Purchasing

Chapter Objectives Be able to: Make a strong case for why purchasing is a critical part of a firm’s supply chain strategy. Identify and describe the various steps of the purchasing process, and discuss how this process will vary according to the type of good or service being purchased. Explain why spend analysis is important and perform a simple spend analysis. © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Introduction Why Purchasing is Critical The Purchasing Process Spend Analysis © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Focus Sourcing decisions and purchasing activities serve to link a company with its supply chain partners Sourcing decisions – (discussed in Chapter 10) High level, often strategic decisions regarding which products or services will be provided internally and which will be provided by external supply-chain partners Purchasing – The activities associated with identifying needs, locating and selecting suppliers, negotiating terms, and following up to ensure supplier performance © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical – I The Changing Global Competitive Landscape To compete globally, you need to purchase globally Global purchasing efforts are supported by advances in information systems © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical – II Financial Impact For the average manufacturer, 52.5% of the value of shipments comes from materials Purchasing represents a major opportunity to increase profitability © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical Financial Impact - I Lowe’s Company Every dollar saved in purchasing for increases pretax profit by one dollar Earnings and Expenses Sales $26,491 COGS $18,465 Pretax earnings $2,359 Selected Balance Sheet Items Merchandise inventory $3,968 Total assets $16,109 Every dollar saved in purchasing inventory lowers total assets by one dollar © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical Financial Impact - II 3% purchasing reduction in COGS Earnings and Expenses Current With 3% saving Sales $26,491 $26,491 COGS $18,465 $17,911 Pretax earnings $2,359 $2,913 Selected Balance Sheet Items Merchandise inventory $3,968 $3,849 Total assets $16,109 $15,990 Pretax earnings increase by $554 (23.4%) ROA increases from 14.6% to 18.2% © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical – III Performance Impact Quality Delivery Ability to exploit new technologies © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical Performance Impact - I Sourcing dialysis machine valves Supplier A Supplier B Cost per valve % good Delivery lead time $10 $2 99.8% 95% Overnight delivery 1 day to 3 weeks © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical Performance Impact - II Effect of defective dialysis machine valves Interruption in patient treatment Rescheduling difficulties Reduction in the effective capacity for dialysis Possible medical emergencies Estimated cost of a failed valve = $1,000 © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Why Purchasing is Critical Performance Impact - III Sourcing 50 dialysis machine valves (Total Costs) Supplier A Supplier B Valve costs Failure costs Backup inventory Total costs 50 x $10 = $500 50 x $2 = $100 0.2% x 50 valves x $1,000 = $100 5% x 50 valves x $1,000 = $2,500 1 valve x $10 = $10 3 valves x $2 = $6 $610 $2,606 © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

The Purchasing Process Needs identification Description No Is there a preferred supplier? Supplier identification and evaluation Yes Supplier selection & contracting Purchase order preparation Follow up and expediting Order cycle Receipt and inspection Settlement & payments Records maintenance © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

The Purchasing Process Needs Identification Purchase requisition – An internal document completed by a user that informs purchasing of a specific need Reorder point system – A method used to initiate the purchase of routine items. Typically, each item has a predetermined order point and order quantity Statement of Work/Scope of Work (SOW) – Terms and conditions for a purchased service. Includes how supplier will be evaluated Needs identification © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

The Purchasing Process Description The communication of a user’s needs to potential suppliers in the most efficient and accurate way possible Description Description by market grade/industry standard Description by brand Description by specification Description by performance characteristics Description by prototypes or samples © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier identification and evaluation The Purchasing Process Supplier Identification and Evaluation - I Supplier identification and evaluation The amount of effort increases as: The complexity of the product or service increases The amount of money that is committed increases The length of the proposed buyer-supplier relationship increases © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier identification and evaluation The Purchasing Process Supplier Identification and Evaluation - II Criteria for supplier assessment: Supplier identification and evaluation Process and design capabilities Management capability Financial condition and cost structures Planning and control systems Environmental regulation compliance Longer-term relationship potential © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier selection & contracting The Purchasing Process Supplier Selection - I Competitive bidding Negotiation Fixed-price contracts Cost-based contracts Supplier selection & contracting © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier selection & contracting The Purchasing Process Supplier Selection - II Preferred supplier A supplier that has demonstrated its performance capabilities through previous purchase contracts and therefore receives preference during the supplier selection process Supplier selection & contracting © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier selection & contracting The Purchasing Process Supplier Selection - III Competitive bidding is most effective when: The buying firm can provide qualified suppliers with clear descriptions of the items or services Volume is high enough to justify the cost and effort The firm does not have a preferred supplier Supplier selection & contracting © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier selection & contracting The Purchasing Process Supplier Selection - IV Negotiation is most effective when: The item is new or technically complex with only vague specifications The purchase requires agreement about a wide range of performance factors The supplier must participate in the development effort The supplier cannot determine risks and costs without input from the buyer Supplier selection & contracting © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Supplier selection & contracting The Purchasing Process Supplier Selection - V Contracting is most effective when: There is a large amount of money involved The business needs specific requirements that need to be put into writing such as quality levels, delivery times Two basic types of contracts: Fixed-price – price does not change for life of contract Cost-based – price tied to cost of selected key input or economic factor Supplier selection & contracting © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

The Purchasing Process The Order Cycle Purchase order preparation Records maintenance Settlement and payment Receipt and inspection Follow-up and expediting Purchase order preparation 74% of firms currently have electronic data interchange (EDI) with some part of their supply base Follow-up and expediting Receipt and inspection Invoice clearance and payment Records maintenance © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Spend Analysis Answers the questions: What are the top 10 commodities by annual spend? (provides priority)* Which commodities have the most suppliers? (helps reduce purchasing load) Which commodities have the lowest spend per supplier? (if also among top 10, potential for savings) * Similar to ABC analysis to identify critical inventory items based on cost and quantity © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Typical Answer to First Question © 2008 Pearson Prentice Hall --- Introduction to Operations and Supply Chain Management, 2/e --- Bozarth and Handfield, ISBN: 0131791036

Case Study in Purchasing The ABCs of Spend Analysis