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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
M

human resource management

Support
activities

technology development

ar

gi

procurement
operations outbound marketing
logistics
& sales

service

M
a
r
gi

inbound
logistics

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

Buying for primary


activities

Buying for support


activities

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

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

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,
Operational,short
short
term,
deal
and
term, deal and
margin
margin
oriented
oriented

Strategic,
Strategic,long
long
term,
performance
term, performanceand
and
value
value
oriented
oriented

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

Definition of concepts
purchasing function
ordering/ operational

tactical / initial
Internal
customer

Specification

Expediting Follow
Selecting Contracting Ordering
and
up/
evaluation evaluation

Sourcing

Supply
Buying
Procurement

Supplier

Importance of purchasing to business

60-85

60-80

50-70

60-80

25-50

Retailers

Computers

Consumer Automotive
electronics

Pharma

10-40

Service
industry

5
12

Admin.

18

Capex

3
12

Spares

50

Services

Tradeitems

Produ
ction
parts

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

RONA
9.9 %

Sales
105 mio

Margin
4.7 %

145 mio
Interest free
liabilities
95 mio

Sales
105 mio
Income
before tax
5 mio

/
Sales
105 mio

Amounts in Euro mio

Net assets
50 mio

Total assets

Total costs
100 mio

Other costs
40 mio

+
Purchased
mat. & serv.
60 mio

DuPont analysis:
Capital turnover ratio
2.1 x

Sales
105 mio

Net assets

Total assets

50 mio

RONA

12.4 ---9.9 %

105 mio
Income
before tax
6.2 --5 mio

/
Sales
105 mio

Amounts in Euro mio

Interest free
liabilities
95 mio

Sales

+ 25 % !!
Margin
4.7 %
5.9 ---

145 mio

Total costs
98.8 ---100 mio

Other costs
40 mio

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