indicated in the break-even chart do not help for all levels of operations. Costs tend
to be higher than shown on the static break-even chart when the plant's operation
approaches 100 per cent of its capacity. Second and third shift payments usually
involve extra payments to the workers and may be more inefficient. As production
moves closer and closer to capacity, it is likely that variable cost per unit would rise
fairly sharply. Under such circumstances, break-even chart probably cannot be used
to establish profits at such extremes. It is assumed in the preparation of break-even
charts that total costs shown are those incurred to produce the sales revenue
82
indicated. This is often not the case. There may be research and development
expenses which, are incurred in one year but whose benefits occurs over a number
of years. The difficulty of matching expenses to income increases when an attempt is
made to apply, break-even analysis to short periods.
The break-even chart assumes that items produced are sold at the same price
regardless of output while reductions in price are expedient in order to maintain
sales. These frequent changes" in the selling price of the product after the reliability
of the break-even analysis.
Linear break-even analysis is especially weak in what it implies about sale
price. Therefore, in order to study profit possibilities under different prices, a whole
series of charts is necessary, one chart for each Price, Alternatively, non-linear
break-even analysis can be used. Lineal break-even analysis is useful as a first step
in developing the basic data required for price and for financial decisions.
The cost of securing funds to expand is disregarded in the chart. Thus, beyond
a certain point in short-run borrowings, the interest charges may go up sharply or
funds may not even be available to the business causing a liquidity position.
5.5.7 Uses of Break-Even Analysis
The above limitations have been elaborated not with a view to minimising the
usefulness of the tool of break-even analysis. In fact, it is a very important and
useful tool of financial management and control. The simplicity of these charts is
one of their great values. As they are easy to understand, they constitute a helpful
mechanism for showing the top management the problems inherent in cost-volumeprofit relationships. They are extremely useful in planning devices. By focusing
attention on marginal income, break-even studies avoid the controversial problems
of locating fixed costs which do not change with volume or price variations.
In planning, short-term strategies, the cost-volume-profit studies helps in
determining the nature and magnitude of sales efforts and establishing volume
requirements. Marginal income analysis, a by- product of break-even analysis, places
emphasis on cost differentials and these, rather than total cost, are influential in
deciding alternative course of action.
5.6 THE LEARNING CURVE
The learning curve concept is developed in connection with new products. That
the costs of production per unit of a new item decreases as additional units of that
product are manufactured is the basis of it. Because the supplier becomes more
skilled as the worker repeats an operation and improves his speed and efficiency,
83
this causes him to reduce the labour and supervision costs. The following are the
factors that bring down the cost:
a) (i) job familiarization,and
(ii) task learning (both worker and supervisor)
b) improvement in shop organization and production control,
c) type of work and method,
d) the ratio of assembly hours to machine hours,
e) tooling quality and coordination, and
f) product.
By way of illustration, if the buyer knows that it takes a supplier 100 hours of
direct labour to make the first unit of a new product and 80 hours to make the
second unit, the average labour hours would be 90 hours. When the production
doubles to four units, the average labour hours would be 90 hours. When the
production doubles to four units the average labour hours would progressively fall.
When the production doubles to four units. The actual average labour hours for four
units are 81 hours per unit of item. If production doubles the average labour hours
declined by about 10%.
84
Figure.5.5.3
Because of this, the learning curve concept has its greatest application in costanalysis of new products only.
application of learning curves for purposes of comparison separately both for the
buyer's firm and the supplier's firm, to determine whether his firm has the lower
average cost than the vendors Will help him to decide whether to make or buy a
particular item. And since learning curve can also be used to forecast required
labour time, it can be used to estimate the vendor's capacity to deliver specified
quantity Within a specified time With the given labour force, which can be extremely
helpful in scheduling deliveries.
5.7 REVISION POINTS
Direct and Indirect Expenses
Price forecasting
Moving Average Forecasting
Exponential smoothing methods
Break even analysis
Learning curve.
5.8 INTEXT QUESTIONS
1. Describe the essentials of pricing tools and price forecasting.
2. Explain fully the break-even analysis concept and its applications.
3. Explain the uses and advantages of learning cure in developing a new
product.
4. With an example explain the Learning curve.
5.9 SUMMARY
Price forecasting is an important function of purchase management. Two
different methods were discussed with examples. Break-even analysis and their
limitations and applications were discussed in details. Learning curve concept were
also included in this lesson.
5.10 TERMINAL EXERCISE
1. Discuss the break-even analysis.
2. List the types of forecasting Techniques
3. List the Limitations of Break even analysis
4. Define learning curve.
85
86
LESSON -6
commodity markets which offer facilities for hedging by means of future contracts.
Specialist commodity buyers are experts in these markets. But other buyers who are
87
not specialists and do not have the opportunity to become experts still have to make
occasional purchases in these markets. Or buy products at prices which are affected
by the cost of the commodities used in their manufacture. Thus it is most desirable
for buyers to understand why commodity prices fluctuate and to have some
appreciation of the buying strategies which can be used in such conditions.
6.1. WHY DO PRICES FLUCTUATE?
Anyone who buys food for a householder a restaurant is familiar with the way
prices change for farm products. The first asparagus reaches the market at
astronomical prices, there is not a lot to sell, but at those prices there are not many
who are willing to buy. Supply and demand are brought into equilibrium by means
of these price changes. Price also changes from year to year due to weather or some
other reason. Exactly the same considerations affect the prices at which the soft
commodities are traded in commodity exchanges, but there are also additional
considerations.
In addition to producers and consumers, participants in these markets include
speculators, dealers and jobbers. Prices react continually to expectations of present
and future supply, or present and future demand of stock situations etc.,
Consequently, even though prices of some commodities stay much the same for
long periods of time,
amount and occur in much shorter periods of time, than changes in the prices of
manufactured goods. Also commodity prices have in the past been almost as likely to
move downwards as upwards, which has not been the case for manufactured goods.
The high amplitude and short period of the price changes which can occur can be
illustrated from the commodity price boom which occurred in 1973-74. ExampleCopper sold on the London Metal Exchange for 450 pounds a ton in January 1973,
by April 1974 the price reached an unprecedented peak of 1400 pounds a ton, yet
only five months after it was back down 600 pounds. Price fluctuations of such
amplitude are unwelcome both to consumers and to products. A major producer of
copper is the developing country of Zambia in Africa, whose main export revenue is
derived from the sale of copper. The Government of such a country faces an
impossible task in planning capital investment programs such as the construction of
school, highways etc. which will take years to complete, when the export revenue
required to finance them can increase by over 300 per cent in a year, only to be cut
in half in a few months. It is generally agreed that consumers and producers alike
would prefer a more stable level of prices, although they might take different views
as to what level is appropriate.
88
Price stability, however, desirable, has not in practice proved easy to achieve.
Commodity price changes reflect changes in the supply of commodities and in the
demand for them. The 1973-74 price boom was unusual in that most commodity
prices rose; usually, some rise while others fall. It was attributed partly to a
considerable increase in demand from the major industrial economics. which were
all expanding, and partly to shortfalls in supply because of poor harvests and crop
failures of agricultural commodities and shipping delays and production problems
for mineral commodities. Flood, drought, plant disease and crop failure can produce
a shortfall of agricultural produce, while good harvests can produce a glut on the
market, and natural results are high prices and low prices respectively: Wars,
strikes, revolutions and changes in Government policy have also had serious
repercussions on the supply of commodities. Changes in economic activity in the
industrialized countries, which are the main customers, have immediate effects on
demand, and changes in taste or technology or the availability of substitutes have
long- term effects on demand. In the case of many commodities, the effect on price
of any changes which occur in supply or demand is increased by the length of time it
takes for any attempt to adjust supply to demand to take effect. Newly planted
rubber trees take years to come into full production. Small changes in metal output
can be made with existing facilities, but a large increase in output might require a
lengthy process of re-opening old mines or digging new mines and providing
housing. transport and shipping facilities to exploit them. A large reduction in
output is equally difficult to achieve because of the serious effects on employment
and export revenue which would result.
6.2 BUYING TECHNIQUES
Time budgeting or averaging is a cautious policy which ensures that the cost of
commodities consumed is the same as the market price. The exact quantity required
is purchased at the time of requirement and no stocks are held. If stocks have to be
held, as is often the case. This simple policy cannot be used. An ingenious formula
approach known as rupees cost averaging or budget buying, does even better by
ensuring that the cost of commodities consumed is less than market price, Provided
that average market price can be predicted successfully and that actual prices
fluctuate in random fashion about this average. The idea is to spend a standard sum
based on the average price at regular intervals of time. This budget amount buys a
larger amount when actual price is below average and a smaller amount when price
is above average. This can be illustrated by taking simple, exaggerated figures. Let us
suppose that one ton a week is required of a commodity of which the average market
price is Rs. 100/- a ton, and that in three successive weeks, actual market price is
Rs: 150/-, Rs. 50/- and Rs. 100/-. With the back to back or averaging policy, 1 ton
89
would have been bought each week: but with the budget buying policy, Rs. 100/would be spent each week, the budget amount to obtain 1 ton at the average market
price. In the first week, Rs. 100/- would buy two thirds of a ton at Rs. 150/- a ton.
In the second week, it would buy 2 tons at Rs. 50/-. In the third week, it would buy
1 ton. Over the three week period, budgeted buying would have resulted in 3 and
2/3 tons being bought for Rs. 300/-, at an average cost below the average market
price. The averaging policy would have resulted in 3 and 2/3, 3 tons being bought
for Rs. 300/- at cost equal to the average market price.
A more sophisticated approach has been developed by operations research
workers and is known as dynamic programming. To illustrate this technique, let us
suppose that 100 tons a week are required of a commodity the price of which
fluctuates randomly between Rs. 200/- and Rs. 300/- a ton, and that the buyer is
authorised to purchase upto ten weeks' supply (i.e., 1000 tons). We will also assume
that future contract are not available. Having found a method of determining each
week how much to buy, we will then reconsider these simplifying assumptions. In
order to establish a yard stick, by which we can measure how well the dynamic
programming technique works, let us first see how well we could buy if we knew in
advance what the market price would be each week. Over a fifty week period, let us
assume that prices each week are going to be as shown in table 6.2.1. Assuming we
start with no stock, we must buy 100 tons in the first week to meet the first weeks
requirements, but as price is falling we buy only one weeks supply. The same applies
in weeks 2 and 3, but in week 4 the price of Rs. 209/- is the lowest until week 8, so
we buy 400 tons to last until week 8. In week 8 the price of Rs. 202/ -is the lowest
which is going to apply for a considerable time, so we buy 10 weeks supply, the
maximum authorised. Each week we look ten weeks ahead and buy as little as
necessary to meet requirements until we can stock up at a low price with the
advantage of advance. Knowledge of price we would be able to supply the fifty week
requirement at an average price of just below Rs. 210/- a tons Known in table 6.2.2.
Table 6.2.1 Actual Market Prices
Weeks
1-5
277
265
220
209
280
6-10
234
246
202
205
204
11-15
215
240
206
287
288
16-20
217
218
277
266
214
21-25
268
227
285
211
217
90
26-30
226
295
268
297
273
31-35
275
264
227
245
201
36-40
287
220
202
219
236
41-45
245
242
296
272
298
46-50
278
281
252
231
288
Table 6.2.2
Week Number
Opening
Stock
Price Paid
Amount
Bought
Total Expense
nil
277
100
27,000
nil
265
100
26,500
nil
220
100
22,000
nil
209
400
83,600
nil
202
1000
2,02,000
10
800
204
200
40,800
13
700
206
300
61,800
20
300
214
100
21, 400
24
Nil
211
1000
2,11,000
25
900
217
100
21,700
35
Nil
201
1000
2,01,000
38
700
202
300
60,600
39
900
219
100
21,900
49
nil
231
200
46,200
Total
5000 tons
10,48,200
91
denote the prices of indifference by Po, P1, P2, P3, .. P10 where the suffix denotes the
number of weeks' stock in hand. These prices can easily be calculated on the simple
assumptions we have made that
1. Demand is 100 tons a week
2. Orders are for multiples of 100 tons
3. Maximum stock is 1000 tons
4. Price varies random}y and evenly from Rs. 200/- to Rs. 300/- a ton.
With nil stock we must buy whatever the price; but as price will not exceed
Rs. 300/- (i.e., P0 is Rs. 300/-).
With one weeks stock, the price of indifference is determined by the fact that
we must buy next week if we do not buy this week. Next weeks price we do not
know but on the average will tend to be half way between Rs. 200/- and Rs. 300/-.
So we should buy this week if the actual price is below Rs. 250; and this gives the
value of P1 as Rs. 250. With two weeks' stock. the situation is more complicated. If
we do not buy this week, next week we will be down to one weeks' stock and P 1 = Rs.
250/-. The changes are even that next weeks price will be below Rs. 250/- and if it
is on the average it will be Rs. 225/- consequently.
P2 = (Probability of price below P1 x (expected price if it is) +
(Probability of price being above P1) x P1 = 0.5 x 225 + 0.5 x 250.
P2 = Rs. 237.50.
With three weeks' stock similar calculation can be made.
P3 = (Probability of price being below P2 x (expected price) + Probability of price
being above P2) x P2.
Since the prices are assumed to be evenly distributed, if the price is below P 2 it
will be on the average half way between 237.5 and 200.
So. P3 = 0.375 x 218.75 + 0.625 x 237.5 = Rs. 230.58
Proceeding in this way we obtain the following prices at indifference:
P0 = Rs. 300.
P1 = Rs. 250.
P2 = Rs. 237.5
P3 = Rs. 230.5
P4 = Rs. 225.8
P5 = Rs. 222.5
92
P6 = Rs. 220.0
P7 = Rs. 218.0
P8 = Rs. 216.4
P9 = Rs. 215.0
P10 = Rs. 214.0
93
94
Stock
Prices
Figure 6.3.2
Having plotted the price of indifference curve a company has only to go to
market, checkup the price and raise the stock to the level of indifference. Thus if P 0,
P1. P9 are the prices of indifference when stocks are for zero week. 1 week, 2 week,
. 9 weeks, what a company needs to check these prices against the stock levels.
(1) Calculation of P0
If a company has no stock on hand, it has to buy atleast one weeks'
requirement no matter what the price is since the highest price is Rs. 6,000/- ton.
Po = Rs.6,000/-.
(2) Calculation of P1
The company has one week's stock on hand. It has to decide whether it should
buy or hold off. We are essentially looking at what the price would be next week. The
prices vary randomly (assume prices to be uniformly distributed between
Rs. 5,000/- and Rs. 6,000/- per ton) and the expected price in the next week would
be Rs. 5,500. Therefore PI = Rs. 5.500/-. i.e., buy with one week's stock on hand if
the price is below Rs. 5.500 per ton say buy the next week's requirement as well in
this week if the price is below Rs. 6.500 per ton.
(3) Calculation of P2
The company has stock for two weeks. It has to decide whether to buy third
week requirement now or hold off.
requirements are:
95
Suppose the decision is to hold off. Next week (i.e. second week) the company
will buy if the price is below P 1 i.e. Rs. 5,500. The chances of the price being below
Rs. 5,500 is 0.5 (50% of the times) and its expected value is Rs. 5,250. There is
again 50% of chances of the price in the second week being above Rs. 5,500 and in
such a case the company will buy in the third week. The expected price in the third
week is Rs. 5,500.
Therefore P2 (price of indifference)
= 0.50 (5250) +0.50 (5500)
= 2625 + 2750
= Rs. 5,375/-.
i.e.. If the price in this week is below Rs. 5,375/- ton buy the third week's
requirement now.
(4) Calculation of P3
The company has 3 week's stock on hand. It has to be decided whether or not
to buy the fourth week's requirement. The alternatives are
96
The company can estimate the average price paid in the long run by applying
these prices of indifference to the price of the 50 weeks which is forecast.
In week 1, the price is Rs. 5,770. Therefore, buy only on week's requirement.
Opening
Week No.
Price
Stock
nil
Amount
bought
5,770
Closing stock
100
Nil
In week 2, the price is Rs. 5,650/-, therefore the company should buy a weeks
requirement.
Opening
Week No.
Price
Stock
Amount
bought
Closing stock
nil
5,770
100
Nil
nil
5,650
100
nil
In week 3 the price is Rs. 5,200. This is equal to P 6 the company should raise
the stock to 6 weeks requirements (Note if the price is below Rs. 5,200/- the
company would buy a weeks requirement even if the stock on hand was six weeks
requirement).
Opening
Week No.
Price
Stock
Amount
bought
Closing stock
nil
5,770
100
Nil
nil
5,650
100
Nil
nil
5,200
600
500
In week 4, the price is Rs. 5,090. This is even below P 9. Hence the company
should raise the stock to full capacity.
Opening
Week No.
Stock
Price
Amount
bought
Closing stock
nil
5,770
100
Nil
nil
5,650
100
Nil
nil
5,200
600
500
500
5,090
500
900
Proceeding on these line for all the 50 weeks, the amount purchased and price
paid for each of the purchases made is listed below.
Table 6.4.1
97
Week No.
Price
Total
Expenses
nil
100
5,770
5,77,000
nil
100
5,650
5,65,000
nil
600
5,200
31,20,000
500
500
5,090
25,45,000
600
400
5,020
20,08,000
900
100
5,050
5,05,000
10
400
100
5,040
5,04,000
13
700
300
5,060
15,18,000
16
700
100
5,170
5,17,000
20
400
600
5,140
30,84,000
24
600
400
5,110
20,44,000
33
100
300
5,270
15,81,000
35
200
800
5,210
40,08,000
38
700
300
5,020
15,06,000
49
nil
100
5.520
5,52,000
49
nil
200
5,310
10,62,000
98
With
99
LESSON-7
100
101
102
concerned. While he may have a definite need for the material, the forward
purchasers assumes a risk regarding future price fluctuations of the material. When
he extends his coverage much beyond a years requirements, in most industries the
buyer has entered the real on of speculative buying. For some materials the time'
period is less than a year. The main objectives of forward buying are as under:
i) The buyer is assured of regular delivery of materials. He can save his firm
from facing shortage of materials which may arise as a result of strikes or go slow
tactics adopted by workers in suppliers plants or transportation problems or
reduction in total supply in the markets or irregularity on the part of suppliers. It
protects the firm against the risks of prospective shortages of materials.
ii) A buyer can purchase the materials of right quality at the right time by
following forward buying policy. Certain materials are available during a certain
season of the year and certain materials available from certain sources only. A buyer
can make advantageous purchases only when the materials are available in large
quantity or materials are offered by the suppliers. A buyer must have detailed
market information for better decisions. If a buyer does not know, when materials
are offered he cannot take advantage of a favourable supply position and reasonable
prices. A buyer takes the advantage of favourable price situation by following the
forward buying policy.
iii) Generally quantity discount or trade discount is allowed by suppliers, when
purchases are made in large quantities. A buyer follows forward buying policy to
take the advantages of large purchases.
iv) Cost of transportation per unit can be reduced by purchasing in large
quantities, some times special reduced freight rates can be obtained for
transportation of material in large quantities.
v) Cost of buying and work load of purchasing- and receiving department can
be reduced by forward buying. By excessive purchasing frequency of orders can be
reduced, which results in decreasing the work of inspection department also.
vi) Some times a buyer wants to know the price of the products of his firm in
advance, because he may have to quote the price for the products yet to made. Now
the cost of material used in such products can be calculated in advance only if the
materials required for such products are purchased in advance. This is true so far as
the unstable market is concerned. In the case of stable market, a buyer can estimate
the cost of materials in advance without purchasing them, but in the case of
unstable market, prices fluctuate very widely and therefore, a buyer cannot estimate
the cost of materials without purchasing the material in advance.
103
104
one year and the average price of the commodity will be about Rs. 10/- per unit,
which may fluctuate within the range of 20%. The cost of materials, for the half year
may be a under.
Cost of materials when price fluctuates in narrow range: (Ref.Table .7.1)
Table .7.1
Quantity
Month
purchased in
units
1
10000
90,000
10000
10
1,00,000
10000
80,000
10000
11
1,10,000
10000
12
1,20,000
10000
10
1,00,000
Total
60000
600000
Thus the firm gets the required quantity of materials at an average cost of
Rs. 10/- per unit and has not to suffer loss due to price fluctuations. When the
price fluctuations are violent, this method may hot prove useful. A buyer can
save money by purchasing in large quantity when price is moving around the
average level.
Cost of purchasing, when price fluctuations are violent: (Ref. Table 7.2)
Table 7.2.
Quantity
Month
purchased in
units
1
10000
10
1,00,000
10000
15
1,50,000
10000
16
1,60,000
10000
11
1,10,000
10000
80,000
10000
60,000
Total
60000
6,60,000
105
Here the average price comes to Rs. 11 per unit. The firm has to spend
Rs. 60,000 more. When the price shows continuous decline, this method can
only prove to be useful.
Cost of purchasing, when price trend shows continuous decline: as shown in
table 7.3.
Table 7.3
Quantity
Month
purchased in
units
1
10000
2.50
25,000
10000
2.45
24,500
10000
2.40
24,000
10000
2.35
23,500
10000
2.30
23,000
10000
2.25
22,500
10000
2.20
21,500
10000
2.15
21,000
10000
2.10
20,500
10
10000
2.05
20,000
11
10000
2.00
19,500
12
10000
1.95
2,67,000
Total
120000
600000
Here the average price covers to Rs. 2.23 approximately. But if the materials
are purchased in large quantity for three months requirements, each time the
average price per unit will be more, which can be seen from the Table 7.4.
Cost of purchasing, when materials are purchased in a big lot equivalent to
three months requirements, in case of declining trend of prices.
Table 7.4
Quantity
Month
purchased in
units
st
30,000
2.50
75,000
4th
30,000
2.35
70,500
106
7th
30,000
2.20
66,000
10th
30,000
2.05
61,500
Total
1,20,000
2,73,000
Here the average price per unit comes to Rs. 2.28 approximately, which is
higher than the price calculated under Table 7.3. It is advisable to increase the
Frequency of purchases, when price is falling continuously.
The savings generated from purchasing by this method depends on (i) the
timing of purchases, (ii) Range of fluctuations in prices, (iii) duration of the price
swing and (iv) accuracy in buyers' forecasting. It is very difficult for the buyer to
estimate what the average price will be and what the highest price will be and also
when the peak level will be reached. Moreover, a buyer may not makes twelve equal
purchases as stated in Tables 7-1 to 7-3. Under this method of purchasing, the
volume of purchases depends on the timing of purchases. When price of the
material is on the upswing, forward buying is used. i.e., purchases are made in
excess of the current requirements and when prices is on downswing hand-tomouth purchasing policy is used as stated in Table 7-3. In both cases the purchases
are averaged i.e. the total requirements for certain period is bought in equal
installments which depends on the price trend. In case of rising trend of price the
frequency of purchasing will be lower, i.e., purchases will be made in large quantity,
equivalent to 2 to 4 months requirements while in case of declining price trend, the
frequency of purchases will be more, i.e., purchases will be made in comparatively
smaller quantity equivalent to 2 to 4 weeks requirements. It is assumed that the
quantity of each purchase remains the same, which may be for weekly requirements
or monthly requirements or quarterly requirements etc. When the prices rises to a
great extent, purchase of the same quantity require more funds, which may not be
possible for the firm to provide for.
107
108
109
LESSON 8
110
imposed on the curve are the purchases made during the period. Horizontal arrows
near the base of the chart indicate the time coverage afforded by each purchase.
Examination of the buying pattern in the example shows that near the rough of the
curve, in January, a four months supply of 80,000 units is purchased. As prices
continue to rise, similar purchases are made in May and September. At the peak of
the cycle, during January month's supply of 20.000 units is purchased. During the
period of price decline, Similar monthly purchases are made for the next eleven
months. Illustration of the deliberate volume-timing technique of purchasing in a
fluctuating market
Fig. 8.1
The result of this purchasing pattern becomes clear upon further examination.
During the period of rising prices three purchases are made. The average unit price
for this purchased material is slightly above the May price and clearly below the
average market price during upswing. On the downswing, the average unit price for
the material purchased is slightly above the average market price during downswing.
If purchase prices are averaged for tile total cycle then the unit price paid is
significantly below the average market price during the complete cycle. The
computation shown in table 8.1. verify this analysis. Thus the average price of
purchases made during the upswing of the cycle is Rs. 0.22 per unit less than the
average price of purchases made on' the downswing. Considering the entire cycle.
this method of buying yields a price saving of approximately Rs. 0.07 per unit or 2.9
percent, over the average price which would have been paid and all purchases
during the two year period been made in quantities of one months' average.
Savings from volume timing of purchases
Date
No. of units
111
January
80,000
2.00
1, 60,000
May
80,000
2.15
1,72,000
September
80,000
2.60
2,08,000
2,40,000
Average cost per unit = 5,40,000/2,40,000 = Rs. 2.25
5,40,000
112
Table 8.1
Downswing Purchase Cost
Cost of per unit
Total cost
Rs. Ps.
Rs.
20,000
2.86
57,200
Feb.
20,000
2.83
56,600
March
20,000
2.80
56,000
April
20,000
2.75
55,000
May
20,000
2.65
53,000
June
20,000
2.55
51,000
July
20,000
2.45
49,000
August
20,000
2.35
47,000
September
20,000
2.25
45,000
October
20,000
2.15
43,000
November
20,000
2.05
41,000
December
20,000
2.00
40,000
Total
2.40,000
Date
No. of units
January
5,93,800
2.43 2.36
100 = 2.9%
2.43
Whether other purchases made using this technique yield greater or lesser
savings depends upon the magnitude and duration of the price swing and upon,
timing of the specific purchases. In actuality, the buyer in the example probably
would not have made three equal purchases on the upswing and twelve equal
purchases on the downswing. Savings clearly would have been greater if purchases
made below the average market price on the upswing had been larger and those
made above the average market price had been some what smaller. But in practice
the difficult problem is that of estimating what the average market price will be and
when the peak and, the trough of the cycle will be reached consequently. The
purchasing pattern for an actual purchase probably would be much less uniform as
113
a result of the buyers anticipation of these two critical factors. The risk involved in
using this technique should now be apparent. The less predictable the price
movement, the greater the risk becomes. For this season, the importance of accurate
forecasting cannot be over emphasized.
8.2 RUPEES BUDGETING OF PURCHASES
This technique is similar in concept to the volume timing technique, but in
practice it is operated some what differentially. Rupees budgeting is also based on
the idea of buying in large quantities when prices are low and reducing purchase
quantities when prices rise. The objective is accomplished in an automatic manner
by budgeting a constant number of Rupees to be spent for a given material each
operating period. The quantity to be purchased 'each operating period thus varies
inversely with market price. This technique is analogous to the Rupees cost
averaging method of buying financial securities in the stock market. Using the same
example as in the preceding section. Fig. 8.2 shows a buying pattern determined by
the dollar budgeting technique imposed on the same market price curve. The
quantity is to be purchased each operating period is determined as follows: (i) First
the buyer must estimate the average market price of the current price cycle based on
previous forecasting investigations. In this example the average market price is
predicted to be Rs. 2.50 per unit. (ii) Next buyer computes approximate usage of the
material for the duration of the price cycle. In the example. usage is estimated to be
20,000 units per month throughout the entire cycle. (iii) From these data, the buyer
computes the number of Rupees to be spent each operating period. In this example.
for convenience, it is assumed that purchases will be made on a quarterly basis.
Thus the quarterly expenditure for material will be 20,000 units per month x 3 x
Rs. 2.50 per unit =Rs. 1,50,000. (iv) As each purchase date arrives, the buyer
computes the number of units to purchase as Rs. 1,50,000 current market price per
unit.
The following results are obtained.
Jan = 1,50,000 = 75,000 units
2.86
2.75
2.45
114
2.70
2.15
No. of
units
Cost
per unit
Rs. Ps.
Total
cost Rs.
Date
No. of
units
Cost
per unit
Rs. Ps.
Total
cost Rs.
Jan.
75,000
2.00
150000
Jan.
52,450
2.86
150000
April
71,770
2.09
150000
April
54,545
2.75
150000
July
63,830
2.35
150000
July
61224
2.45
150000
Oct.
55,550
2.70
150000
Oct
5,04,169
100 = 2.1%
150000
115
In this example,
Rs.0.05 less than average market price, yielding a saving of approximately 2.1 per
cent. Again in actual practice, savings might be more or less, depending upon the
contour of the price cure and to some extent, upon the purchase period selected.
materials behave so erratically that this is often the more prudent course of action.
In these situation, a buyer is usually interested in mineralizing the risk resulting
from fluctuations. Two techniques that may be used in attempting to accomplish this
objective are (i) time budgeting of purchase and (ii) Hedging.
8.3.1 Time Budgeting of Purchase
Using this technique buyers can frequently purchase a material over the long
run at an average price very close to the average market price existing throughout
the cycle. They do this by purchasing small quantities of material over short
operating periods of equal length. Consider again, for a moment, the preceding
example of the volume-timing of purchases.
Note that on the downswing cycle. 20,000 units of product were purchased
every month until prices began to turn up. The result was that the average price
paid was neat, but some what above, the average market price during the
downswing. Had the volume of each purchase been reduced to a two week or a week
or a single day's coverage, the average price paid would have moved successively
closer to the average market price. If a buyer who makes small equally spaced
purchases on the cycle upswing, it will produce the same result except that the
average price paid will be some what under the average market price. Consequently,
by employing this technique over the duration of entire cycle, a buyer can be
reasonably sure of paying an average price which is very close to the average market
price. The smaller the purchases and the more frequently they are made, the closer
the average price paid will be to the average market price. When purchases are small
116
this procedure affords good protection even if the price cycle behaves extremely
irregular. The Disadvantage of this technique are the high costs of buying,
administration and materials handling as well as the risk of possible stock outs.
8.3.2 Concept Of Hedging
It is a technique used to minimize the risk associated with fluctuating market
prices. However, It can be use only in buying materials for which an organized
commodity exchange exists. An organized commodity exchange is a market place,
usually located in a large city, where a particular commodity is bought and sold in
substantial quantities. At many of the exchanges, both cash transaction and future
transactions take place. A cash transaction involves a current exchange of cash for
the physical commodity. A future transaction involves a current purchase, at a
quoted price, for which the physical commodity will be delivered at a specified date
in the future. With the passage of time the current cash price for a commodity and
its futures price often fluctuate together, approximately paralleling one another. It is
the future transaction that is essential in a hedging operation. The most important
single factor to the hedger is the difference between the cash price and futures price
commonly called the basis. In a completely competitive situation where supply and
demand are in balance, the futures price would be expected to exceed the cash
price: by the total cost of carrying the commodity in storage until the future date.
Because supply and demand typically do not remain in balance long for free market
commodities, the difference between futures and cash prices is influenced
considerably by the way buyers evaluate present and anticipated supply demand
conditions. This explains why futures price exceed cash prices for some commodities
at times 'and why at other times cash prices exceed futures prices.
Hedging, for the industrial buyer, is a technique which can provide protection
against market price declines during the period when his firm is processing a raw
material preparatory to selling it In some form as a finished product. With this
financial worry removed, the manufacturer is free to concentrate on normal
production and sales activities. For example suppose chocolate manufacturer has
signed a contract to sell a large candy manufacturer ten car loads of refined
chocolate syrup each month for the next year. The contract stipulates that chocolate
syrup Will be sold at a price based on the market price of raw cocoa at the time of
delivery of the chocolate -syrup. What happens to the chocolate manufacturer, then,
if he buys raw cocoa at Rs. 26 per kg., and one month later, when he delivers the
refined chocolate made from this cocoa, the market price for raw cocoa has fallen to
Rs. 21 per kg. He has to sell the chocolate at a lower price than he intended to when
he purchased the cocoa. Consequently his profit margin is reduced, or perhaps
entirely eliminated. To protect himself against such an occurrence, the chocolate
117
Cash
market
purchase
15
February
15
Purchaser
= 100,000 x 0.26
= 26,000
incurs
February 15
Sells
refined
chocolate
(equivalent 100,000 kg of
cocoa) to customer at Rs. 0.64
per kg.
Net gain on
manufacturing activity
=-5000
= 100,000 x 0.275
118
= 27,500
= 100,00 x 0.225
= 22,500
= 27,500 22,500
= 5,000
Thus, while the chocolate manufacturer lost Rs. 5000/- on his manufacturing
activity because of the drop in cocoa prices, he was able to offset this loss with a Rs.
5000/- gain by hedging in the futures market, had the price of cocoa risen from
January 15 to February 15, the situation would have been reversed. He would have
shown an extra profit in his manufacturing operation because of the price increase,
but he would have suffered a loss on his futures transaction; thus he would still
experience no net gain or loss as a result of fluctuating market prices. The preceding
case is simplified example of a perfect hedge, which, to reiterate, is based on two
assumptions.
(1) The selling price of the buyers' finished product will move exactly parallel to
the cash market price of his major raw material. (2) Futures prices will move exactly
Parallel to cash market prices.
In practice these conditions exist only imperfectly. The degree of perfection
found in the relationship depends largely upon specific market conditions and upon
the characteristics of each specific sellers market. The hedger nearly always gains or
loses some money on a hedging transaction because the spread between futures and
cash prices and the spread between product selling price and material purchase
price both vary with time. However, this by no means invalidates the technique.
Provided the relationships show reasonable stability, hedging can in many cases
provide good protection against risk of wide piece swings.
To use hedging successfully, buyers must be skilled enough to estimate the
magnitude of possible gain or loss through basis variation. Their decision to hedge
or not to hedge rests on a comparison of this factor with an assessment of the
probable magnitude and direction of cash market fluctuation.
119
Jan
Feb
The first approach is to reduce the average price paid for the
120
121
LESSON-9
122
Apparatus X
Apparatus Y
5000
7500
1000
500
Preventive
Maintenance
P1
P2
P3
Year 1
200
200
200
Year 2
200
200
100
100
Year 3
300
300
150
160
Year 4
700
300
902
200
Year 5
200
700
98
990
expenses
P4
100
Two sets of figures are given in this table for each apparatus depending upon
whether the overhauling is done in the fourth or fifth year. Under the of uncertainty,
viz. requirement in years and overhauling period, the problem is to decide on the
purchase of one apparatus.
For each apparatus there are four possible alternatives corresponding to two
periods of use and two periods of overhauling. The average annual costs incurred
may be calculated in any case by the following steps. For simplicity, the scrap in this
123
case and other sophisticated costs have been assumed to be zero and due to
arithmetical adjustments can be made if scrap value is to be considered. This
illustration may be suitably extended if there are Increased number of apparatus or
any other' similar kind of uncertainty situations.
Apparatus X
Life 4 Years
overhauling.
Investment
Rs. 5,000
Rs. 4,000
Rs. 1,400
Total cost
Rs. 10,400
Rs. 2, 600
Similarly, all permutations and combinations can be worked out for the
different alternatives and the average annual expenses in rupees can be tabulated
as shown in Table 9-2. After having obtained the given information, the following
principles help the executive In choosing one apparatus.
Table- 9.2
Life in Years
P1
P1
P2
P2
P1
P1
P2
P2
P3
P3
P3
P3
P4
P4
P4
P4
Preventive
Maintenance X
Preventive
Maintenance Y
Apparatus
2600
2320
2500
2340
2600
2320
2500
2340
Apparatus
2713
2290
2713
2290
2513
2310
2515
2310
30
50
87
10
30
Apparatus
113
213
15
124
average or expected gain. In the given illustration the average expense for all
combinations of X or E (X) -expected value of X is-2,440 and Y or E (Y) is Rs. 2,456.
E(X) = 2,440
[i.e. 2,600 + 2,320 + 2,500 + 2340 = 9,760/4 = 2,440)
E (Y) = Rs. 2,456/Since the average expense of X is expected to less. the apparatus X is to be
preferred in this situation.
This principle is usually adopted by practicing managers.
9.1.2 Principles of Minimax
The second criterion which was established, by Abraham Wald is known as
minimax criterion or criterion of pessimism.
This criterion is suited to a problem situation which forces the attitude of the
executive to be very conservative, pessimistic, unadventurous and compels him to
play too safe in order to protect him from the falling of the Damocle's word. In such a
situation, the decision rule is to examine the minimum profit or maximum cost
associated with each strategy and choose that strategy which maximizes the
minimum profit or minimise the maximum cost so that the worst out come is made
as desirable or possible. It is observed that worst X is Rs.2,600/-, where as worst Y
is Rs. 2,713/- and the best of the two, namely, apparatus X is to be chosen in this
particular situation.
9.1.3 Principle of Maximax
It
may be noted that on the other extreme end of the minimax rule is the
maximax criterion. This deals with a problem situation which forces the attitude of
the executive in that situation to be rash and optimistic thinking that the
circumstances are going to be benevolent always. In such a case the executive
chooses that strategy which maximises the maximum profit. The best X is
Rs. 2,320/-, best Y is Rs. 2,290/-and so apparatus Y is to be preferred under these
circumstances.
9.1.4 Principle of Optimum
Hurwicz's criterion of optimism is brought in to avoid extreme conservatism of
minimax principle or extreme radicalism of maximax principle. The criterion allows
for the varying degrees of moderation according to the variation in optimism or
pessimism of the attitude of the decision-maker in a specific problem situation. If
the index of optimism L= 1, the criterion reduces to the maximax principle. A
knowledge of L will enable one to choose the best strategy in such a specific
125
P1
P1
P2
P2
P1
P1
P2
P2
P3
P3
P3
P3
P4
P4
P4
P4
Preventive
Maintenance X
Preventive
Maintenance Y
Apparatus
2600
2320
2500
2340
2600
2320
2500
2340
Apparatus
2713
2290
2713
2290
2513
2310
2515
2310
30
50
87
10
30
Apparatus
113
213
15
The decision rule in such a case is to identify the maximum regret for each
strategy and choose that strategy for which the maximum regret is least. In the
above example maximum regret for X is 87 and for Y is
126
Principle of Optimum
Principle of Regret
9.3 INTEXT QUESTIONS
1. Explain the uncertainty situation with a suitable example.
2. Describe briefly the different statistical criteria available to the executive to
face situation with optimism.
3 Two equipments are under consideration by, purchase department. The prices
are Rs. 10,000/- and Rs. 12,000/- respectively. The brand names are FXZ -48 and
FXZ -50. The purchase department collected information from four previous users of
these equipment. (Two users for each type). According to them the equipment
requires major overhaul in fifth or 6 th year. Their figures of maintenance costs for
each year are given below.
FXZ -48
Amount of operating cost
FXZ -50
2000
1200
V2
V3
V4
200
200
175
200
200
190
200
225
250
260
200
250
300
300
250
250
200
300
600
300
250
200
175
600
127
128
LESSON-10
CREATIVE PURCHASING
OBJECTIVES
To know the parameters such as right price, Right Quality, Right
Quantity, Right time, Right terms, Right Source, Right Place, etc. to
ensure continuity of supply of raw materials and spare parts.
To understand the concept of negotiation, purchase budget, bill market
system and insurance.
CONTENT
10.0 Introduction
10.1 Creative purchasing
10.2 Negotiation in purchasing
10.3 Purchase Budget
10.4 Bill market system
10.5 Insurance.
10.6 Revision Point
10.7 Intext Questions
10.8 Summary
10.9 Terminal Exercises
10.10 Suggested Redding/ reference books/set books
10.11 Key words
10.0 INTRODUCTION
Purchasing has come to stay as the most important, function on materials
management. The moment a buyer places an order he commits a substantial portion
of the finance of the organisation which affects the working capital and cash flow
position. He is a highly responsible person who meets various salesmen and thus
cap be considered to have been contributing to the public relations efforts of the
company. Thus, the buyer can make or mark the companys image by his excellent
or poor relation with the vendors.
10.1 CREATIVE PURCHASING
The basic objective of the purchasing function is to ensure continuity of supply
of raw materials, sub-contracted items and spare parts and at the same time reduce
the ultimate cost of the furnished products. For ensuring this, there are a large
number of well known parameters such as Right price, Right quality, Right quantity,
129
Right time, Right terms, Right source, Right place, Right mode of transportation and
Right attitude.
10.1.1 Right Price
It is the primary concern of any manufacturing organisation. But right price
need not be the lowest price. It is very difficult to determine the right price, general
guidance can be had from the cost structure of the product. The tender system, of
buying is normally used in public sector organisations but the objective is to identify
the lowest responsible bidder and not the lowest bidder. The technique of laming
curve also helps the purchase agent to determine the price of items with high labour
content. The price can be kept low by proper planning and not buy rush buying.
10.1.2 Right Quality
It implies that quality should be available measurable and understandable as
far as practicable. In order to determine the quality of a' product, sampling schemes,
inspection etc.. will be useful. The quality particulars are normally obtained from
the indents, and experience indicates that a substantial portion of the indents
prepared by user departments are invariably incomplete. Such incomplete indents
often cause unnecessary delays in procurement as the indent or has to be referred
to, and if Rot referred results in heavy rejection.
10.1.3 Right Time
For determining the right time, the purchase manager should have lead time
information for all products and analyse its components for, reducing the same.
While determining the purchases. the buyer has to consider emergency situations
like floods, strikes etc. He should rave contingency plans when force majored classes
become operative. However, rush purchase should be resorted to only in exceptional
cases.
10.1.4 Right Source
The source from which the material is procured should be dependable and
capable of supplying items of uniform quality. The buyer has to decide which item
should be directly obtained from the manufacturer. In emergencies, open market
purchases and buyer purchases are resorted to Techniques such as value analysis
will enable the buyer to locate the right material. Right modes of transportation have
to be identified as this forms a critical segment in the cost of the shipping of ore
gravel sand etc., is nominally more than cost of item itself. Specifying the right place
of delivery, say head office or works, would often minimise the handling and
transportation costs. Similarly, packaging forms an important aspect in the cost of
an item; for instance. In tooth paste the tube is costlier than the paste it holds.
130
131
He may be forced to contract to whatever terms and conditions that are imposed on
him, especially if the seller adopts a take it or leave it attitude. 'The long term
strategy open to the buyer is to develop another source of supply. However, this
depends on the availability of technology and requisite volume of business. Till then
he will have to be content with the monopolists, or share the experience with other
buyers.
Price is the major consideration during most negotiations. The buyer cannot
afford to force the seller to always reduce his price below his profitable limits. He
must not forget that the seller also exists in business, so that he may obtain a
reasonable return on his investment. If the buyer persists in price reduction, then
the solutions that are possible are detrimental to his interests. He will have to search
for a new vendor, or will be forced to accept inferior goods. In both cases he will be
the loser. Just as the buyer cannot afford to arbitrarily reduce the prices, the seller
also cannot quote at his will. Even a monopoly supplier who quotes unreasonably
high prices, runs the risk of inviting competitors, as the buyers will always develop
new sources, which can deliver material at better rates in the long run or from
buyers' cartels as a short-term remedy, in order to ration the requirements among
the consumers.
Price negotiations will have various dimensions, other than the intrinsic cost
consideration, factor such as rates of trade discounts. quantity discounts, taxes,
freight, insurance rates, assured supply, etc. to be finalised during the negotiations.
In the case of works contracts, the supply of long lead-time items and international
currency fluctuating price variation clauses will have to be added. Besides price, the
buyer has to negotiate discounts, specifications, quality,' quantity, delivery, legal
terms, payment terms, dispatch terms: insurance and contracts. The negotiations
will normally be long drawn out in the case of capital equipment buying decisions.
The buyer will have to consider after sales service, availability of spares, supply of
spares, guarantee, and buy-back clauses. Negotiating for these characteristics
requires both technical and commercial knowledge. In the case of imported items,
the negotiator will have to contend with other factors, like exchange regulations,
currency fluctuations, legal-terms, international contracts, marine insurance and all
dealing with foreign national or their agents. There can even be language problems
in these negotiations and there have been instances where the foreigner feigns
ignorance of common language in order to get away with as little commitments as
possible. Such notions will have to consider both the technical and careful enough
not to lose track of one, while trying to clinch an issue with regard to the other.
Human nature plays a leading role in affecting the progress of a negotiation. If a
negotiator is made to fee that the opposite party is just letting him have his say, then
132
133
sizes, schedules of production and bill of material are obtained. We will have to work
backward from the sales targets, break them into assemblies, sub-assemblies and so
on, after allowing for rejections at all stages. Besides giving the timing of purchases
and estimated cost of raw materials. this will give us the material requirements that,
will have to be procured from outside the organization.
The purchase executive must then formulate his purchase plan, taking into
account the procurement lead time. From this he must compute the funds required
and monthly cash out flows. The quantity specifications and the time schedule of
the requirements are available from the material plan. The purchase division will
have to give the price data and a multiplication and summation exercise will give the
funds needs for procurement action. The computer can be useful for the
multiplication of price by the quantity and will have access to latest price by holding,
the supplier data file. The purchase budget covers capital items, tools, raw
materials, production material, spares and miscellaneous items. It is also possible
to' have it class-wise, department wise and work centre wise, brought in for
compiling the budget. Periodic reviews and regular feed back enable the purchase
executive to identify the variances and take an appropriate remedial measure in
consultation with the user department, on factors such as genuine price increase,
increased quantity of consumption, higher in process rejection etc.
Management uses the purchase budget for the purpose of educating the
performance and exercising the function of control, which envisages an improvement
of performance by knowing how exactly we have performed in the past. The objective
of any purchasing division is to expend only the right price for the purchased
quantities. In other words, we have to optimize the utilization of the available
resources by procuring as much as possible. The responsibility for budget
preparation operation, supervision, must be formally defined for this purpose. In
any organisation unless the operations are monitored and controlled, they can cause
havoc. This is more important in the case of purchasing, as it is the main expender
of the organizations finance, and budgetary control comes in very handy in such
situations. Based on budgets, costing exercises and the price forecasts, we can
estimate fairly accurately; the upper limits of expenditure under broad categories of
materials, such as raw materials, consumables and spares. We can have separate
limits for each of the A category items and group limits for categories. So long as
the purchasing division is keeping the consumables supplied and functioning within
the budgetary constraints, the operations are well under control. No sooner is there
a clam our for materials, or the budget is exceeded, then remedial action is called
for, as to whether' the price has increased or consumption is more. Price reduction,
134
or performing within the budget, while at the same time meeting the consumers'
requirement goes to the credit of the purchasing and operating divisions. Naturally,
this should preclude situations where there is a general price decrease. Similarly
adopting conservative budgeting strategies to be on the safe side, should be
discouraged. One obvious advantage of budgetary control is that, we can do away
with the system of sanctioning by the competent authority. This will reduce the leadtime required for converting an indent into a 'purchase order and will increase the
discretionary powers of the purchasing executive, thereby improving the over all
efficiency of the operating system.
10.4 BILL MARKET SYSTEM
The discussion on the purchase budget will not be complete without reference
to, the bill market scheme periodically announced by the Reserve Bank of India. The
scheme encourages increasing use of bills of exchange as an instrument of credit.
From the point of view of the short-term borrower, the advantage would be that a
clean bill of exchange can be discounted at rates lower than those charged by banks
on cash credits or overdrafts. The authorities said that the scheme will not only
impose financial discipline on the purchaser but also help the suppliers and
producers to plan their financial commitment's realistically. Depending upon the
health of the Indian economy several changes in scope of the bill on purchases from
the suppliers, he should then request them to draw the bill of exchange for the
period of credit received by the buyer on such extended period of credit upto 120
days. If on the other hand, the buyer does not receive credit, the suppliers may be
asked to draw trade bills, the period of usance corresponding to the period required
for conversion of stocks into finished goods. The format in which the bills of
exchange should be drawn for rediscount in the Reserve Bank of India under the bill
marketing scheme, is shown below.
135
To
(Name' and address of buyer)
No: .......................
....................... .......................
Place: .......................
....................... .......................
Date: .......................
....................... .......................
At .......... . days after date sight (inclusive of days of grace) pay to us or to our
order at .......................the sum of rupees inclusive of interest at .............
Signature of the seller,
Note:- This bill of exchange has been drawn in connection with the sales
of. ..............(specify the description of goods sold) .......... covered by (Number and
date of document) like railway receipt, lorry receipt, invoice no. etc.
We accept this ................ date of 1974 to revise the bill on maturity.
Signature of the buyer.
10.5 INSURANCE
All business
business from a risk, which may affect its solvency. Any organisation is concerned
with insurable risks at different stages mainly raw material transit, from supplier to
the stores and also the transport of finished goods from warehouse to retail out let.
The buyer is involved in the decision process of what property to insure, what value
to be insured for and what risks to be covered. Hence, he Should have a thorough
knowledge of the various types of policies, cost of purchasing insurance, the
conditions and warranties affecting the settlement of claims if an insured event
occurs, etc. The purchase managers' association with insurance begins from the
time he places an order with the supplier, till the materials reach in the hands of the
ultimate user. He has to analyse the insurance needs, so that the possibility of
catastrophe and losses to his organisation are avoided. The buyer has to are that the
claims against the insurance are lodged at the appropriate time in such away, that
compensation from insurers' is received in full with minimum delay.
10.5.1 Marine Insurance
Marine cargo insurance deals with the insurance of goods in transit. It is a
valued policy, as it covers the invoice value of the cargo, amount of import duty in
the case of imports and the reasonable amount of profits and the incidental. The
sum insured stated in the policy is binding on the insurer and it is normal to
insurer overseas consignment for 110 per cent of cost plus insurance plus, freight
value however greater values can be insured with the insurer to take care of duty
and profit. The policy can over the invoice value of cargo Import duty and reasonable
136
profit. The risk covered may relate to overseas Import shipment, inland transit, war
and strikes from port to port. Commercial risks, like loss of market production
stoppages, etc are not included in this.
The conduct of marine business is governed by the Marine Insurance Act. 1963
Unlike other policies, marine policies are insured for one particular voyage transit,
Land journey incidental to sea journey, both before and after, is treated as part of
the given transit. There are three sets of clauses known as A, B and C, as the new
institute cargo clauses in the case of imports/exports. Clause C provides cover
against risks of fire or explosions, stranding/ sinking, overturning, derailment,
collision, discharge of cargo at port of distress, Jettisoning, salvage charges, and
general agency sacrifices. Clause B provides cover against risks of all events covered
under clause B provides cover against risks of all events covered under clause C plus
lightning, earthquake, washing over board and total loss of package in loading and
unloading. Clause A provides against all risks of loss or damage except risks
specifically excluded. This would mean that unless it is specifically excluded, it is
covered by this clause. The insurance of duty and profit is available only to the
holders, of replacement license. An open insurance scheme is available, whereby a
total sum is assured for a particular period, and as the dispatches are made the
value is debited. As and when the total dispatches equal the sum assured a new
contract is made.
The exclusion common to all the three sets of clauses are as follows. (a) Willful
misconduct of the assured, (b) Ordinary leakage/loss of weight/wear and tear (c)
Insufficiency or unsuitability of packing, (d) inherent vice or nature of commodity, (e)
delay even caused by insured risk, (f) Insolvency of financial default of operators of
owner/ mangers/ charters/ operators of vessels,
distribution by harmful actor malicious and (I) war and strike risks. The insurance
cover ceases as soon as the goods are delivered to the consignee at the destination
named in the policy. The cover ceases if the goods are stored at a warehouse, which
the insured elects to use for storage other than in the ordinary course of transit. The
cover is operative only during the ordinary course of transit. Where there is a change
of voyage or termination of voyage before the goods' reach the final destination, the
cover is operative provided prompt notice is given to the insurer and additional
premium paid. Subrogation means one's right to claim the third party who had
caused the loss. Once the claim against is settled by the insurer, the latter acquires
all the rights and remedies of the insured to legally proceed against the carriers who
are responsible for the loss of damage to goods in transit to recover the losses. All
the three sets of clauses provide warehouse to warehouse cover. There is however, a
limit of 60 days after discharge at the final port for the inland journey to be
137
completed. This is the maximum period. If due to circumstances beyond the control
of the insured, extension is required, the insurers have to be approached and
additional cost paid for such extensions naturally granted for a period of 30 days at
one time.
10.5.2 Inland Transit Insurance
Two types of police are, in case of goods transported in the country. In case of
goods transported in the country.
collision, overturning and derailment. While policy A covers all risks. The cover is
available from warehouse to warehouse with the limitation of 7 days at the carriers
godown at the destination.
weeks by payment of additional premium. If the goods still are not cleared, only fire
and burglary can be insured, by means of specific policies, periods of storage at the
destination should be clearly specified during which the risk will be covered.
The
term of the cover should be as wide as an all risk policy or as restricted as road risk
or rail risk policy. The all risk policy provides for compensation in the event of any
accidental damage to the cargo except those covered by delay inherent or the nature
of the subject matter insured. War risk on land cannot be covered by the insurance
companies. Riot and strike cover is an exclusion under the standard policy, which
should be included specifically by payment of additional premium. The insurance
commences with the loading of the material into the vehicle, extends during the
transit including transshipment, prior to reaching' the destination and cases seven
days after the arrival of the vehicle at the destination.
The extent of cover must be determined by asking the following questions. (a)
should the insurance be done restricted to road risk or rail risk basis or on wider
terms. (b) should the insurance be left to the supplier stipulating that the supplier
should replace the damaged goods. (c) if it is to be self-insurance, what are the risk
accumulation points. (d) what is the maximum possible loss arising out of an
accident. (e) if insurance is arranged, what is the period of storage at the destination
for which cover has to be extended. (f) while railways and lorry transport companies
are liable for compensating the consigner for negligent handling of goods, the time
and effort enquired to recover from them is substantial and their reliability like riot
damages is doubtful.
10.5.3 Stores Insurance
During storage, goods are usually insured against fire, explosion riot, Strike,
flood, earthquake, pilferage etc., standard fire policies cover the risks of fire, water
damage, fire brigade damage, damage during removal, lightening, explosion of gas or
boiler used. The fire policy excludes perils due to earthquake, war, riot, malicious
138
damages and losses due to theft during fire, spontaneous combustion burning by
order of public authority short circuiting or overheating of electric machines. The
articles excluded in the fire insurance policy are items held on trust, bullion, work
part exceeding rupees one thousand, manuscripts, plans, drawings, securities,
stamps, paper, money, cheques, books of accounts, and explosives. Some of these
require payment of additional premium. Fire policies are not valued policies; so, for
insurance of stocks, with fluctuating value a declaration policy can be obtained,
provided value of the stock is atleast Rs. 20 lakhs. A fidelity guarantee policy for the
key personnel controlling the stores, often turns out to be a wise investment since
the cost for such insurance is relatively low; monthly declaration of stock values
have to be made and the actual premium is charged on the basis of average of these
declaration, with the provision that the refund premium would not exceed 35% of
the deposit made. The benefit of escalation clause for stock is usually about 15% to
take care of inflation. The basis of rating depends upon the type of construction,
occupation, commodity, warrantees, use of fire extinguishing appliances etc.
It has been found in practice that the loss of production or consequential loss
following a fire is generally more substantial than the material damage. It is possible
to insure this loss of profits by taking out a policy for gross profits, calculated for the
previous year. But this policy is issued only if material damage policy has been
taken. The period of indemnity should be the period required to get back into the
normal production after the fire. There are reinstatement value policies, that are
applicable to builders, plant and machinery. Claims are settled for the cost of
building or replacement and hence the sum insured must be related to these costs.
The payment is based on the actual reinstatement.
10.5.4 Contractors All Risk Insurance
This policy is meant for insurance of contracts, where a major portion of the
risk, i.e., over 50% relates to civil engineering works, like erection of buildings, road
or railway construction, waterworks, bridge construction, sewage works, drainage
scheme etc. The insured is protected against accidents resulting in physical loss or
damage of the work in progress and constructional plant and equipment. This policy
cover is available against the risk of: (a) accident/damage/loss/damage caused by
the use of faulty material or workmanship. (b) burglary theft/ malicious damage; (c)
fire/lightning/explosion/storm,(d) earthquake/ flood/ inundation/ landslide;
(e)
139
materials can be
covered by this policy. Only forcible violent entry while breaking open the door is
covered by this policy. A fidelity guarantee policy can be taken to cover pilferages by
employees. Obviously, robust commonsense will be the guiding factor in deciding the
burglary insurance. For example, heavy casting which cannot be pilfered need not be
insured. Engineering insurance is available for machinery action and testing,
machinery breakdown, boiler explosion and loss of profits. Specialized risks in
manufacturing industries are covered under the scheme.
The purchase executive has to consider the premium, while considering the
landed cost of any imported item. Usually, the market value or value for which any
asset/property can be bought or sold in its existing condition is considered for
determining the premium. A simple and practical method of arriving at his value
would be to determine the replacement cost as new and reduce it by depreciation for
age, use, maintenance, wear and tear etc. This is the value for which property
should be insured. The computation of the cost of the risks involved is based on
statistical and actuarial principles. The average total insurance cost, including
transit and stores Insurance in industry is about 3 per cent of the average value of
the stocks, while its range has been 1 to 8 per cent. It is desirable to insure all
transit material with Indian, insurance companies. This allows faster claim
settlement and conserves foreign exchange. The premium rate for warehousing is
140
dependent on the nature of the storage and it is possible to economies the premium.
if hazardous material is segregated from non hazardous items.
10.6 REVISION POINT
Negotiation in purchasing
Purchase Budget
Insurance
10.7 INTEXT QUESTIONS
1. Explain clearly the various parameters considered for creative purchasing.
2. (a) What is negotiation? What are the important 4 factors that influence
negotiation?
(b) How does human behaviour playa decisive role in negotiation?
3. Explain the use of purchase budget.
4. Describe briefly the following insurance system:
(a) Marine insurance.
(b) Stores insurance.
(c) Inland transit insurance
(d) Contractors risk insurance.
10.8 SUMMARY
In this lesson, the concept of negotiation and how it influence the purchasing
function and purchase budget, and insurance were discussed in detail.
10.9 TERMINAL EXERCISE
1. Explain the negotiating strategy and tactics. What is negotiable
instruments? Discuss.
2. What is negotiable instruments? Discuss.
3. Explain the method of preparing a purchase budget.
10.10 SUGGESTED READING/ REFERENCE BOOK/ SET BOOK
1. Donald
W.Dobler
and
David
N.
Burt,
Purchasing
and
supply
Management , Text and Cases, Tata Mc-Graw Hill, 2002, 6 ed, pp- 357.
th
141
142
LESSON -11
143
numerous considerations come into play. One approach is to first establish the
economic feasibility and then follow with a consideration of more value based "less
economic" factors. The use of "Break-Even Analysis" come handy in solving make-orbuy decisions.
11.1 BREAK EVEN ANALYSIS
Break even analysis implies that at some point in the operations of an industry,
the total revenue from the sale of manufactured products equals the total cost of
measuring them. The point, in terms of the quantity of products sold or in terms of
currency at which the revenues and the costs agree exactly is termed as BREAK
EVEN POINT.
144
FC
P-VC
Fixed Cost
1992
Rs. 100 .
Rs. 12,00,000
1993
Rs. 200
1994
Rs. 250
VBEP =
FC =
Rs. 12,00,000 =
Variable cost/unit
Rs. 30
Rs. 12,00,000
145
P-VC
250 30
220
146
147
productivity
g) capacity utilization
h) Plant efficiency and engineering features
i)
j)
maintenance decision
k) replacement decision
l)
physical life-span
m) economic life-span
n) tax life
o) purchase costs
p) capital costs
148
q) installation costs
r) breakdown or shortage costs
s) depreciation policy as straight line or sum digit or double declining
t)
u) capital gains
v) time value of money
w) social benefit
x) internal rate of return
y) decision making structure and decision alternatives based on scientific
analysis of appropriate data
11.4 ROLE OF PERT AND CPM IN MAKE/BUY DECISIONS
It is the time and cost estimates, which play a vital role in the successful
implementation of any project. Since these estimates are, in the majority of cases,
judgmental values, care should be taken to involve a number of concerned technical
experts. Not only should the person entrusted With the job be involved in the
estimation process, but also his boss and his peers. More such estimation should be
done after a number of sittings so that factors not considered in one sitting may be
considered in another. These estimates are the very heart of "management by
network analysis". PERT/CPM, thus help in the estimations of the time and hence
the cost of manufacturing a product aid consequently the intricacies arising in the
make versus buy decisions are solved.
11.5 ILLUSTRATIVE PROBLEMS
1) A manufacturer of motorcycles buy spark plus at Rs. 40 each. In case he
makes it himself the fixed and variable costs would be Rs. 10,000 and Rs. 30 per
plug respectively. Should the manufacturer make or buy the spark plug?
Fixed Cost
Rs. 10,000
Variable cost
Assuming BEP as Q
Variable costs for manufacturing Rs. 30 x Q.
Fixed Cost
Price-Variable Cost'
149
10,000
40.30
Ans:
(i) If the requirement is less than 1000 pieces - BUY.
(ii) If the requirement is more than 1000 pieces - MAKE.
2) Deepak and Co. has been buying a particular part from a private firm at a
price of Rs. 80 per part. The part is a cast iron machined item. Deepak and Co. has
so far been purchasing this item though they have both foundry and machine shop.
Since the capacity of the above said shops are increased now, the decision to make
or buy has to be taken. The cost estimation reveals the following:
150
Foundry
Machine Shop
Rs.
Rs.
Material cost
25-00
Direct Labour
10-00
15-00
Overhead
12-00
20-00
Total
47.00
35.00
Rs.32.00
80.00-66.00
Rs.32.00
14
4
2
14 pieces
Approximate 3 pieces.
ANS:
(1) If the requirement is less than 3 pieces -BUY.
(11) If the requirement is more than 3 pieces MAKE
11.6 REVISION POINTS
Break even analysis, Influencing a factor for Make or Buy Decision.
11.7 INTEXT QUESTIONS
1. The Evergreen tractor company has extra capacity that can produce gears
that the company has been buying for Rs. 400 each. If Evergreen makes the gears, it
will incur materials cost of Rs. 120 per unit, labour costs Rs. 60 per unit and
variable overhead cost Rs. 40 per unit. The annual fixed cost associated with the
unused capacity is Rs. 3,20,000. Demand over the next year is estimated at 4,000
units.
a) would it be profitable for the company to make the gears?
151
Switch
30,000
18,000
Material cost/unit
4.00
Rs. 100
400
220
Rs. 500
Rs. 500
Purchase price/unit
Rs.20
Rs.9
If Buy:
The direct labour cost is Rs. 360 per hour, and the variable position of overhead
is Rs. 480 per labour hour. The fixed overhead of the available capacity is estimated
at Rs. 1,04,000 per year. Suggest a suitable solution.
3. Northwest products company has received an order for 800 portable heating
cells from a military agency. The heaters have a special casing that must be molded
to such close tolerances that some of the them don't fit and must be reworked, The
percentages of defectives, along with the probabilities of occurrence are(as shown:
% Defective
Probability
P(D)
0.60
0.20
0.10
0.05
0.03
0.02
152
The casing cost Rs. 2400 to make and Rs, 2000 to purchase, A buyer in the
purchasing department has located a potential supplier of Rs, 2450 per casing.
Determine whether the company should purchase the casings or produce them,
a) What is the break-even point in the proportion of defectives such that the
cost of the making the casings would be equal to the cost of buying them?
b) What proportion of defectives can be expected if the firm produces its own
casings?
c) On the basis of this data. should North West make or buy the casings?
4. What general procedure is to be followed in analyzing a make versus buy
decision'?
5. How is break-even analysis adopted to analyse a make versus buy decision.
11.8 SUMMARY
Concept of Break even analysis and use of this bream even analysis in make or
Buy Decision were discussed in detail, With examples. The criterias that influence
the make or buy Decision are also reviewed.
11.9 TERMINAL EXERCISE
1. Briefly explain the concept of Break-even analysis
2. List the factors that influence the make / buy Decisions.
3. Explain the role of PERT and CPM in make /buy Decisions
11.10 SUGGESTED READING/ REFERENCE BOOKS/ SET BOOKS
1.
2.
Donald. W.
153
LESSON 12
154
at identifying
unnecessary costs and eliminating the same from the system without affecting the
functional utility / guarantee/ safety performance. The essence of value analysis is
to identify the function of the product, to examine alternative ways by which the
function can be accomplished and finally choosing that, which involves the least
cost. Value analysis correlates the cost of purchasing a product or service with its
end use. It attempts to examine critically the make-up of every item, which I
contributes towards the cost of the product and whether this cost contributes to the
function appropriately. It is an approach of providing the required function of the
product at the desired time and place at the lowest cost. This approach is concerned
with the right quality, design, specifications, standards, methods of manufacture,
etc. and involves the substitution of material or component at a lesser price or better
quality.
Several, other techniques closely resembling value analysis are also used in the
industry with different names, and these are mentioned in the following. The
application of the value analysis ideas during design and engineering stage of
product before its manufacture, is known as value engineering. Some of the related
techniques
using the
same logic
are
listed below:
PROFIT-Product return
155
Leaders like Robert McNamara used this tool in Department of Defense in the USA
and saved a reported $ 14 billion in rive years. As a result, the Defense Department
wrote an incentive clause making value engineering an integral part of government
contracts on projects above a particular value. The Society of American Value
Engineers -SAVE -was formed in 1959 to give the new methodology continuing
vitality and stimulation. The Indian Value Engineering Society founded 1978,
conducts annual conferences and brings out a quarterly journal Invest, wherein
successful Indian experiences have been shared.
12.3 CONCEPT OF VALUE
The English dictionary has several meanings of the word "value" such as worth,
a fair equivalent, intrinsic worth, relative worth, that which renders something
useful, etc. In the field of purchasing value can be defined as the lowest cost for
reliably performing an essential function and should be considered as the ratio of
worth to-cost. The determination of value requires a combination of the following
considerations:
a. Functional or use value which helps in accomplishing a task: this may be
divided into primary, secondary and tertiary.
b. Esteem value -associated with pride of possession and sentiment.
c. Exchange value -exchange value is the barter value expressed as the sum of
use and esteem value.
d. Cost value -depends upon the commercial value of the cost of production.
e. Scrap value -the money that can be recovered when the item is no longer
needed.
The concept of value is dynamic and it changes with time. An item which has
functional value today will have esteem value after some time and finally as time
passes, the item will have only scrap value.
12.4. ITEMS FOR VALUE ANALYSIS
The product life-cycle concept comes in handily for identifying the product for
value analysis. It is well known that any product like the human race, goes through
the do of the life-cycle, namely-concept development, growth, maturity and decay.
The return on investment also varies from one type of product to another. When the
product stabilizes or reaches the stage of maturity, the competitors enter the market
with an improved version of the product and this will force the organization to effect
modifications in the product for survival. These efforts for cost reduction start right
from the design stage and is continued in the production system through process
modification, tool changes, materials substitution etc. Thus the product with
156
Ideally,
value
analysis
is
basically,
team
effect
and
requires
157
tapping the creative human power. It makes employees cost conscious and promotes
team work. Value analysis studies emphasize on total system concept and the
studies should be carried out keeping the interests of producers, consumers,
employees, traders and the society. Many areas of application in different sectors
and industries have been reported in a large number of articles in different stages
and some are mentioned below:
The value analysis team in one steel plant in India found that many of the rigid
material and process specifications in some of the intermediate stage were not
required, for the tasks for which the steel products are ultimately expected to
perform. This has allowed the organization to reduce some of the required
processing of various steel items to offset the physical over design. The electrical
engineering industry has substituted the indigenously able aluminium instead of
imported copper, a major breakthrough resulting in substantial savings.
The DGS&D -a central buying organization catering to for the needs of defiance,
railways and P&T buys above Rs. 3000 corers per year, has through value analysis
saved substantially on just one supplier of inspection lamps. In one engineering
firm, value analysis was applied at the; design stage of the machines and it was
found that a spring loaded stripper arm can do the same function by remaining
stationary. This resulted in considerable reduction in maintenance cost. Value
analysis has been practiced by many firms as a policy for import substitution. In the
packaging of consumer goods like tooth paste, instant coffee, soap, cigarettes,
biscuits, etc., value analysis techniques have been profitably used to bring about
economy in packing. Thus value analysis helps to maximise the conservation of
scarce material resources in the country and helps to achieve cost reduction.
12.7 TECHNIQUES FOR VALUE ANALYSIS
The sequential steps involved in carrying out a value analysis include the
following: (1) product selection (2) information gathering (3) definition of function of
the product (4) identification of function (5) speculation of alternatives (6) evaluation
of alternatives (7) reporting
follow up. Darsiri means to 'consider' in Sanskrit and this also follows similar steps.
Here Darsiri method stands for data collection, analysis, record ideas, speculate,
Investigate, recommend and implement. Other techniques include MISS-modify,
improve, subdivide, substitute and EXCHANGE Eliminate, keep, change. The given
specifications are challenged in the meeting, if necessary by assigning rupee value
for the tolerance. Simplification, diversification and standardization can also
contribute to the cost reduction and must, be used In conjunction with value
analysis. The team should be familiar with the material sciences and the research
that has taken place in the context of the chosen items.
158
In the value engineering approach, the definition of the value on the function
should be limited only to two words, a verb and a noun. The two-worded definition
must suggest the function of the product of the item considered for value analysis.
For example the function of a "cigarette lighter" can be defined as to "provide
Ignition". After the definition, the functions are classified as primary and secondary
functions. For any product or part, there can be only one primary function and
there can be any number of secondary functions. The primary function of a shirt is
to cover the body, while the secondary function can be to appear elegant.
Sometimes the functions are also classified based on different disciplines, such
as structural function, electrical function, mechanical function, etc. However,
generally the utility is usually classified as primary and secondary in value analysis.
After defining the functions for the main assembly, sub-assemblies, parts and
components, a group of the functions are selected by the team for speculation of
alternatives. Either the product as a whole, or a few of the parts are selected for
speculation of alternatives. Speculation of alternatives' emphasizes creativity.
Creativity means looking at problems from unconventional angles. There are three
stages in creativity, viz. imitation, innovation and invention. Creativity emphasises
the principles of blast, create and refine the ideas.
12.8 BRAIN STORMING: A to Z WAYS
Brain storming sessions help in creativity and speculation of alternatives." The
philosophy of brain storming sessions is not to judge the ideas as they come as this
inhibits the people in coming out with creative ideas. Here the emphasis is on
creation of as many ideas as possible. The brain storming groups normally consist of
five to seven people with different backgrounds drawn from different departments of
the organization. They meet in a group to speculate the alternatives. The alternatives
suggested by different members of the group are listed in this step for evaluation in
the subsequent step.
The following illustrative questions aid in creative thinking and in the
speculation of alternatives and finding answers to some questions in the committee
to help to reduce the cost:
a) What is the item and can we do without the item?
b) Why is it this shape? How does it contribute to the value?
c) If it is flat can it be round (vice versa)?
d) Can two components be made into one (vice versa)'?
e) Why does it need to be so thick? Does it need all the features?
159
160
b. Functional phase- Here, a few items of poorest value (they cost far more
than they should) are identified, and the functions that must be
performed by the product are inspected, analysed and classified.
c. Creative phase -A probing, for reaching collection of solutions, probable
and improbable, is gathered in an effort to generate ideas to perform the
functions identified for the poor value items.
d. Judicial analysis phase -The ideas generated in the creative phase are
now evaluated in a practical, pragmatic and analytical mode. Several
ideas are selected and ranked in order of importance.
e. Development phase -The best creative and practical ideas are now
refined by the team and brought into shape. The cost factor is added here
and applied to reality. This is a consolidation of what the team thinks.
f.
161
162
i.e. its acceptability. The total weightage coefficients, or the acceptability of the
samples can then be ranked for a final decision.
This various attributes are listed horizontally in the table and their average
weightage coefficient entered under each. The samples are listed vertically at the left
and their sample weightage coefficient with respect to each attribute entered under
the appropriate average weightage coefficient. The weightage of each of the samples
in relation each of the attributes is obtained by multiplying the average weightage
coefficient by the corresponding sample weightage coefficient and entered against
each sample in the different attribute columns. These weightages are then totaled
for the final ranking of the samples. On the basis of the total weightage or overall
acceptability, the ranking is made.
The decision matrix can be usefully employed in many situations, where an
unbiased and objective decision is required among a large number of suppliers and
factors. Such a decision is forced on one by the very nature of the method. In
addition to the selection of samples of an item, the decisions matrix can be employed
by some firms in selecting a candidate for promotion at senior levels where, from a
number of candidates having more or less identical claims, only one can be
promoted to the higher post in the light of a few well-chosen attributed for the post.
In each of the situations mentioned, the evaluating committee must be carefully
chosen and must include all top or senior personnel: who how intimately the
samples/candidates/ problems/objectives suppliers and are affected by the
decision. Even though this method is complex, involving numerical figures, it
enables us compare several suppliers for a large number of performance factors
simultaneously; to identify the least cost item.
12.11 ROAD BLOCKS TO VALUE ANALYSIS
Like any other cost reduction technique, value analysts also has its limitations.
The common limitations to using value analysis techniques and excuses given for its
non-implementation are as follows:
a) lack of motivation
b) resistance to change
c) inertia
d) lack of knowledge
e) lack of patience
f) it would not work in India
g) we are too small
h) we are too big
163
164
165
LESSON -13
INTERNATIONAL BUYING
OBJECTIVES
To know the import policy
To have a clear view about the procedures involved in importing the
materials
To understand the various problem in imports
CONTENT
13.0 Introduction
13.1 Import policy
13.2 Classification of Importers
13.3 Objectives of control
13.4 Fees and validity of License
13.5 Preliminary formalities
13.6 Source Selection
13.7 License procedures
13.8 Letter of credit
13.9 Documentation
13.10 Bill of lading
13.11 Customs clearance
13.12 Problems in Imports
13.13 Revision Point
13.14 Intext Questions
13.15 Summary
13.16 Terminal Exercises
13.17 Suggested Redding/ reference Books/set books
13.18 Key words
13.0 INTRODUCTION
Self-sufficiency in today's inter-dependent countries of the world is a far cry.
One has no alternative but to depend upon other countries in some form or the
other, for his own or his society's needs. For a growing economy like ours, achieving
self- sufficiency should be the long-term goal. In this process, importing or
166
purchasing the material from outside the country is an essential economic function.
Even an industrially advanced nation like the United States, which, is endowed with
most of the natural resources, imports materials. This follows from Riccardo's
Princip1e of comparative advantage which states that it would be beneficial for an
economy to concentrate on production of items, in which it specialises, export these
items and import its requirement of other items, in order to arrive at altruistic
solutions. But international trade is not guided merely by simple rules, as every
country wants to protect its interest and controls the international trade emanating
from its shore through protective legislative measures. India is forced to import due
to lack of certain natural resources, like crude oil and due to lack of high technology.
13.1 IMPORT POLICY
To facilitate the easy flow of goods, the government announces its annual
import policy, usually in the beginning of the new financial year, i.e. on first of April,
The Import Trade Control (ITC) Policy, popularly known as the Red Book, is issued in
two volumes. These policies are periodically updated by amendments depending
upon socio-economic and political factors. Volume 1 deals with the policy of the
government with regard to user's import of materials and Volume 2 deals with the
government policy with regard to registered exporters. It is an established practice,
that the Government of India publ1shes handbooks of rules and procedures
simultaneously along with the Red Book.
The Government of India reviews the import policy considering various
aspects,such as trade balances, raw material positions, crude production, shortages
on agricultural front, etc. The concerned ministries, DGTD and other administrative
ministries and consulted, recently, the import policy has been liberalized, as
shortage of raw materials has led to under-utilization of capacity. In some cases,
automatic licenses will be issued to cut down the procedural delays, Import policies
as such are not static and changes in policies and procedures are very important to
industries, which depend upon imports for their production. The review of the policy
is a combined approach to see that import is allowed to the extent required, to
enable the indigenous industries to have access to their requirements of raw
materials at the most competitive prices -i.e. at the international price, but at the
same time to avoid unnecessary imports of items, which would directly affect the
indigenous production. Even though a three-year policy was announced for the
period ending 31 March 1988, licensing period continues to be one year and the
government resumes the right to amend the policy at any time. For case of
referencing,
it
was
proposed
to
issue
six-
monthly
compilation
of
all
167
Import of spare parts, the procedures for which have been released, is usually
on a repeat basis, i.e. for same value as in earlier years. In the case of non-priority
industries, a consolidated license for spare parts and raw material is issued. Small
industries can have a special status when they apply through their respective
sponsoring authority. The application for import of capital goods must go through
the sponsoring authorities. There is a special capital goods committee, which clears
these applications on the basis of various factors, such as availability from
indigenous sources, essentiality, of import availability of foreign exchange, etc. For
emergency requirements of spare parts, the procedures are simplified and there are
special forms.
The policy is more liberal towards registered exporters. Industries that export a
certain minimum percentage of their production will be given preferential treatment
in the allocation of foreign exchange. They have several duty agreement, like refund
or exemption from payment from central excise "duties, and customs/excise duty
drawback on raw material used for the exported items. Ini addition, they get refund
of local duties and exemptions in freight, income tax, sales tax, etc., under certain
conditions they can even transfer the licenses and nominate beneficiaries.
Actual users who require additional raw materials, components, consumables
and spares may submit their applications for supplementary licenses after giving
adequate reasons for the additional requirements. They are required to maintain
separate accounts of consumption of materials imported against supplementing
licenses. New units, who have made firm arrangements for land, premises, power,
plant, machinery, etc. should apply for their import requirements through the
respective sponsoring authorities and the value is initially up to Rs. five lakhs.
13.2 CLASSIFICATION OF IMPORTERS
The importers are broadly categorized as: a) actual users (industrial), (b) actual
users (non-industrial) (c) registered exporters (d) registered importers, i.e. those who
import under the import policy for registered equipments, and (e) others. Actual user
means a persons or any company who applied for/secured a license for the import of
any item or an allotment of any imported item required for his own use and not for
business or trade in it. Thus in the case of industrial undertaking, the item
concerned should be used for the manufacturing processes or operations conducted
within its authorized premises (or) made available to jobbing into 'or other units
outside for intermediate processing, only as a part of production effort). In the nonindustrial category such as hospital, research and development, commercial
establishments and individuals, the concerned item shall be utilised for his own use
for the purpose for which the item was sought for import. The actual users are
further classified as priority and non-priority industries, scheduled units registered
168
with DGTD and small-scale industries. Registered exporter means a person holding
a valid registration certificate issued by an export promotion council.
Every importer/exporter, whether an individual or firm or company importing
or exporting goods, will have to get importers code number from the licencing
authority concerned, under whose jurisdiction the importer falls and without this
code number, the customs authorities will not permit. The policy also defines
exporters, trading houses, capital goods and component, Spares is defined as a
part of sub-assembly for substitution of worn out parts, whereas accessory/
attachment means an assembly that contributes to the effectiveness of a price of
equipment. Separate licences are issued for instrument test equipments and
samples.
The requirements of actual users in the matter of raw materials, consumables,
spares and components will be met by open general licences, list number 8 of
Appendix gives a list of items to be allowed under open general licence. At present
import control covers practically articles and are included in schedule of import
control order 1955. Import of gold, silver, currency notes are controlled by the
Reserve Bank of India under the Foreign Exchange Regulation Act.
13.3 OBJECTIVES OF CONTROL
The foreign exchange resources available to our country are not unlimited and
the government has to optimally utilise the funds available so that all sectors of our
economy benefit. The import control was first introduced as a war time measure in
the early period of the Second World War. The primary objective is to conserve the
foreign exchange resources of the country. As we know, India imports goods worth
about Rs. 30,000 crores, whereas it exports only about Rs. 20,000 crores worth
creating the years in spite of the efforts to reduce the imports and boost the exports
resulting always in adverse balance of payment position. While our nation has to
import these items from other countries, it will be equally fruitless to undertake
import substitution of all items at any cost. It is noted that crude oil, food, fuel,
fertilizer, capital equipments and spares and industrial raw material from the bulk of
the imports in the country.
After the Second World War, the emergency provisions ordinance was
promulgated to continue import control provisions, and this was replaced by the
Import and Export Control Act. 1947. Thereafter, gradually the act has been
extended for an indefinite period. Several notifications and amendments have been
reproduced in appendices 1A, 1 B, 1C of the Handbook of Import Export Procedures,
1985-1988 and subsequent publications.
169
The main objectives of the import and export control are to provide easy access
to imports, essential for production and exports, at the same time safeguarding the
reasonable interests of the domestic industries, thereby to discourage, excessive
imports to items that are manufactured in the country and also to encourage export
of items which are not of strategic importance. Sensitive in nature or mass
consumption, etc. It is neither liberalized nor restrictive, but a balance between the
need for import and export production.
13.4 FEES AND VALIDITY OF LICENCE
Every application has to be accompanied with a fee of Rs. 50, if value of goods
specified does not exceed Rs.50,000 and Re. 1 per additional 1000, subject to a
maximum of Rs. 10,000. The last date for filing applications are (a) 31 October for
automatic licences; (b) 28 February for filing for supplementary licences; (c) 31
December for actual user for non-permissible spares; (d) 28 February for all
applications including capital goods; and (e) for emergency spare any time within the
licensing period. The year represents the financial year of Government of India i.e.
from 1 April to 31 March.
The validity period will be six months for emergency spares for capital goods 24
months and for others. 12 months. Licences may be general currency area licences
or specific licences issued under special credits, like World Bank, Asian Bank,
Special Drawing Rights and from different countries. Aid India Consortium or rupee
currency area licences valid for countries with which rupee trade agreements. There
can also be replenishment licences and capital goods licences. Procurement is
limited if the credit is tied to a country.
The licencing authority scrutinizes the application to ascertain the following
requirements before issuing the-licences; (a) foreign exchange, its requirements.
Quantity and availability; (b) monetary ceiling, (c) stock in hand and expected arrival
on date of application against the licences already issued, (d) the indigenous
sources, availability of materials, the country for which import licences are issued,
(e) imports in the past by-the applicant (f) consumption in the past by the applicant,
(g) estimated and actual during the preceding period, (h) shortfall in production
schedule and estimate and (i) policy of the government with respect to the item for
which respect to the item for which the licence is required.
13.5 PRELIMINARY OF FORMALITIES
the first act of an intending importer is to make sure that the material or its
equivalent is not available indigenously. The publications of DGTD, namely (a) A
handbook of indigenous manufacturers for chemical and miscellaneous stores, Gives
a list of indigenous sources. The case of plant and equipment are advertised in the
170
Indian trade journal. If the indigenous manufacturers are not in a position to quote,
the intending importer should get such a declaration from them. Once it has been
established theat there are no suitable indigenous sources. The buyer should
approach his sponsoring authority. The sponsoring authority for large-scale
industries is the directorate general of technical development, some of the other
sponsoring authorities are the state directors of industries, commissioner for small
scale industries and trade associations like the handloom board, Tea board, Etc. The
sponsoring authorities play only a recommendatory
quantities to the licencing authorities. The licencing authority works under the
ministry of commerce and is under the chief controller of imports and exports,
Which has branches in important places in the country. Companies can get import
entitlements on the exports even if they be indirect.
13.6 SOURCES SELECTION: A TO Z FACTORS
The source selection process is similar to the indigenous source identification.
As many foreign companies, Have their representative in India, The buyer can also
get useful information by contacting Ministry of Trade, foreign consultants, foreign
trade missions, foreign embassies, overseas agents, foreign publications, through a
process of global tenders, foreign directories, etc. Usually a foreign consulate has a
commercial attache, who is well versed with the list of suppliers in his country. The
quotations have to be evaluated and the supplier to be selected afterwards. The
matters on which negotiations take place are a) price, b) validity of price c)
guarantees and warrantees d) currency payment, e) currency fluctuations, f) mode of
payment g) contract terms, h) CIF-price including cost, insurance and freight i) C&F
cost and freight alone with buyer arranging for insurance j) FOB -free on board
k) FAS-free alongside steamer or port of export l) ex-works-buyer arranges the
movement from seller's factory (m) arbitration/adjudication n) packaging o) delivery
schedules p) transportation q) credit facilities r) service after sales s) replacement of
rejected goods t) commitment to contractual objections u) delivery schedules v)
reputation of the supplier w) meeting emergency commitments x) financial
soundness of parties y) technological advancement including high-tech z) long
lasting commitment on supply of spares.
It is advisable to compare the price on the basis of landed cost. The cost of
packing and forwarding to the port of despatch, the loading and port duties, cost of
freight and insurance, clearing and forwarding at port. Of receipt, and the cost of
transportation to the point of' consumption must be added to the ex-factory price to
get landed cost.
Once these have been agreed tothe buyer should apply for import licence.
171
known outside, and who other wise would not be trusted with goods by a trader in
another country.
172
receiving the letter should see whether the bank is acceptable or not. c) The
instrument mentions the name and full address of the beneficiary i.e. the seller in
whose favour it is issued. d) The amount for which the credit is issued is clearly
stated. e) Since banks are not willing to honor drafts for smaller or larger amount,
some flexibility is introduced by resorting to the word-about. F) The name of the
person, for whose account the credit is opened, is mentioned in the letter of credit. g)
The credit standing of the importer is of little consequence to the seller, if he is
satisfied with the issuing bank. h) The tenure of draft or drafts to be drawn under it
must be clearly stated in it. i) The letter of credit lists the documents to be attached
in the draft drawn under it. The documents clearly indicate, the discharge of
contractual obligation by the exporter. Any discrepancy may result in refusal by the
advising bank to honour the draft. J) The letter of credit has an expiry date
indicating its validity. k) If the time given is not enough, the exporter may
communicate with the issuing bank or the importer to get the date changed. l) The
type of credit revocable, irrevocable, confirmed, unconfirmed, revolving - is stated on
the instrument m) The letter of credit mentions any other conditions that may be
demanded by the importer and iliat may have been settled between the importer and
the exporter.
13.9 DOCUMENTATION
The items that are imported must be cleared from port and customs before
these can be used. These agencies have an established procedure and it is advisable
to use a clearing agent unless the organization has so many transactions to warrant
the establishment of a separate clearance cell. The nature of documents involved in
import of goods are discussed below. To clear the goods from customs, a bill of entry
should be filled with them. This should be accompanied by a) bill of lading, b) signed
commerial invoice, c) packing list, d) specification/test certificate, e) country of
origin certificate, f) insurance certificate, g) indent and acceptance, h) catalogue or
write up, i) valid import licence, j) markings of packing, k) commercial invoice from
seller to buyer indicating conditions of sale and description of goods, rates of
exchange, 1) export and import permit numbers.
After scrutiny of the documents, the customs appraiser will assess the
consignment and fix the duty to be paid. On payment of the duty, the consignment
will be released. After this formality, the Port dues have to be cleared before the
goods can be removed by the importer. When materials are received in bulk,
importers have the option to store them in a bonded warehouse and release the
quantity required on payment of appropriate amount of duty. The import licence
should be valid and there should be a consonance between the description in the
licence and the description of goods. Fortunately, the new customs tariff is based on
173
the Brussels tariff nomenclature and it is easier for importers to use similar
nomenclature, both with suppliers and authorities.
13.10 BILL OF LADING
The bill of lading is the most important document which accompanies bills of
exchange drawn under letters of credit. This is signed by the master of the ship and
indicates that the goods have been despatched by the supplier and gives the
importer title to the goods. This is an undertaking by the carrier of having received
from the consignor, the goods under description from the given place of origin to be
delivered to the order of the consignor at the port of destination.
Details such as freight to be paid, number of packages, condition of packages,
contents, Shipping marks, etc., are also included in the bill. It is usually made out
in sets of four, the fourth copy being retained by the carrier. The carrier protects
himself by entering in what stage of packing he has received the goods and whether
they are suitable for normal handling abroad the vessel. Insurance claims are
invalid, when the packing is bad. The carrier has the claim of the goods upto his
freight charges and need release them only if they are paid. Hence, endorsement on
freight is a key factor. Though the bill of lading transfers the title yet the transferee
obtains it subject to equities i.e. if there were any fraud he will not obtain any title.
Thus bill of lading is, a) receipt of goods delivered to carrier for transportation, b)
contract between the shipper and the carrier for transportation of goods and c)
document of title of goods giving the holder title to the goods mentioned. The bill of
lading can be transferred by endorsement to another person, as a quasi-negotiable
instrument subject to equities.
A bill of lading which indicates that the goods are in apparent good condition
without any qualification, is known as a clean bill of lading. It does not have a
superimposed clause, expressly declaring a defective condition of item. If the bill
bears some remark relating to a defect in packing, such as tom, broken, damped
condition etc. it is known as a foul bill of lading which is not an acceptable
document.
13.11 CUSTOMS CLEARANCE
Both national and individual interest require that the goods imported are
cleared expeditiously, so that they can be put to productive use as soon as possible.
The time delay increase the cost of goods by locking up the capital and demurrages.
Further, the ports get clogged and free movement is prevented. The following are
useful tips for early clearance of goods from customs:
174
a) The importer can file his documents much earlier to the arrival of the vessel
and complete the documentation part of it in the customs house, even before
the arrival of the vessel.
b) On arrival of vessel, he can straightaway proceed to take delivery of the goods
after examination.
c) When the importer does not have the full information relating to imported
goods, he can request for provisional assessment of the goods on execution of
an appropriate bond.
d) Even when goods have to be tested prior to release, the importer can request
for release of goods on execution of a suitable bond. In some cases he can ask
for part delivery of the goods, even without execution of bond.
e) When the importer does not have the licence with him for submission to the
customs officer, he can request for clearance of the goods on a bond after
furnishing a Photostat copy of the licence, to satisfy the customs officer that
he has in fact a valid licence with him to cover the goods and that he is
unable to produce it because of certain circumstances.
f)
When the importer is prevented from clearing his goods due to some
extraordinary circumstances, like lock out and strike, he can deposit the
goods in a warehouse without actually going through the warehousing
procedure. This will ensure that the goods do not incur demurrage.
g)
When an importer imports goods solely for export production, he can take
recourse to the facility of manufactured in bond, so that he may avoid
payment of duty.
When goods are imported for the setting up of a plant, or a specified project
for substantial expansion of an existing plant by following project import
regulations, goods can be assessed at confessional rates. This will facilitate
assessment of raw materials, semi-finished goods, and spare parts within
limits at the same confessional rates applicable to the machinery.
j)
When customs duties are levied because of application of wrong rates of duty,
or because of misclassification, the importer may me a claim with the
assistant collector of customs within six months from the payment of duty.
175
l)
In case of shortages, the exchange control copy of the import licence will be
automatically treated as valid for replacement of the consignment.
176
Customs clearance
13.14 INTEXT QUESTIONS
1. How are the importer classified?
2. Discuss a) Letter of credit and b) Bill of lading.
3. What are the various problems encountered in imports?
4. Give the stepwise procedure for obtaining an import licence.
5. Give the stepwise procedure for importing raw materials for your
organization.
13.15 SUMMARY
The import
177
LESSON-14
To Know the various laws that have a direct impact on the purchasing
executives
And also to know the laws that have an indirect impact on the marketing
operations of the purchasing executives.
CONTENT
14.0 Introduction
14.1 Law of agency
14.2 Power of attorney
14.3 Sale of goods Act
14.4 Transit Damages
14.5 Inspection and Acceptance
14.6 Law of carriage of goods
14.7 Transfer of title
14.8 Negotiable Instruments
14.9 Arbitration
14.10 Revision points
14.11 Intext Questions
14.12 Summary
14.13 Terminal Exercises
14.14 Suggested Redding/ reference Books/set books
14.15 Key words
14.0 INTRODUCTION
My word is my bond is the slogan in the Liverpool stock exchange. But, being
the main expender of the company's finances, the purchasing executive can ill afford
to overlook the legal implications of his actions. The purchase document is legal
document that binds the company to buy from the seller. Hence the purchase
executive must understand the relationship existing between himself and the
company with which he is connected, on the one hand and the consequences of his
actions to the market on behalf of the company on the order. A lack of knowledge of
178
the law can lead to costly blunders. While contracting the supply of good and
services.
The laws that have a direct impact on the purchasing executive are the Law of
Agency, the Law of Contract and the Law of Sale of Goods. The laws pertaining to
Negotiable Instruments, Insurance, Arbitration, Sales Tax, Customs, Central Excise,
Insolvency, Companies Act, MRTP Act, Trade Marks, and Patents have an indirect
impact on the market operations of the purchasing executives. Therefore, it is
imperative, for the purchasing executive to have at least a working knowledge of
these laws. In fact, a lack of knowledge of the existing laws can never be given as an
excuse for an illegal act of omission or commission. Not only must this purchase
executive know his own rights, but also those of his suppliers.
14.1 LAW OF AGENCY
The concept of agency is important for corporations. The board of directors
designates certain individuals In the company to have power of attorney. The
purchasing executive and the company he serves lead a symbiotic existence. Just as
the company expects an unequivocal loyalty from him, it reciprocates by supporting
his actions. Even though this inter-relation is much more than what is required by
the Law of Agency, yet it is worthwhile for both parties to have a clear understanding
of the legalities of their situations. The purchase contracts are negotiated and signed
by the purchase executive on behalf of the company. Thus, the executive is an agent,
whose actions are binding on the company who are his principals.
The Law of Agency elaborates the relationships that exists between the
principal and the agent and the authority of the agent to act for his principals. The
principal or the company enters into contracts with outsiders through the agent.
This contract of an agency by which the executives act on behalf and as the agent of
the company, can be made either verbally or in writing, and such a written contract
is called the power of attorney . The rules of agency is based on 'Qui fact per actum
facit per se, which means that he who does through another does it by himself. This
is subject to the conditions set forth in the rules of agency.
14.2 POWER OF ATTORNEY
The duties of an agency include the following:
a. duty to execute the mandate given by the principal;
b. duty to follow instructions or accepted customs;
c. duty of reasonable case and skill expected of a man of average prudence;
d. duty to avoid conflict of interest with principal;
e. duty to remit money wherever earned by him to the principal and
179
180
it, should be noted that more than legal remedies, good buyer-seller relationships
will help solve these payment problems in an altruistic basis. Unless a different
intention appears from the tends of contract, stipulations of payment are not
deemed to be the essence of contract of sale.
It should be noted that the sale of goods act accommodates only a reasonable
time' for the supply of goods. This is based on the normal conditions that are
prevailing in the market, the knowledge between the two parties. Hence if the
purchaser wants to guard himself, he must stipulate the delivery periods, while
entering into the contract. In such case, the buyer can reject the goods supplied
beyond the schedule.
A major problem which risks both the buyer and the seller is that. who is
responsible for any damage to the material during transit? Usually transport
companies undertake goods only on their clients' risk and this leads to the need for
a transit insurance. But obtaining the claims, whether from the transport company
or from the insurer, is a tedious process and hence both the buyer and the seller
would like to avoid such a burden. Here, it should be noted, that the risk of loss
generally follows the FOB point specified in the contract. i.e. the risk follows the title
to the goods, and the title holder at the time of the damage, has the burden of the
claims.
14.5 INSPECTION AND ACCEPTANCE
It is a normal practice for the buyer to inspect the goods before acceptance, so
that he can assure himself of its quality and quantity and whether it is according to
the specifications. Such an inspection must be made within a reasonable time of
receiving the goods. But the difficulty arises mainly in industrial goods, where all
the defects may not be evident on inspection, but may come into focus on use.
Problems may also arise when inspection is carried on at suppliers works and one
can always commit the error of passing defects. Hence, the buyer has to be
extremely careful in these cases. Usually, it is advisable to purchase on the basis of
samples. The advantages to tile buyer is that, he always has the sample as a
standard for comparison. But most of the goods are purchased or sold by
description. In these cases, the purchaser must be unambiguous about his
specifications by furnishing drawings and tolerances, or referring to standards, or by
prescribing tests that the item has to pass. Stage-wise inspection as well as third
party inspection are also in vogue and in such cases the third party is responsible if
defective items are passed by them in inspection.
Legally, once the buyer irrevocably accepts the goods, he cannot thereafter
reject it. But he has remedies if the goods are later found defective and he can claim
181
damages from the seller. The buyer has the choice between accepting the entire
quantity, or accepting part or rejecting the entire quantity of goods, if they fail to
meet the specifications and quite expectedly he needs to pay only for the accepted
quantity at the contracted rate. In addition to this, he has the right to damages
even if he accepts the entire quantity. It should however be noted that the buyer
must take sufficient care of goods rejected, if they are in his custody. He should not
leave them in the open as they deteriorate in quality and should follow the
reasonable instructions of the seller with regard to their return. In all these cases.
the passing of the title from the seller to the buyer is very important.
14.6
company -other than the government - who or which transport goods over hand or
inland water-ways without discrimination between different consignors. Thus any
person who offers for hire, as a regular business for money, to carry from one place
to another of goods of any person who choose to employ him for the purpose, is
called a common carrier. In ordinary circumstances, a common carrier cannot
refuse to carry goods for anyone if (a) the person asking him to do so is prepared to
pay the established charges; (b) the goods
carrier has declared to carry and (c) the place of destination is within the area in
which he operates. A common carrier takes upon himself the responsibility of safe
delivery of goods, if they are stolen within his custody or destroyed by fire or handed
over to a wrong person. He can refuse to deliver the goods until his charges are paid
and has a right to recover damages due to the goods being dangerous in nature.
A person or company who carries the goods for selected parties and not for all
clientele is a private carrier. The private carrier does not make a general offer but
restricts his clientele to particular parties with whom he negotiates special terms
and is governed by the law relating to bailment. Good is are divided into dangerous
goods, like explosive / acid / poison, as well as scheduled and non-scheduled goods.
The scheduled goods include, inter-alia, gold, silver, ornaments precious stones,
Clocks, time piece, hundies, bank notes, maps, writings, paintings, photograph,
work of art, sculptures, glass, china silk, shawls, opium, ivory, coral, sandalwood,
musical instruments and scientific gadgets. A carrier is not liable for loss or damage
of scheduled goods over Rs.100 if at the time of booking their description and value
are not given.
14.7 TRANSFER OF TITLE
The following are the details relating to transfer of title:
a. In the case of specific goods in a deliverable state property in them passes
at the time when the contract is made.
182
183
184
LESSON 15
185
the ancient warning of the 'coveat emptor' or buyer beware still operates. The words
of George Herbert, 'the buyer needs a hundred eyes, the seller not one, are relevant
today. Absolute power in any sphere-social, political, economic, religious, industrial
corrupts absolutely, forcing unethical decisions.
In the context of ethics, Mahatma Gandhi mentioned the seven ills of the
society which should be avoided: (a) politics without principle (b) wealth without
work (c) pleasure without conscience (d) knowledge without character (e) science
without humanity (f) commerce without morality, and (g) worship without sacrifice.
These statements are particularly true in the context of purchasing, which is the
largest spending department in the organisation and hence, is bound to be wisdom
of temptations and allurements and compromises in the form of wine, women,
wealth, arts, commission, kickbacks, donations, Winding up charges,
bribery,
ideas,
ideological
beliefs,
instead
of
physiological
or
biological
organisation. Hence this influence the socio-economic environment, while the socioeconomic ethos itself is determined by the interaction of culture ethics and psychosocial factors. Ethical values are inseparable from the pursuits of ordered human
society and dharma is the value that bind people together to form an integrated
organisation the society. The essence of our socio-economic ethics should be a
pervasive social awareness contributing towards efficiency and humanizing our
outlooks and actions.
The conduct of an individual citizen or a corporate citizen involves the destiny
of one or more individuals or corporate bodies in the society and affects others. It is
like the state taking taxes from the people only to ensure their own prosperity in
return; just as the sun takes up the moisture only to give back in thousand-fold
measure. One should devote oneself to perform with a spirit of dedication; the
pursuit of excellence through efficiency in work is held out as the highest form of
yoga and improves the quality of life. In this context, ethics can be defined as a
self-generated system of moral standards in the realm of business, to which a
substantial majority of executives give voluntary assent; genuine differences of
186
opinions and dissidence should not be stifled as indiscipline. The concepts such as
Work is workshop, action is thy duty -fruit is not thy concern, trust begets trust
and other ideals should be practised institutions and nor discarded as theoretical
slogans.
15.2 ETHICS IN BUYING
Ethics is a philosophy of life and based on the principle, "do unto others as you
would like others do unto you". Ethics is the discipline which points out the
obligations between persons or group of persons, based on a written code of civilised
conduct. If there is such a thing, as a profession, as distinct from a vocation, it must
consist of the ideals in which they maintain character, which they bring to the
performance of their duties and the austerity of self imposed ethical standards. It is
the most important element among others, which is related to the simplest principle
of the purchasing profession, as it is the primemover and motivating force for
shaping moral character. Ethics try to set standards in absolute terms, as ethical
behaviour gets a man respect, social recognition, moral strength and internal
satisfaction. The personal characteristics of the buyer will largely determine what
other people think of him. The personal ethics are derived from well-set moral
standards and must be on a higher plane than business ethics, if there is to be
improvement and must be pulled but not pushed up. The buyer has not only to
build his reputation, but must appreciation that the reputation of his organisation
depends on his thought, action and deeds.
It is well-known that a buyer can purchase everything, but he cannot buy
reputation or honesty or integrity, which have to be built by professional ethics,
moral character, wisdom, reliability etc. The concept-that all methods are fair in war,
low and buying, must be avoided in the field of purchasing. The ethics and integrity
of the purchasing personnel must be such that their suppliers always trust them:
Since their decisions affect the company's business, their conduct must be above
reproach. The qualification of a good buyer should be a confidence in his own
judgement in fair dealings. Relating to source development, source selection,
adherence to purchase order, placing, disputes, quantity to be ordered, negotiated
price, inspection, documentation, etc. Hence the buyer-seller relationship should be
correct, cordial, fair and long-lasting. However, the concept of morality, fair dealings,
trust and other ethical values is confined only to youngsters, probationers.
temporary staff, etc. and change with experience in service for a long period in
consonance with the central values of the organisation.
15.3 CODE OF ETHICS
The ethical code of the international federation of purchase and materials
management states that members shall not use their authority or office for personal
187
gain and shall seek to uphold and enhance the standard of purchasing by a)
maintaining an unimpeachable standard of integrity in all their business
relationships both inside an outside the organisation in which they are employed b)
complying with the letter and spirit of the laws of the country in which they work.
Loyalty to the company, justice to those with whom he deals and faith in his
profession are the basic codes of purchasing professionals. In this context, the code
of a professional organisation, the Indian Institute of Materials Management, is given
below a) to consider first the total interest of one's organisation in all transactions
without impairing the responsibility and dignity to one's office b) to buy without
prejudice. seeking to obtain the maximum ultimate value for each rupee of
expenditure; c) to subscribe and work for honesty and truth in buying and selling, to
denounce all forms and manifestations of commercial bribery and to eschew antisocial practices; d) to accord to prompt and courteous reception, so far as conditions
will permit, to all who call up on legitimate business mission; and e) to respect one's
obligations and those of one's organisation consistent with good business practice.
It will be admitted that these codes are worthless if it is not backed up by
deeds, preferably supported by policy statements. It is expected that the buyer
should never forget that he is the symbol of all ethical standards and at all costs, in
all circumstances, he would never deviate from the ethical standards to fall prey to
temptations and allurements.
15.4 PROBLEMS IN ETHICS
It is well known that purchasing executives negotiate contracts worth millions
of rupees and hence are exposed to temptations which few other executives in other
functional areas have to encounter. The foundations of transactions are based on
honesty, equity, fairplay, integrity, etc. between the two parties of the game and
hence must enjoy the support and confidence of their companies and the
relationship between the two parties is one of trusteeship. If there is a lack of trust,
or the actions of the purchase executive is suspect, the company cannot be expected
to prosper. If the chief concern of a purchase executives is pf getting, rich quickly,
then the relationship will weaken and crumble. Dishonesty, corruption, cuts,
kickbacks, commissons, etc. in the area of purchasing are merely a reflection of the
prevalent creed in the organisation, industry, society, public life, as well as in the
socio-political environment in the national and international areas.
It is noted that in many organisations, all purchasing decisions are influenced
by the user department which indicates the sources of supply. The" marketing
department sometimes exerts its own pressures on the plea of reciprocal buying. Top
management dictates to purchasing, particularly when large contracts and capital
188
of
integrity
have
fallen,
with
honour
and
patriotism
becoming
189
weeding out from the system and recognise successful ones to reward them
adequately. For this purpose, the materials function has to be judged by the success
it achieves in the field of productive wealth brought through its contributions to the
corporate profits. If the organization succeeds, the materials management is
understood to have carried out his job effectively. On the contrary, if it fails, the first,
blame will come to purchasing as purchasing represents a result oriented activity of
the firm.
15.5.1 Background Conditions
Before proceeding to discuss the process of evaluation, it is desirable to identity
the background conditions in which the purchasing function operates in a
developing economy like India. While all the management functions like production,
marketing etc. as well as many oilier professions in the world are evaluated on the
basis of their achievements, materials is one of the few professions which is judged
essentially by failures or non- delivery resulting in stock-outs.
In a controlled, scarce and developing economy like India, the purchase
managers feel that it is difficult to practice scientific management principles. The
lead-time particularly in public sectors and that too for imported items, is invariably
large. In a few firms, including semi processed goods, scrap, obsolete items,
furnished goods, stores and material planning, which demands different types of
competence. The job description for managing the materials function includes such
diverse aspects as commercial, technical, financial, legal and public relations. In
view of such problems, goals are difficult to set for the materials function and
deviations are impractical to measure, as ideal conditions do not exist in actual
practice, However, it will be appreciated that evaluation of materials function is a
continuous process, in order to attain the corporate excellence. To operate
effectively, the executive must become a coordinator, representing corporate
interests, respecting other functions, responsibilities and opinions and using a
unified approach to outside vendors.
A materials executive, a) who Is completely familiar with his company's product
line, is up-to-date on and market developments, b) who has acquired knowledge,
experience and expertise in modem techniques of materials management; c) who can
justify his decisions in placing orders on sound and ethical grounds; d) who
appreciates the long-term advantages of good will and sound relationships with
suppliers; e) who deals with his staff with understanding and humility f) who is loyal
to his company without surrendering his own principles of correct conduct, honesty
and integrity; is the ideal man for the job. If the profession of materials is to gain in
value and importance, materials executives must raise themselves to the highest
levels of technical competence and managerial leadership, to be able to take their
190
191
It is also known that the suppliers, who are evaluated by the purchase
department, in turn, evaluates the buyer and his company, in terms 'of quality
consciousness, seriousness of adherence- to delivery schedule, his decision-making
capacity in the organisation and the adherence to, bill payment date. The other
external agencies interested in the efficiency of the procurement division are the
shareholders, banks with regard to credit-worthiness and bill discounting, excise,
customs, vigilance, railways, lorries, carriers, professional associations, industry
association, etc., particularly with regard to the ethical standards, adopted in
purchasing. In a few cases, consultants are brought in to evaluate the performance
of the purchase division and compare it with that of similar organisations.
15.5.4 Reporting
The evaluation of the materials function is usually done by the top
management on the basis of periodic reports emanating from the materials wing.
More facts reflect what has happened, whereas the reports would give the summary
of the working of the purchasing function. The report should be written in a simple
language. Clearly and briefly, Reporting is a communication which helps in setting
things right and goes a long way in efficient functioning of the department. Besides
establishing an effective communication, reporting is the means for collection and
dissemination of data. This process is a two-way traffic, weekly reports containing
the value of purchases, stock status, stock- outs, etc. usually meant for the middle
-level executives, are common in many organisations. Monthly and annual
summaries of the report with special emphasis on long-term aspects, such as effects
of cost reduction achieved, source development, vendor rating, value analysis, are
found to be useful documents for the management.
In order to take suitable remedial corrective measures and to improve materials
activities in the organisation. The reports should be submitted at the appropriate
time-viz. Monthly reports in the first week of the following month and an annual
report in the first month of the following year. Wherever necessary, diagrams, charts,
graphs, tables and comparative statements with adequate explanatory notes should
be made in the reports. The frequency and content of the reports depend upon the
level to which it is intended. Quarterly and annual reports with specific
recommendations on future are intended for top-management, while the monthly
reports with detailed information may be sent to all in the purchase and user
department. The reports should be accurate, up-to-date, brief, clear and to the
point. The report should be serve the materials policy in an organization, namely,
Continuity of supply of uniform quality of inputs, with the lowest cost of ultimate
product. For this purpose, the reports should be presented such that they are easily
read and understood. The report must include enough supporting diagrams, data
192
'and charts to explain the variations from the budgeted figures. The reports should
cater to the managements needs, an analysis of the business conditions,
environment
price
movements
material
requirements,
estimates
of
cash
193
performance
measurement
should
cover,
among
other
things,
Each lot of material received from the supplier is subjected to rigorous quality
control exercises and based companies quality control level (), the lots are either
accepted or rejected. The quality index of vendor rating the ratio of the rejected lots
to accepted lots of supplied material.
g. Vendor rating price index:
194
Quotations would be invited from all the short listed vendors and the ratio of
the lowest price of all the prices quoted to the price quoted by the particular vendor
is the vendor rating price index. This ratio will always be equal to or less than 1.00.
h. Vendor rating delivery :
i. Forecast price Index :
Delivery on Schedule
Total no.of deliveries
Discounts availed
Total value of purchase
o. Negotiation efficiency :
p. Value analysis index:
q: Cash discount index :
195
K. RAGHUKANDAN
Reader in Production Engg.
Annamalai University
196
ANNAMALAI UNIVERSITY
DMM-9
1-15
COURSE :1
PURCHASING MANAGEMENT
LESSON 1-15
197
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