Chapter 1

The role of Purchasing in the Value Chain

Program

The role of purchasing in the value chain Definition of concepts Importance of purchasing to business Classification of purchasing goods New developments in purchasing Conclusions

The role of purchasing in the value chain

Primary activities can be divided in five generic categories:

Inbound Logistics Operations Outbound logistics Marketing and sales Services

The procurement function should be able to meet the material requirements related to inbound and outbound logistics, and to operations.

The role of purchasing in the value chain

firm infrastructure Support activities human resource management

technology development

procurement
inbound logistics operations outbound marketing logistics & sales service

Primary activities
Drawn from Porter, 1985

The role of purchasing in the value chain

Support activities can be divided in four generic categories:

Procurement Technology development Human resources management Firm infrastructure

Procurement activities may be also related to supplying products and services for the other support functions.

The role of purchasing in the value chain

Aspects
Product assortment Number of suppliers Purchasing turnover Number of Purchase orders Average order size Control Decision-making unit

Buying for primary activities

Limited to large Limited, transparent Very large, considerable Considerable High Depends on type of production planning Engineering, manufacturing specialists dominant

Buying for support activities

Very large Very large Limited Very Large Small Limited, forecast-related or project-related planning Fragmented, varies with product or service

Definition of concepts
Purchasing:
All activities for which the company receives an invoice from outside parties. Differentiation between: Purchasing function Purchasing department

Definition: Managing the companys external resources in such a way that the supply of all goods, services, capabilities and knowledge which are necessary for running, maintaining and managing the companys primary and support activities is secured at the most favorable conditions.

Procurement:
All activities that are required in order to get the product from the supplier to its final destination.

Definition of concepts
Sourcing:
Finding sources of supply, guaranteeing continuity in supply, ensuring alternative sources of supply and gathering knowledge of procurable resources.

Purchasing Management:
All activities that are required to manage supplier relationships.

Supply Chain Management:

The management of all activities, information, knowledge and financial resources associated with the flow and transformation of goods and services up from the raw materials suppliers, component suppliers and other suppliers in such a way that the expectations of the end users of the company are being met or surpassed

Value Chain Management:

Challenging suppliers to improve the value proposition to the end-customers of the value chain. Usually the supplier works closely together with the customers technical and marketing staff to reduce the products overall costs and add new designs or features to the product which increase the value for the end-customer.

Definition of concepts
Different definitions... Ordering Buying Purchasing Procurement Sourcing Supply Chain Management Value chain management.

Operational, short term, deal and margin oriented

Strategic, long term, performance and value oriented

Purchasing: relates to every activity the company receives an invoice for

Definition of concepts
purchasing function tactical / initial
ordering/ operational

Internal customer

Specification

Expediting Follow Selecting Contracting Ordering and up/ evaluation evaluation

Supplier

Sourcing Buying

Supply

Procurement

Importance of purchasing to business

5 12 18 60-85 60-80 50-70 60-80 3 12
Admin. Services Capex Spares Tradeitems

25-50

10-40

50

Produ ction parts

Retailers

Computers

Consumer Automotive electronics

Pharma

Service industry

Typical structure
adapted from Kluge, 1996

Importance of purchasing to business

Challenge for managers: how to manage our EXTENDED ENTERPRISE ?

Sales: 100%

Profit 1,5 %

Value added: 20 %

Question: what should managers do?

Purchased materials And services: 78,5 %

Purchased materials and services have a large impact on company profitability

Definition of concepts
Challenge: how to manage our EXTENDED ENTERPRISE ?

Sales: 100%

Profit 1,5 %

Value added: 20 %

Question: what should managers do?

Purchased materials And services: 78,5 %

Suppliers determine 78,5% of total cost, innovation, carbon footprint and customer value

DuPont analysis:
Capital turnover ratio 2.1 x

Sales 105 mio

Total assets 145 mio

Net assets 50 mio

Interest free liabilities 95 mio

RONA
9.9 %

Income before tax 5 mio

Sales 105 mio

Total costs 100 mio

Margin 4.7 %

Other costs 40 mio

/
Sales 105 mio

+
Purchased mat. & serv. 60 mio

Amounts in Euro mio

DuPont analysis:
Capital turnover ratio 2.1 x

Sales 105 mio

/
Net assets 50 mio

Total assets 145 mio

Interest free liabilities 95 mio

RONA

12.4 ---- % 9.9 + 25 % !!

Income before tax 6.2 -- mio 5

Sales 105 mio

Total costs 98.8 ---- mio 100

Margin 4.7 5.9 --- %

Other costs 40 mio

/
Sales
105 mio

+
Purchased mat.& serv. 58.8 --- mio 60

Amounts in Euro mio

-2%

Classification of purchasing goods (1)

The purchasing process may concern a large variety of goods and services. In general, purchased materials and services can be grouped into the following categories:

Raw materials; materials which have undergone no transformation or

a minimal transformation and which serve as the basis materials for a production process

Supplementary materials; materials that are not absorbed

physically in the end product

Semi-manufactured products; products that have already been

processed once or more times and that will be processed further at a later stage

Components; manufactured goods that will not undergo additional

physical changes, but which will be incorporated in a system with which there is a functional relationship by joining it with other components

Classification of purchasing goods (2)

Finished products; all products which are purchased to be sold, after

negligible added value, either together with other finished products and/or manufactured goods

Investment goods or capital equipment; products that are not

consumed immediately, but which purchasing value is depreciated over a period of time

Maintenance, repair and operating materials (MRO items);

materials, which are necessary for keeping the organization running in general and for the support activities in particular

Services; labor intensive, non material activities that are executed by third
parties on a contract basis

New developments in purchasing

1. Sellers market Buyers market

2. Increasing pressure on sales prices and margins leads to:

Leveraged purchasing and supply strategies Global sourcing Supplier integration Early supplier involvement in new product development Reciprocity agreements and compensation agreements Corporate Social Responsibility and business integrity

Conclusions

In short, purchasing represents a business area which is being confronted with many changes and challenges.
Without doubt these challenges will put purchasing and supply chain management more in the spot light in business.