9/1/2015

Purchasing
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M&DCPurchasing&SupplyChain:MaterialManagement

Purchasing

IntroductiontoMaterialManagement

MasterScheduling

Contents

MaterialRequirementsPlanning
CapacityManagement

1.

Introduction

ProductionActivityControl

2.

EstablishingSpecifications

Purchasing

3.

FunctionalSpecificationDescription

4.

SelectingSuppliers

5.

PriceDetermination

6.

ImpactOfMaterialRequirementsPlanningOnPurchasing

7.

SomeOrganizationalImplicationsOfSupplyChainManagement.

Forecasting
InventoryFundamentals
OrderQuantities

IndependentDemandOrderingSystems
PhysicalInventoryandWarehouseManagement
PhysicalDistribution

1.Introduction
Purchasingistheprocessofbuying.Manyassumepurchasingissolelytheresponsibilityofthe
purchasingdepartment.However,thefunctionismuchbroaderand,ifitiscarriedouteffectively,all
departmentsinthecompanyareinvolved.Obtainingtherightmaterial,intherightquantities,withthe
rightdelivery(timeandplace),fromtherightsource,andattherightpriceareallpurchasingfunctions.
Choosingtherightmaterialrequiresinputfromthemarketing,engineering,manufacturing,and
purchasingdepartments.Quantitiesanddeliveryoffinishedgoodsareestablishedbytheneedsofthe
marketplace.However,manufacturingplanflingandcontrol(MPC)mustdecidewhentoorderwhich
rawmaterialssothatmarketplacedemandscanbesatisfied.Purchasingisthenresponsiblefor
placingtheordersandforensuringthatthegoodsarriveontime.
Thepurchasingdepartmenthasthemajorresponsibilityforlocatingsuitablesourcesofsupplyandfor
negotiatingprices.Inputfromotherdepartmentsisrequiredinfindingandevaluatingsourcesofsupply
andtohelpthepurchasingdepartmentinpricenegotiation.Purchasing.initsbroadsense,is
everyonesbusiness.

a.PurchasingandProfitLeverage
Ontheaverage,manufacturingfirmsspendabout50%oftheirsalesdollarinthe
purchaseofrawmaterials,components,andsupplies.Thisgivesthepurchasing
functiontremendouspotentialtoincreaseprofits.Asasimpleexample,supposeafirm
spends50%ofitsrevenueonpurchasedgoodsandshowsanetprofitbeforetaxesof
10%.Forevery$100ofsales,theyreceive$10ofprofitandspend$50onpurchases.
Otherexpensesare$40.Forthemoment,assumethatallcostsvarywithsales.
Thesefiguresareshowninthefollowingasasimplifiedincomestatement:
INCOMESTATEMENT
Sales$100
CostofGoodsSold
Purchases$50
OtherExpenses4090

ProfitBeforeTax$10
Toincreaseprofitsby$1,a10%increaseinprofits,salesmustbeincreasedto$110.
Purchasesandotherexpensesincreaseto$55and$44.Thefollowingmodified
incomestatementshowsthesefigures:
INCOMESTATEMENT(SAI~ES
INCREASE)
Sales
$110
CostofGoodsSold
Purchases$55
OtherExpenses44
99

ProfitBeforeTax
$11

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However,ifthefirmcanreducethecostofpurchasesfrom$50to$49,a2%
reduction,itwouldgainthesame10%increaseinprofits.Inthisparticularexample,a
2%reductioninpurchasecosthasthesameimpactonprofitasa10%increasein
sales.
INCOMESTATEMENT(REDUCED
PURCHASECOST)
Sales
$100
CostofGoodsSold
Purchases$49
OtherExpenses40
89

ProfitBeforeTax
$11

b.PurchasingObjectives
Purchasingisresponsibleforestablishingtheflowofmaterialsintothefirm,following
upwiththesupplier,andexpeditingdelivery.Misseddeliveriescancreatehavocfor
manufacturingandsales,butpurchasingcanreduceproblemsforbothareas,further
addingtotheprofit.
Theobjectivesofpurchasingcanbedividedintofourcategories:
Obtaininggoodsandservicesoftherequiredquantityandquality.
Obtaininggoodsandservicesatthelowestcost.
Ensuringthebestpossibleserviceandpromptdeliverybythesupplier.
Developingandmaintaininggoodsupplierrelationsanddevelopingpotential
suppliers.
Tosatisfytheseobjectives,somebasicfunctionsmustbeperformed:
Determiningpurchasingspecifications:rightquality,rightquantity,and
rightdelivery(timeandplace).
Selectingsupplier(rightsource).
Negotiatingtermsandconditionsofpurchase(rightprice).
Issuingandadministrationofpurchaseorders.

c.PurchasingCycle
Thepurchasingcycleconsistsofthefollowingsteps:

1.
2.

Receivingandanalyzingpurchaserequisitions.

3.

Determiningtherightprice.

4.

Issuingpurchaseorders.

5.

Followinguptoassuredeliverydatesaremet.

6.
7.

Receivingandacceptinggoods.

Selectingsuppliers.Findingpotentialsuppliers,issuingrequestsfor
quotations,receivingandanalyzingquotations,andselectingtheright
supplier.

Approvingsuppliersinvoiceforpayment.

Receivingandanalyzingpurchaserequisition.
Purchaserequisitionsstartwiththedepartmentorpersonwhowillbe
theultimateuser.Inthematerialrequirementsplanningenvironment,
theplannerreleasesaplannedorderauthorizingthepurchasing
departmenttogoaheadandprocessapurchaseorder.Ata
minimum,thepurchaserequisitioncontainsthefollowing
information:
Identityoforiginator,signedapproval,andaccounttowhich
costisassigned.
Materialspecification.
Quantityandunitofmeasure.
Requireddeliverydateandplace.
Anyothersupplementalinformationneeded.

Selectingsuppliers.
Identifyingandselectingsuppliersareimportantresponsibilitiesof

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thepurchasingdepartment.Forroutineitemsorthosethathavenot
beenpurchasedbefore,alistofapprovedsuppliersiskept.Ifthe
itemhasnotbeenpurchasedbeforeorthereisnoacceptable
supplieronfile,asearchmustbemade.Iftheorderisofsmall
valueorforstandarditems,asuppliercanprobablybefoundina
catalogue,tradejournal,ordirectory

Requestingquotations.
Formajoritems,itisusuallydesirabletoissuearequestfor
quotation.Thisisawritteninquirythatissenttoenoughsuppliersto
besurecompetitiveandreliablequotationsarereceived.Itisnota
salesorderAfterthesuppliershavecompletedandreturnedthe
quotationstothebuyer,thequotationsareanalyzedforprice,
compliancetospecification,termsandconditionsofsale,delivery,
andpaymentterms.Foritemswherespecificationscanbe
accuratelywritten,thechoiceisprobablymadeonprice,delivery,
andtermsofsale.Foritemswherespecificationscannotbe
accuratelywritten,theitemsquotedwillvary.Thequotationsmust
beevaluatedfortechnicalsuitability.Thefinalchoiceisa
compromisebetweentechnicalfactorsandprice.Usuallyboththe
issuingandpurchasingdepartmentsareinvolvedinthedecision.

Determiningtherightprice.
Thisistheresponsibilityofthepurchasingdepartmentandisclosely
tiedtotheselectionofsuppliers.Thepurchasingdepartmentisalso
responsibleforpricenegotiationandwilltrytoobtainthebestprice
fromthesupplier.Pricenegotiationwillbediscussedinalater
sectionofthechapter.

Issuingapurchaseorder.
Apurchaseorderisalegaloffertopurchase.Onceacceptedbythe
supplier,itbecomesalegalcontractfordeliveryofthegoods
accordingtothetermsandconditionsspecifiedinthepurchase
agreement.Thepurchaseorderispreparedfromthepurchase
requisitionorthequotationsandfromanyotheradditional
informationneeded.Acopyissenttothesuppliercopiesare
retainedbypurchasingandarealsosenttootherdepartmentssuch
asaccounting,theoriginatingdepartment,andreceiving.

Followingupanddelivery.
Thesupplierisresponsiblefordeliveringtheitemsorderedontime.
Thepurchasingdepartmentisresponsibleforensuringthatsuppliers
dodeliverontime.Ifthereisdoubtthatdeliverydatescanbemet,
purchasingmustfindoutintimetotakecorrectiveaction.This
mightinvolveexpeditingtransportation,alternatesourcesofsupply,
workingwiththesuppliertosolveitsproblems,orrescheduling
production.
Thepurchasingdepartmentisalsoresponsibleforworkingwiththe
supplieronanychangesindeliveryrequirements.Demandforitems
changeswithtime,anditmayhenecessarytoexpeditecertain
itemsorpushdeliverybackonsomeothers.Thebuyermustkeep
thesupplierinformedofthetruerequirementssothatthesupplieris
abletoprovidewhatiswantedandwhen.

Receivingandacceptinggoods.
Whenthegoodsarereceived,thereceivingdepartmentinspectsthe
goodstobesurethecorrectoneshavebeensent,areintheright
quantity,andhavenotbeendamagedintransit.Usingtheircopyof
thepurchaseorderandthebillofladingsuppliedbythecarrier,the
receivingdepartmentthenacceptsthegoodsandwritesupa
receivingreportnotinganyvariance.Iffurtherinspectionisrequired,
suchasbyqualitycontrol,thegoodsaresenttoqualitycontrolor
heldthereforinspection.Ifthegoodsarereceiveddamaged.the
receivingdepartmentwilladvisethepurchasingdepartmentandhold
thegoodsforfurtheraction.Providedthegoodsareinorderand
requirenofurtherinspection,theywillbesenttotheoriginating
departmentortoinventory.
Acopyofthereceivingreportisthensenttothepurchasing
departmentnotinganyvarianceordiscrepancyfromthepurchase
order.Iftheorderisconsideredcomplete,thereceivingdepartment
closesoutitscopyofthepurchaseorderandadvisesthe
purchasingdepartment.Ifitisnot,thepurchaseorderisheldopen
awaitingcompletion.Ifthegoodshavealsobeeninspectedbythe
qualitycontroldepartment,they,too,willadvisethepurchasing
departmentwhetherthegoodshavebeenacceptedornot.

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Approvingsuppliersinvoiceforpayment.
Whenthesuppliersinvoiceisreceived,therearethreepiecesof
informationthatshouldagree:thepurchaseorder,thereceiving
report,andtheinvoice.Theitemsandthequantitiesshouldbethe
sameonalltheprices,andextensionstoprices,shouldbethe
sameonthepurchaseorderandtheinvoice.Alldiscountsand
termsoftheoriginalpurchaseordermustbecheckedagainstthe
invoice.Itisthejobofthepurchasingdepartmenttoverifythese
andtoresolveanydifferences.Onceapproved,theinvoiceissent
toaccountspayableforpayment.

2.EstablishingSpecifications
Thefirstconcernofpurchasingwhattobuyisnotnecessarilyasimpledecision.Forexample,
someonedecidingtobuyacarshouldconsiderhowthecarwillbeused,howoften,howmuchoneis
willingtopay,andsoon.Onlythencananindividualspecifythetypeofcarneededtomakethebest
buy.Thissectionlooksattheproblemsthatorganizationsfacewhendevelopingspecificationsof
productsandthetypesofspecificationsthatmaybeused.
Inpurchasinganitemoraservicefromasupplier,severalfactorsareincludedinthepackagebought.
Thesemustbeconsideredwhenspecificationsarebeingdevelopedandcanbedividedintothree
broadcategories:
Quantityrequirements.
Pricerequirements.
Functionalrequirements.

a.QuantityRequirements
Marketdemandfirstdeterminesthequantitiesneeded.Thequantityisimportant
becauseitwillbeafactorinthewaytheproductisdesigned,specified,and
manufactured.Forexample,ifthedemandwasforonlyoneitem,itwouldbedesigned
tobemadeatleastcost,orasuitablestandarditemwouldbeselected.However,if
thedemandwereforseveralthousand,theitemwouldbedesignedtotakeadvantage
ofeconomiesofscale,thussatisfyingthefunctionalneedsatabetterprice

b.PriceRequirements
Thepricespecificationrepresentstheeconomicvaluethatthebuyerputsontheitem
theamounttheindividualiswillingtopay.Iftheitemistobesoldatalowprice,
themanufacturerwillnotwanttopayahighpriceforacomponentpart.The
economicvalueplacedontheitemmustrelatetotheuseoftheitemandits
anticipatedsellingprice.

c.FunctionalRequirements
Functionalspecificationsareconcernedwiththeenduseoftheitemandwhatthe
itemisexpectedtodo.Bytheirverynature,functionalspecificationsarethemost
importantofallcategoriesandgoverntheothers.
Inasense,functionalspecificationsarethemostdifficulttodefine.Tobe
successful,theymustsatisfytherealneedorpurposeofanitem.Inmanycases,
therealneedhasbothpracticalandaestheticelementstoit.Acoatismeanttokeep
onewarm,butunderwhatcircumstancesdoesitdosoandwhatotherfunctionsisit
expectedtoperform?Howcoldmustitgetbeforeoneneedsacoat?Onwhat
occasionswillitbeworn?Isitforworkingordresswear?Whatcolorandstyleshould
itbe?Whatemotionalneedsisitexpectedtofill?Inthesameway,wecanaskwhat
practicalandaestheticneedsadoorhandleorsideviewmirroronacarisexpected
tosatisfy.

d.Functionalspecificationsandquality.
Functionalspecificationsareintimatelytiedtothequalityofaproductorservice.
Everyoneknows,orthinksheorsheknows,whatqualityis,butthereareseveral
misconceptionsaboutwhatitisandwhatitisnot.Asksomeonewhatismeantby
quality,andyouwillgetrepliessuchas,Thebestthereis,Perfection,Degreeof
excellence,andVerygood.Allsoundgreatbutdonotmeanverymuch.
Therearemanydefinitionsofquality,buttheyallcenterontheideaofuser
satisfaction.Onthisbasis,itcanbesaidthatanitemhastherequiredqualityifit
satisfiestheneedsoftheuser.
Therearefourphasestoprovidingusersatisfaction:

1.

Qualityandproductplanning.

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2.

Qualityandproductdesign.

3.

Qualityandmanufacturing.

4.

Qualityanduse.
Productplanningisinvolvedwithdecisionsaboutwhichproductsandservicesa
companyistomarket.Itmustdecidethemarketsegmenttobeserved,theproduct
featuresandqualitylevelexpectedbythatmarket,theprice,andtheexpectedsales
volume.Thebasicqualitylevelisthusspecifiedbyseniormanagementaccordingto
theirunderstandingoftheneedsandwantsofthemarketplace.Thesuccessofthe
productdependsonhowwelltheydothis.
Theresultofthefirmsmarketstudiesisageneralspecificationoftheproduct
outliningtheexpectedperformance.appearance.price,andsalesvolumeofthe
product.Itisthenthejoboftheproductdesignertobuildintothedesignofthe
productthequalityleveldescribedinthegeneralspecification.Ifthisisnotproperly
done,theproductmaynotbesuccessfulinthemarketplace.
Formanufacturedproducts,itistheresponsibilityofmanufacturing,asaminimum,
tomeetthespecificationslaiddownbytheproductdesigner.Iftheitemisbought,it
ispurchasingresponsibilitytomakesurethesuppliercanprovidetherequiredquality
level.Forpurchasingandmanufacturing,qualitymeansconformingtospecifications
orrequirements.
Tothefinaluser,qualityisrelatedtohisorherexpectationofhowtheproductshould
perform.Customersdonotcarewhyaproductorserviceisdefective.Theyexpect
satisfaction.Iftheproductiswhatthecustomerwants,welldesigned,wellmade,and
wellserviced,thequalityissatisfactory.
Functionalspecificationsshoulddefinethequalitylevelneeded.Theyshould
describeallthosecharacteristicsofaproductdeterminedbyitsfinaluse.
Function,quantity,service,andpriceareinterrelated.Itisdifficulttospecifyone
withoutconsiderationoftheothers,indeed,thefinalspecificationisacompromiseof
themall,andthesuccessfulspecificationisthebestcombinationofthelot.
However,functionalspecificationsultimatelyaretheonesthatdrivetheothers.Ifthe
productdoesnotperformadequatelyfortheprice,itwillnotsell.

3.FunctionalSpecificationDescription
Onceauthorizationtoprocessanorderhasbeenreceived,productionactivitycontrolisresponsible
forplanningandpreparingitsreleasetotheshopfloor.Theordershouldbereviewedtobesurethat
thenecessarytooling,material,andcapacityareavailable.Iftheyarenot,theordercannotbe
completedandshouldnotbereleased.

1.

Bybrand,

2.

Byspecificationofphysicalandchemicalcharacteristics,materialandmethodofmanufacture,
andperformance.

3.

Byengineeringdrawings.

4.

Miscellaneous.

a.DescriptionbyBrand
Thepricespecificationrepresentstheeconomicvaluethatthebuyerputsontheitem
theamounttheindividualiswillingtopay.Iftheitemistobesoldatalowprice,
themanufacturerwillnotwanttopayahighpriceforacomponentpart.The
economicvalueplacedontheitemmustrelatetotheuseoftheitemandits
anticipatedsellingprice.
Itemsarepatented,ortheprocessissecret.
Thesupplierhasspecialexpertisethatthebuyerdoesnothave.
Thequantityboughtissosmallthatitisnotworththebuyersefforttodevelop
specifications.
Thesupplier,throughadvertisingordirectsaleseffort,hascreateda
preferenceontheDartofthebuyerscustomersorct~ff
Whenbuyingbybrand,thecustomerisrelyingonthereputationandintegrityofthe
supplier.Theassumptionisthatthesupplierwishestomaintainthebrands
reputationandwillmaintainandguaranteethequalityoftheproductsorepeat
purchaseswillgivethebuyerthesamesatisfaction.
Mostoftheobjectionstopurchasingbybrandcenteroncost.Brandeditems,asa
group,usuallyhavepricelevelsthatarehigherthannonbrandeditems.Itmaybe
lesscostlytodevelopspecificationsforgenericproductsthantorelyonbrands.The
othermajordisadvantagetospecifyingbybrandisthatitrestrictsthenumberof
potentialsuppliersandreducescompetition.Consequently,theusualpractice,when
specifyingbybrand,istoaskfortheitembybrandnameorequivalent.Intheory,
thisallowsforcompetition.

b.DescriptionbySpecification
Thereareseveralwaysofdescribingaproduct,buttheyusuallyincludeoneormore
ofthefollowing.Whatevermethodisused,descriptionbyspecificationdependson
thebuyerdescribingindetailexactlywhatiswanted:

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Physicalandchemicalcharacteristics.Thebuyermustdefinethephysical
andchemicalpropertiesofthematerialswanted.Petroleumproducts,
pharmaceuticals,andpaintsareoftenspecifiedinthisway.
Materialandmethodofmanufacture.Sometimesthemethodofmanufacture
determinestheperformanceanduseofaproduct.Forexample,hotandcold
rolledsteelsaremadedifferentlyandhavedifferentcharacteristics.
Pelfo?7nance.Thismethodisusedwherethebuyerisprimarilyconcerned
withwhattheitemisrequiredtodoandispreparedtohavethesupplierdecide
howperformanceistobeattained.Forexample,awaterpumpmightbe
specifiedashavingtodeliversomanygallonsperminute.Performance
specificationsarerelativelyeasytoprepareandtakeadvantageofthe
suppliersspecialknowledge.
Whateverthemethodofspecification,thereareseveralcharacteristicstodescription
byspecification:
Tobeuseful,specificationsmustbecarefullydesigned.iftheyaretooloosely
drawn,theymaynotprovideasatisfactoryproduct.Iftheyaretoodetailed
andelaborate,theyarecostlytodevelop,aredifficulttoinspect,andmay
discouragepossiblesuppliers.
Specificationsmustallowformultiplesourcesandforcompetitivebidding.
Ifperformancespecificationsareused,thebuyerisassuredthatiftheproduct
doesnotgivethedesiredresults,thesellerisresponsible.Theyprovidea
standardformeasuringandcheckingthematerialssupplied.
Notallitemslendthemselvestospecification.Forexample,itmaynotbe
easytospecifycolorschemesortheappearanceofanitem.
Anitemdescribedbyspecificationmaybenomoresuitable,andagreatdeal
moreexpensive,thanasuppliersstandardproduct.
Ifthespecificationsaresetbythebuyer,theymaybeexpensivetodevelop.
Theywillbeusedonlywherethereissufficientvolumeofpurchasesto
warrantthecostorwhereitisnotpossibletodescribewhatiswantedinany
otherway.

Sourcesofspecifications.
Therearetwomajorsourcesofspecifications:

1.

Buyerspecifications.

2.

Standardspecifications.

Buyerspecifications.
Buyerdevelopedspecificationsareusuallyexpensiveandtime
consumingtodevelop.Companiesusuallydonotusethismethod
unlessthereisnosuitablestandardspecificationavailableorunless
thevolumeofworkmakesiteconomicaltodoso.

Standardspecifications.
Standardspecificationshavebeendevelopedasaresultofmuch
studyandeffortbygovernmentalandnongovernmentalagencies.
Theyusuallyapplytoraworsemifinishedproducts,component
parts,orthecompositionofmaterial.Inmanycases,theyhave
becomedefactostandardsusedbyconsumersandbyindustry.
WhenwebuymotoroilforacarandaskforSAE10W30,weare
specifyingastandardgradeofmotoroilestablishedbytheSociety
ofAutomotiveEngineers.Mostoftheelectricalproductswebuyare
manufacturedtoUnderwritersLaboratory(UL)standards.Steeland
structuralsteelmembersaremanufacturedtostandardssetbythe
AmericanSocietyofMechanicalEngineers.
Thereareseveraladvantagestousingstandardspecifications.First,
theyarewidelyknownandacceptedand,becauseofthis,are
readilyavailablefrommostsuppliers.Second,becausetheyare
widelyaccepted,manufactured,andsold,theyarelowerinprice
thannonstandarditems.Finally,becausetheyhavebeendeveloped
withinputfromabroadrangeofproducersandusers,theyare
usuallyadaptabletotheneedsofmanypurchasers.
Marketgradesareatypeofstandardspecificationusuallysetbythe
governmentandusedforcommoditiesandfoodstuffs.Whenwebuy
eggs,webuythembymarketgradesmall,medium,orlarge.

c.EngineeringDrawings
Engineeringdrawingsdescribeindetailtheexactconfigurationofthepartsandthe
assembly.Theyalsogiveinformationonsuchthingsasfinishes,tolerances,and
materialtobeused.Thesedrawingsareamajormethodofspecifyingwhatiswanted
andarewidelyusedbecauseoftenthereisnootherwaytodescribetheconfiguration
ofpartsorthewaytheyaretofittogether.Theyareproducedbytheengineering
designdepartmentandareexpensivetoproduce,butgiveanexactdescriptionofthe

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partrequired.

d.Miscellaneous
Thereareavarietyofothermethodsofspecificationincludingthefamousphrase,
Gimmeonejustlikethelastone.Sometimessamplesareused,forexample,where
colorsorpatternsaretobespecified.Oftenavarietyofmethodscanbeused,and
thebuyermustselectthebestone.
Themethodofdescriptioniscommunicationwiththesupplier.Howwellitisdonewill
affectthesuccessofthepurchaseandsometimesthepricepaid.

4.SelectingSuppliers
Theobjectiveofpurchasingistogetalltherightthingstogether:quality,quantity,delivery,andprice.
Oncethedecisionismadeaboutwhattobuy,theselectionoftherightsupplieristhenextmost
importantpurchasingdecision.Agoodsupplierisonethathasthetechnologytomaketheproductto
therequiredquality,hasthecapacitytomakethequantitiesneeded,andcanrunthebusinesswell
enoughtomakeaprofitandstillsellaproductcompetitively.

a.Sourcing
Therearethreetypesofsourcing:sole,multiple,andsingle.

1.

Solesourcingimpliesthatonlyonesupplierisavailablebecauseofpatents,
technicalspecifications,rawmaterial,location,andsoforth.

2.

Multiplesourcingistheuseofmorethanonesupplierforanitem.Thepotential
advantagesofmultiplesourcingarethatcompetitionwillresultinlowerprice
andbetterserviceandthattherewillbeacontinuityofsupply.Inpracticethere
isatendencytowardanadversarialrelationshipbetweensupplierandcustomer.

3.

Singlesourcingisaplanneddecisionbytheorganizationtoselectonesupplier
foranitemwhenseveralsourcesareavailable.Itisintendedtoproducealong
termpartnership.Thisaspectisdiscussedatmorelengthinthesectionin
Chapter15onsupplierpartnerships.

b.FactorsinSelectingSuppliers
Theprevioussectiondiscussedtheimportanceoffunction,quantity,service,andprice
specifications.Thesearewhatthesupplierisexpectedtoprovideandarethebasisfor
selectionandevaluation.Consideringthis,thereareseveralfactorsinselectinga
supplier.

Technicalability.
Doesthesupplierhavethetechnicalabilitytomakeorsupplythe
productwanted?Doesthesupplierhaveaprogramofproduct
developmentandimprovement?Canthesupplierassistinimproving
theproducts?Thesequestionsareimportantsince,often,thebuyer
willdependuponthesuppliertoprovideproductimprovementsthat
willenhanceorreducethecostofthebuyersproducts.Sometimes
thesuppliercansuggestchangesinproductspecificationthatwill
improvetheproductandreducecost.

Manufacturingcapability.
Manufacturingmustbeabletomeetthespecificationsfortheproduct
consistentlywhileproducingasfewdefectsaspossible.Thismeans
thatthesuppliersmanufacturingfacilitiesmustbeabletosupplythe
qualityandquantityoftheproductswanted.Thesuppliermusthavea
goodqualitycontrolprogram,competentandcapablemanufacturing
personnel,andgoodmanufacturingplanningandcontrolsystemsto
ensuretimelydelivery.Theseareimportantinensuringthatthe
suppliercansupplythequalityandquantitywanted.

Reliability.
Inselectingasupplier,itisdesirabletopickonethatisreputable,
stable,andfinanciallystrong.Iftherelationshipistocontinue,there
mustbeanatmosphereofmutualtrustandassurancethatthe
supplierisfinanciallystrongenoughtostayinbusiness.

Aftersalesservice.
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Iftheproductisofatechnicalnatureorlikelytoneedreplacement
partsortechnicalsupport,thesuppliermusthaveagoodaftersales
service.Thisshouldincludeagoodserviceorganizationand
inventoryofserviceparts.

Supplierlocation.
Sometimesitisdesirablethatthesupplierbelocatednearthebuyer,
oratleastmaintainaninventorylocally.Acloselocationhelps
shortendeliverytimesandmeansemergencyshortagescanhe
deliveredquickly.

Otherconsiderations.
Sometimesotherfactorssuchascreditterms,reciprocalbusiness,
andwillingnessofthesuppliertoholdinventoryforthebuyershould
beconsidered.

Price.
Thesuppliershouldbeabletoprovidecompetitiveprices.Thisdoes
notnecessarilymeanthelowestprice.Itisonethatconsidersthe
abilityofthesuppliertoprovidethenecessarygoodsinthequantity
andqualitywanted,atthetimewanted,aswellasanyotherservices
needed.
Inamodernbusinessenvironment,thetypeofrelationshipbetween
thesupplierandthebuyeriscrucialtoboth.Ideally,therelationship
willbeongoingwithamutualdependency.Thesuppliercanrelyon
futurebusiness,andthebuyerwillhaveanassuredsupplyofquality
product,technicalsupport,andproductimprovement.
Communicationsbetweenbuyerandsuppliermustbeopenandfullso
bothpartiesunderstandtheproblemsoftheotherandcanwork
togethertosolveproblemstotheirmutualadvantage.Thus,supplier
selectionandsupplierrelationsareoftheutmostimportance.

c.IdentifyingSuppliers
Onemajorresponsibilityofthepurchasingdepartmentistocontinuetoresearchall
availablesourcesofsupply.Someaidsforidentifyingsourcesofsupplyfollow:
Salespersonsofthesuppliercompany.
Catalogues.
Trademagazines.
Tradedirectories.
Informationobtainedbythesalespeopleofthebuyerfirm.

d.FinalSelectionofSupplier
Somefactorsinevaluatingpotentialsuppliersarcquantitative,andadollarvaluecan
heputonthem.Priceistheobviousexample.Otherfactorsarequalitativeand
demandsomejudgmenttodeterminethem.Theseareusuallysetoutinadescriptive
fashion.Thesupplierstechnicalcompetencemightbeanexample.
Thechallengeisfindingsomemethodofcombiningthesetwomajorfactorsthatwill
enableabuyertopickthebestsupplier.Onemethodistherankingmethod,
describednext.

1.
2.

Selectthosefactorsthatmustbeconsideredinevaluatingpotentialsuppliers.

3.

Ratethesuppliersforeachfactor.Thisratingisnotassociatedwiththe
weight.Rather,suppliersareratedontheirabilitytomeettherequirementsof
eachfactor.Again,usuallyascaleofonetotenisused.

4.

Rankthesuppliers.Foreachsupplier,theweightofeachfactorismultiplied
bythesupplierratingforthatfactor.Forexample,ifafactorhadaweightof8
andasupplierwasrated3forthatfactor,therankingvalueforthatfactor
wouldhe24.Thesupplierrankingsarethenaddedtoproduceatotalranking.
Thesupplierscanthenbelistedbytotalrankingandthesupplierwiththe
highestrankingchosen.

Assignaweighttoeachfactor.Thisweightdeterminestheimportanceofthe
factorinrelationtotheotherfactors.Usuallyascaleofonetotenisused.If
onefactorisassignedaweightoffiveandanotherfactoraweightoften,the
secondfactorisconsideredtwiceasimportantasthefirst.

Figure7.1showsanexampleofthismethodofselectingsuppliers.Theoretically,
supplierB,withthebiggesttotalof223,willbeselected.
Therankingmethodisanattempttoquantifythosethingsthatarenotquantifiedby
nature.Itattemptstoputfiguresonsubjectivejudgment.Itisnotaperfectmethod.

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butitforcesthebuyingcompanytoconsidertherelativeimportanceofthevarious
factors.
Factor

Weight RatingofRankingof

Suppliers

10

10

80

100

60

60

Cost

10

24

40

72

80

Service

72

32

40

56

Technical

35

45

20

10

Credit
Terms

SuppliersSuppliers

Function

Assistance

12

16

219

223

204

222

Total(rankofsuppliers)

Figure7.1Supplierrating

5.PriceDetermination
Priceisnottheonlyfactorinmakingpurchasingdecisions.However,allotherthingsbeingequal,itis
themostimportant.Intheaveragemanufacturingcompany,purchasesaccountforabout50%ofthe
costofgoodssold,andanysavingsmadeinpurchasecosthasadirectinfluenceonprofits.
However,rememberthatyouonlygetwhatyoupayfor.Thetrickistoknowwhatyouwantandnot
paymorethannecessary.Whenapurchaseismade,thebuyerreceivesapackageoffunction,
quantity,service,andpricecharacteristicsthataresuitedtotheindividualsneeds.Theideaofbest
buyisthemixturethatservesthepurposebest.

a.BasisforPricing
Thetermfairpriceissometimesusedtodescribewhatshouldbepaidforanitem.
Butwhatisafairprice?Oneansweristhatitisthelowestpriceatwhichtheitem
canbebought.However,thereareotherconsiderations,especiallyforrepeat
purchaseswherethebuyerandsellerwanttoestablishagoodworkingrelationship.
Onedefinitionofafairpriceisonethatiscompetitive,givestheselleraprofit,and
allowsthebuyerultimatelytosellataprofit.Sellerswhochargetoolittletocover
theircostswillnotstayinbusiness.Tosurvive,theymayattempttocutcostsby
reducingqualityandservice.Intheend,boththebuyerandsellermustbesatisfied.
Sincewewanttopayafairpriceandnomore,itisgoodtodevelopsomebasisfor
establishingwhatisafairprice.
Priceshaveanupperandalowerlimit.Themarketdecidestheupperlimit.What
buyersarewillingtopayisbasedontheirperceptionofdemand,supply,andtheir
needs.Thesellersetsthelowerlimit.Itisdeterminedbythecostsofmanufacturing
andsellingtheproductandprofitexpectation.Ifbuyersaretoarriveatafairprice,
theymustdevelopanunderstandingofmarketdemandandsupply,competitive
prices,andthemethodsofarrivingatacost.
Onewidelyusedmethodofanalyzingcostsistobreakthemdownintofixedand
variablecosts.Fixedcostsarecostsincurrednomatterthevolumeofsales.
Examplesareequipmentdepreciation,taxes,insurance,andadministrative
overhead.Variablecostsarethosedirectlyassociatedwiththeamountproducedor
sold.Examplesaredirectlabor,directmaterial,andcommissionsofthesalesforce.

Totalcost=fixedcost+(variablecostperunit)
(numberofunits)

totalcost

Unit(average)cost=
.
numberofunits

fixed
cost
=
+variablecostperunit
numberof
units
Figure7.2showstherelationshipoffixedandvariablecoststosalesvolumeandhow
revenuewillbehave.Thesumofthefixedandvariablecostsislabeledtotalcoston
thegraph.ThethirdlinerepresentsthesalesrevenueWherethislineinterceptsthe
totalcostline,revenueequalstotalcost,andprofitiszero.Thisiscalledthebreak
evenpoint.Whenthevolumeislessthanthebreakevenpoint,alossisincurred
whenthevolumeisgreater,aprofitisrealized.Thebreakevenpointoccurswhere
therevenueequalsthetotalcost.
Revenue=totalcost
(Priceperunit)(numberofunits)fixedcost+(variablecostperunit)(numberofunits)

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b.ExampleProblem
Tomakeaparticularcomponentrequiresanoverhead(fixed)costof$5000anda
variableunitcostof$6.50perunit.Whatisthetotalcostandtheaveragecostof
producingalotof1000?Ifthesellingpriceis$15perunit,whatisthebreakeven
point?

Answer
Totalcost=$5000+($6.50x$1000)=$11,500
Averagecost=$11,5001000=$11.50perunit
Breakevenpoint:LetX=numberofunitssold
$15X=$5000+$6.5X
$8.50X=$5000
X=588.2units
Breakevenoccurswhen588.2unitsaremadeandsold.

c.PriceNegotiation
Pricescanbenegotiatedifthebuyerhastheknowledgeandtheclouttodoso.A
smallretailerprobablyhaslittleofthelatter,butalargebuyermayhavemuch.
Throughnegotiation,thebuyerandsellertrytoresolveconditionsofpurchasetothe
mutualbenefitofbothparties.Skillandcarefulplanningarerequiredforthe
negotiationtobesuccessful.Italsotakesagreatdealoftimeandeffort,sothe
potentialprofitmustjustifytheexpense.
Oneimportantfactorintheapproachtonegotiationisthetypeofproduct.Thereare
fourcategories:

1.

Commodities.Commoditiesarematerialssuchascopper,coal,wheat,meat,
andmetals.Priceissetbymarketsupplyanddemandandcanfluctuate
widely.Negotiationisconcernedwithcontractsforfutureprices.

2.

Standardproducts.Theseitemsareprovidedbymanysuppliers.Sincethe
itemsarestandardandthechoiceofsupplierslarge,pricesaredeterminedon
thebasisoflistedcatalogprices.Thereisnotmuchroomfornegotiation
exceptforlargepurchases.

3.

Itemsofsmallvalue.Theseareitemssuchasmaintenanceorcleaning
suppliesandrepresentpurchasesofsuchsmallvaluethatpricenegotiationis
oflittlepurpose.Theprimeobjectiveshouldbetokeepthecostofordering
low.Firmswillnegotiateacontractwithasupplierthatcansupplymanyitems
andsetupasimpleorderingsystemthatreducesthecostofordering.

4.

Madetoorderitems.Thiscategoryincludesitemsmadetospecificationoron
whichquotationsfromseveralsourcesarereceived.Thesecangenerallybe
negotiated.

6.ImpactOfMaterialRequirementsPlanningOnPurchasing
Thematerialinthischapterhasdescribedthetraditionalroleandresponsibilitiesofpurchasing.This
sectionwillstudytheeffectmaterialrequirementsplanning(MRP)hasonthepurchasingfunctionand
thechangingroleofpurchasing.
Purchasingcanbeseparatedintotwotypesofactivities:procurement,andsupplierschedulingand
followup.Muchofwhathasbeencoveredinthischapterisintheareaofprocurement.Procurement
includesthefunctionsofestablishingspecifications,selectingsuppliers,pricedetermination,and

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negotiation.Supplierschedulingandfollowupisconcernedwiththereleaseoforderstosuppliers,
workingwithsupplierstoscheduledelivery,andfollowup.Thegoalsofsupplierschedulingarethe
sameasthoseofproductionactivitycontrol:toexecutethemasterproductionscheduleandthe
materialrequirementsplan,ensuregooduseofresources,minimizeworkinprocessinventory,andto
maintainthedesiredlevelofcustomerservice.

a.Planner/buyerconcept.
Inatraditionalsystem,thematerialrequirementsplannerreleasesanordereitherto
productionactivitycontrolortopurchasingPurchasingissuespurchaseordersbased
onthematerialrequirementsplan.Productionactivitycontrolpreparesshoporders,
schedulescomponentsintotheworkflow,andcontrolsmaterialprogressthroughthe
plant.Whenplanschange,astheyinvariablydo,theproductionplannermustadvise
thebuyerofthechange,andthebuyermustadvisethesupplier.Theproduction
plannerisincloser,morecontinuingcontactwithMRPandtheirfrequentlychanging
schedulesthanisthebuyer.Toimprovetheeffectivenessoftheplanner/buyer
activity,manycompanieshavecombinedthetwofunctionsofbuyingandplanning.
Theplannersjobandthebuyersjobarecombinedintoasinglejobdonebyone
person.Planner/buyersdothematerialplanningfortheitemsundertheircontrol,
communicatetheschedulestotheirsuppliers,followup,resolveproblems,andwork
withotherplannersandthemasterschedulerwhendeliveryproblemsarise.The
planner/buyerhandlesfewercomponentsthaneitheraplannerorabuyer,buthasthe
responsibilitiesofboth.Theplanner/buyerisresponsiblefor:
Determiningmaterialrequirements.
Developingschedules.
Issuingshoporders.
Issuingmaterialreleasestosuppliers.
Establishingdeliverypriorities.
Controllingordersinthefactoryandtosuppliers.
Handlingalltheactivitiesassociatedwiththebuyingandproductionplanning
functions.
Maintainingclosecontactwithsupplierpersonnel.
Becausetheroleofproductionplanningandbuyingarecombined,thereisasmoother
flowofinformationandmaterialbetweenthesupplierandthefactory.The
planner/buyerhasakeenerknowledgeoffactoryneedsthanthebuyerdoesandcan
bettercoordinatethematerialflowwithsuppliers.Atthesametime,theplanner!buyer
isbetterabletomatchmaterialrequirementswithsuppliersmanufacturing
capabilitiesandconstraints.

b.Contractbuying.
Usuallyamaterialrequirementsplanningsystemgeneratesfrequentordersfor
relativelysmallquantities.Thisisparticularlytrueforcomponentsthatareorderedlot
forlot.Itiscostly,inefficient,andsometimesimpossibletoissueanewpurchase
orderforeveryweeklyrequirement.Thealternativeistodevelopalongtermcontract
withasupplierandtoauthorizereleasesagainstthecontract.Oftenthesupplieris
givenacopyofthematerialrequirementsplansotheyareawareoffuturedemands.
Thebuyerthenissuesareleaseagainsttheschedule.Thisapproachisefficientand
costeffectivebutrequiresclosecoordinationandcommunicationwiththesupplier.
Again,contractbuyingcanbemanagedverywellbyaplanner/buyer.

c.Supplierresponsivenessandreliability.
Becausematerialrequirementsoftenchange,suppliersmustbeabletoreactquickly
tochange.Theymustbehighlyflexibleandreliablesotheycanreactquicklyto
changesinschedule

Contractbuying
assuressuppliersagivenamountofbusinessandcommitsthemto
allocatingthatamountoftheircapacitytothecustomer.Suppliers
aremoreresponsivetocustomerneedsandcanreactquicklyto
changesinschedules.Becausecustomersknowthecapacitywill
beavailablewhenneeded,theycandelayorderinguntiltheyare
moresureoftheirrequirements.

Closerelationshipwithsuppliers.
Contractbuyingandtheneedforsupplierflexibilityandreliability
meanthebuyersupplierrelationshipmustbecloseandcooperative.
Theremustbeexcellenttwowaycommunication,cooperation,and
teamwork.Bothpartieshavetounderstandtheirownandtheothers
operationsandproblems.
Theplanner/buyerandthesuppliercounterpart(oftenthesuppliers

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productionplanner)mustworkonaweeklybasistoensureboth
partiesareawareofanychangesinmaterialrequirementsor
materialavailability.

Electronicdatainterchange(EDI).
Electronicdatainterchange(EDI)enablescustomersand
supplierstoelectronicallyexchangetransactioninformationsuchas
purchaseorders,invoices,andmaterialrequirementsplanning
information.Thiseliminatestimeconsumingpaperworkand
facilitateseasycommunicationbetweenplanner/buyersand
suppliers.

Vendormanagedinventory.
Inrecentyearstherehasbeenagrowthinthepurchasingapproach
knownasvendormanagedinventory.Inthisconcept,asupplier
maintainsaninventoryofcertainitemsinthecustomerfacility.The
supplierownstheinventoryuntilthecustomeractuallywithdrawsit
foruse,afterwhichthecustomerthenpaysforthatuse.The
customerdoesnothavetoorderanyoftheinventory,asthe
supplierisresponsibleformaintaininganadequatesupplyinthe
facilityforcustomeruse.Thisapproachismostcommonlyusedfor
lowervalueproductsthathavearelativelystandarddesign,suchas
fasteners,standardelectricalequipment,etc.

Internet.
Internettechnologyhasbecomethemostquicklyaccepted
communicationsmediumever.Therearethreevariationsof
networksused:Internet,intranet,andextranet.TheInternetismost
commonlyusedandisopentothegeneralpublic.Theintranetisan
internalnetthatisnormallyusedwithintheboundariesofa
company.Itmaystretchacrossmanymanufacturingsitesoreven
countries.Muchofthedatasharedinthisenvironmentisconsidered
sensitive,andthereforeaccessisusuallylimitedtopeoplewithin
thecompany.Extranetisanintranetsharedbytwoormore
companies.Eachparticipatingcompanymovescertaindataoutside
ofaprivateintranettotheextranet,makingitavailableonlytothe
companiessharingtheextranet.(Anexamplemightbeproviding
informationtoasupplier.)

7.SomeOrganizationalImplicationsOfSupplyChainManagement.
Organizationsthataltertheirperspectiveawayfromtraditionalpurchasingtowardsupplychain
managementmustrecognizethattheirperspectivetowardmanagingtheentireorganizationmustalso
change.Forinstance,mostorganizationsthathaveadoptedasupplychainperspectivefindthe
following:
Theircostfocushasaltereddramatically.Oftendecisionsarenotbasedonjustproductprice,
butinsteadontotalcostandvalue.Thisimpliesanintegratedviewofprice,quality,
serviceability,durability,andanyothercharacteristicthatthecompanyplacesontotalvalue.It
alsocanincludetransportation,storage,andmaterialhandlingcosts.Toaccomplishthis
changedperspective,organizationshaveadoptedtechniquesofprocessanalysis,valuestream
analysis,andmutual(betweenthecompanyandtheirsuppliers)valueanalysis.
DecisionmakinghaschangedfromtheIsayandyoudooranegotiatedperspectivewith
supplierstooneofLetstalkaboutthebestwaytohandlethisandmakeamutually
advantageousdecision.Thisalsoimpliesverylongsuppliercontracts.
Informationsharinghaschangedfromsimplygivingoutinformationabouttheordertothe
perspectiveofsharingsomeimportantinformationaboutthebusinessitself.
Measurementsystemslookatallaspectsofthesupplychainandnotjustsupplier
performance.
Thereisagrowthinelectronicbusiness(cbusiness).ThisimpliesusingtheInternetmorefor
handlingbusinessinformationflowsandtransactions.

a.SavingsCanBeSubstantial.
Therearemanyadvantagesassociatedwithaneffectivesupplychainperspective.
Someofthesesavingsinclude:
Moreeffectiveproductspecification,allowingforefficientproductsubstitutions
andproductspecificationsfocusedonfitnessofuse.
Betterleveragingofvolumediscountsandsupplierconsolidation.
Longtermcontractswithefficientcommunicationsystems,significantly
reducingtheadministrativecostoforderingandordertracking.

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Moreeffectiveuseoftechniquessuchaselectroniccommerce,usingcredit
cardsforpayments,andblanketordering.

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