CH 07

Purchasing
Chapter 7
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.
Purchasing
the process of buying Requires input from:
Marketing Engineering Manufacturing Manufacturing Planning and Control
what materials to order when to order them
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.
Purchasing and Profit Leverage

On average 50% of sales dollars
raw materials components supplies
Tremendous potential to increase profits
Income Statement
Sales Cost of Goods Sold Purchases Other expenses Profit Before Tax $100
$50 40
90 $ 10
assume a profit before tax of 10%

Income Statement (sales increase)

$55 44
99 $ 11
to increase profits by $1; sales must increase by 10%

Income Statement (reduced purchase cost)

$49 40
89 $ 11
to increase profits by $1; decrease costs by 2%

Sales / Purchasing Leverage

A 10% increase in sales is the same impact on profits as A 2% decrease in the purchase cost
Leverage effect is 5:1
Objectives of Purchasing
Obtain goods and services:
of the required quantity and quality at the lowest possible cost at the best possible service and delivery while maintaining and developing suppliers
Purchasing Functions
Determining purchasing specifications
right quality right quantity right time (delivery) right place (delivery)
Selecting supplier
right source
Purchasing Functions (continued)

Negotiating terms and conditions
right price
Issuing and administering purchase orders
Purchasing Cycle
1. Receive and analyse purchase requisitions
2. Select suppliers, issue quotations 3. Determine the right price 4. Issue purchase orders 5. Followup to assure correct delivery 6. Receive and accept the goods 7. Approve invoice for payment
Receiving and Analyzing Requisitions

From planners (MRP system) and all other users Purchasing will:
Identify originator, account number, approvals Check material specifications Verify quantity and unit of measure Verify delivery date and place Ensure all supplemental information
Selecting Suppliers
Often from a list of approved suppliers For small items:
internet catalogues trade journals
For large items, issue a request for quotation

Requesting Quotations
Written inquiries sent to enough suppliers
to ensure competitive and reliable quotes are received
Quotes are analyzed

price compliance to specification technical suitability often with the involvement of the originator
Determining the Right Price

Usually the lowest May involve negotiations
Responsibility of the Purchasing Department
Issuing a Purchase Order

Legal document Forms a contract with the supplier upon acceptance Copies to:
Supplier Originator Accounting Receiving Purchasing file
Follow-up and Delivery

Ensure on-time delivery Negotiate any changes Take corrective action:
expedite as required find alternative sources of supply work with suppliers to resolve problems reschedule production?
Receiving and Accepting Goods

Receiving inspects goods for correct quantity and any damage Accepts goods and generates a receiving report
send to quality for further inspection hold goods damaged in transit
Copies to Accounting, Purchasing

Approving Invoice for Payment

Agreement with: Original Purchase Order Receiving Report Invoice
price including discounts quantity
Send approval to Accounts Payable

Establishing Specifications
Purchasing can help to make the best buy
Quantity requirements Price Requirements Functional Requirements
Quantity Requirements
Small volume
find a standard item
Large items
design for economies of scale reduce cost satisfy functional needs
Price Requirements
Relates to the use of the item
Relates to the selling price of the finished product
Functional Specifications
What the item is expected to do
Set by the end user
performance expectations aesthetic expectations
Example: functional specifications for a car

run reliably? make you look cool? safety?
Functional Specifications and Quality

Quality and product planning
to meet the expectations of the marketplace
Quality and product design

determining the specifications
Quality and manufacturing

meeting the specifications
Quality and use

satisfying customer expectations
Functional Specification Description

1. Brand 2. Physical and chemical specifications Material and method of manufacturing Performance 3. Engineering drawings 4. Miscellaneous methods
Description by Brand
Items are patented Special supplier expertise Small quantity
not worth the effort of developing specifications
Preferred by
customers the buyer
Description by Brand
Reputation of the supplier
guarantees / warranties
Limits competition
higher price easy to inspect
Specify by brand or equivalent

Description by Specification
Physical and chemical specifications
buyer defined
Material and method of manufacture

environmental or food issues
Performance specifications
state what the item is supposed to do uses supplier expertise
Specifications
Too loose
may not give the desired performance
Too detailed
costly to develop may limit competition
Should allow for multiple sources Can be difficult to do i.e. colors Best to use suppliers standard products
Sources of Specifications
Buyer specifications
expensive and time consuming
Standard specifications
set by government and nongovernmental agencies SAE 10W30 motor oil Underwriters Laboratories (UL) ASME steel standards
Standard Specifications
Widely known and accepted Lower in price Adaptable to customers needs
Market grades
describe many aspects of a product eggs: Grade A small, medium or large
Engineering Drawings
Detailed description of parts
finishes tolerances materials used no other way to describe the item
Expensive to produce Can be used for inspection

Miscellaneous Specifications
Samples used for colors / patterns Combination of methods
e.g. curtains
drawing of the window dimensions fire or safety rating type of material to use samples of pattern desired
Selecting Suppliers
The right supplier:
can supply the quality needed has the capacity to deliver the quantity need and on time (JIT deliveries?) makes a profit, but at a good price contributes to the improvement of your product
Factors in Selecting Suppliers

Technical ability Manufacturing capability Reliability After-sales service Location Other considerations Price
Technical Ability
Do they have the technical capability? Is there a program of product development and improvement? Can they assist in improving your product? Their products become part of your product
Manufacturing Capability
Can they consistently meet the specifications and quality desired?
quality control programs competent personnel
Do they have good manufacturing planning and control systems?

to supply information on delivery
Reliability
Reputable Stable Financially strong
Were in this together
After-Sales Service
Service organization Supply of spare parts Technical support
Supplier Location
Location may effect delivery time Local inventories May be required for after-sales service
will your customers require service?
Other Considerations
Credit terms Willingness to hold inventory JIT Information technology Reciprocal business
Price
Not always the lowest May include other services
Supplier Selection
On-going relationship Mutual benefit Supplier can depend on future business Buyer can be:
assured supply of quality products technical support product improvements / problem solving
Identifying Suppliers
Internet Catalogues Salespeople Trade magazines Trade directories Salespeople of the buyers firm
Supplier Selection Weighted-Point Plan

Factors
Weights Rating Ranking
Things that must be considered as part of what we will be buying The relative importance of each of the factors How well each supplier compares on each factor The weight times the rating
Weighted-Point Plan
1. 2. 3. 4. Select the factors Assign a weight to each factor Rate the suppliers for each factor Rank each supplier
multiply the weight by the rate for each factor
Weighted-Point Plan
Figure 7.1 Supplier rating

Price Determination
Direct influence on companys profit 50% of cost of goods sold (CoGS) Package of:
function quantity service price
you only get what you pay for

Basis for Pricing

Fair price
competitive gives seller a profit allows buyer to make a profit
Upper limit
established by buyers
Lower limit
established by sellers
Analyzing Costs
Fixed Costs
costs incurred no matter the volume of sales
equipment, insurance, overhead
Variable Costs
costs which vary with the volume produced
direct labor, direct materials
Analyzing Costs
Total cost = fixed cost + (var cost/unit)(volume)
Unit cost = total cost volume = fixed cost + variable cost per unit volume
Break Even Point

The volume of sales where total revenue equals total costs A seller must have sufficient volume to make a profit Knowing the sellers break even point is useful in negotiations
increased volume may lower price paid
Break Even Point -example

Fixed Cost = $5,000 Variable Cost = $6.50 / unit Selling Price = $15 per unit Average Cost = $5,000 1000 + $6.50 = $11.50 per unit To find the Break Even Point Let X = Number of Units $15X = $5,000 + $6.50X $8.50X = $5,000 X = 588.2 units The volume must exceed 588.2 units to make a profit
Price Negotiation
Buyer needs knowledge of sellers costs Buyer must have sufficient clout Should benefit both supplier and buyer Savings must justify the time and effort required
Negotiations - Type of Product

Commodities
price is determined by the market concern for future contracts
Standard products
price set by catalogue listings little room for negotiation
Small value items

try to reduce ordering costs or increase volume
Made-to-order items (negotiation possible)

quotations from a number of sources
Impact of MRP on Purchasing

Purchasing - two categories of activity: Procurement
establishing specifications, selecting suppliers, determining price, negotiations
Supplier scheduling and follow-up

same as production activity control execute the master schedule and the MRP ensure good use of resources, minimize WIP, provided the desired level of customer service
Buyer / Planner Concept

Production activity control
controls the flow of work through the plant schedules need for components
Purchasing
coordinates the flow of goods from suppliers
Plans are going to change!

Buyer / Planner Concept

Responsibility of planning and buying Works with the Master Scheduler and other Planner / Buyers Handles fewer components Smoother flow of information
knowledge of factory needs matches material requirements with supplier capabilities
Planner / Buyer Responsibilities

Determining material requirements Developing schedules Issuing shop orders Issuing material releases to suppliers Establishing delivery priorities Controlling orders in the factory and to suppliers Handling all the activities associated with the buying and the production scheduling Maintaining close contact with suppliers
Contract Buying
Long term contract with a supplier for small volume items
Authorize releases against the contract when goods are needed
Supplier may be given a copy of the material requirements plan Requires close coordination Works best with Buyer / Planner concept
Supplier Responsiveness and Reliability

Material requirements often change Suppliers must be able to react to change Flexibility
in volume in products needed
Reliable
in delivery promises
Contract Buying
Assures supplier of a certain amount of business Suppliers are more responsive to buyers needs
Assures buyer that capacity will be available when needed Buyer can delay actual ordering
Close Relationship with Suppliers

The need to understand each others capabilities and constraints Cooperation and team work Very frequent communications Between the buyer/planner and the suppliers production planner
Electronic Data Interchange (EDI)

Electronic exchange of information between customers and suppliers
purchase orders invoices material requirements plans
Reduces time involved Avoids costly paper work

Vendor Managed Inventory

Supplier maintains an inventory of certain items at the customers plant Customer only pays for the inventory when it is actually used Usually for standard, small value items
fasteners electrical components
The Internet
Internet
open public access to posted information valuable source of supplier and product information
Intranet
internal to company personnel only
Extranet
between participating companies
Supply Chain Management Organizational Implications

Total cost focus
not just price includes transportation, storage, handling value stream mapping mutual value analysis with suppliers
Supply Chain Management Organizational Implications

Mutually advantageous supplier negotiations Information sharing
costs schedules inventory levels
Measurement systems
all aspects of the supply chain
Growth in electronic business (Internet)

Supply Chain Management Savings

More effective product specifications Leveraging through volume discounts and supplier consolidation Lower costs through long-term contracts and efficient communications Lower payment costs
credit cards electronic commerce blanket orders

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Purchasing

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Purchasing and Profit Leverage

Tremendous potential to increase profits

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

assume a profit before tax of 10%

Income Statement (sales increase)

to increase profits by $1; sales must increase by 10%

Income Statement (reduced purchase cost)

to increase profits by $1; decrease costs by 2%

Sales / Purchasing Leverage

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Purchasing Functions (continued)

Issuing and administering purchase orders

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Receiving and Analyzing Requisitions

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

For large items, issue a request for quotation

Quotes are analyzed

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Determining the Right Price

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Issuing a Purchase Order

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Follow-up and Delivery

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Receiving and Accepting Goods

Copies to Accounting, Purchasing

Approving Invoice for Payment

Send approval to Accounts Payable

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Example: functional specifications for a car

Functional Specifications and Quality

Quality and product design

Quality and manufacturing

Quality and use

Functional Specification Description

Specify by brand or equivalent

Material and method of manufacture

Expensive to produce Can be used for inspection

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Factors in Selecting Suppliers

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Do they have good manufacturing planning and control systems?

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Supplier Selection Weighted-Point Plan

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Figure 7.1 Supplier rating

you only get what you pay for

Basis for Pricing

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Break Even Point