1. Purchasing

2. 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:

3. 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:

4. 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:

5. 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:

6. 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:

7. 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:

8. 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, $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:

9. 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:

10. 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:

11. 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:

12. 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:

13. 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:

14. 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:

15. 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:

16. 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:

17. 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:

18. 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:

19. 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:

20. 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:

21. 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:

22. 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:

23. 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:

24. 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:

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

26. Case Study in Purchasing
The ABCs of Spend Analysis