Detailed Scheduling and Planning (Lesson 9)

Detailed Scheduling and Planning
Unit 2
UUnit
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DDetailed
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PPlanning
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Lesson 9
Procurement Plans and Supplier Relations
Unit 2
© 2004 e - SCP -The Centre for Excellence in Supply Chain Management
No portion of this publication may be reproduced in whole or in part.
The Leading Edge Group will not be responsible for any statements, beliefs, or opinions expressed by the
authors of this workbook. The views expressed are solely those of the authors and do not necessarily
reflect any endorsement by The Leading Edge Training Institute Limited.
This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA, CFPIM,
CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and Certification
Council for use as study material for the APICS CPIM certification examination.
The Leading Edge Training Institute Limited

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Ireland
© Copyright Leading Edge Training Institute Limited ii

Unit 2
Preface............................................................................................................4
Course Description................................................................................................................. 4
Lesson 9 – Procurement Plans and Supplier Relations ....................................5
Introduction and Objectives.................................................................................................. 5
Purchasing Decisions .............................................................................................................. 5
Evaluation............................................................................................................................. 12
Price Principles..................................................................................................................... 17
Contract Types ..................................................................................................................... 19
Order Placement Processes................................................................................................. 22
Procurement Process Control ............................................................................................. 23
Approval Systems ................................................................................................................. 23
Supplier Rating Systems ...................................................................................................... 24
Contract Management ......................................................................................................... 26
Ethical Issues ........................................................................................................................ 26
International Purchasing ..................................................................................................... 27
Summary ............................................................................................................................... 30
Further Reading ................................................................................................................... 30
Review ................................................................................................................................... 31
What’s Next? ........................................................................................................................ 32
Appendix.......................................................................................................33
Answers to Review Questions .............................................................................................. 34
Glossary ........................................................................................................37
© Copyright Leading Edge Training Institute Limited iii

Unit 2
Preface
Course Description
This document contains the final lesson in the Detailed Scheduling and Planning unit, which is
one of five units designed to prepare students to take the APICS CPIM examination. Before
completing the Detailed Scheduling and Planning unit, you should complete the Basics of
Supply Chain Management unit or gain equivalent knowledge. The five units that cover the
CPIM syllabus are:
Basics of Supply Chain Management
Master Planning of Resources
Execution and Control of Operations
Strategic Management of Resources
Please refer to the preface of Lesson 1 for further details about the support available to you
during this course of study.
This publication has been prepared by E-SCP under the guidance of Yvonne Delaney MBA,
CFPIM, CPIM. It has not been reviewed nor endorsed by APICS nor the APICS Curricula and
Certification Council for use as study material for the APICS CPIM certification examination.
© Copyright Leading Edge Training Institute Limited 4

Unit 2
Lesson 9 – Procurement Plans and Supplier Relations
Introduction and Objectives
In this lesson, the concepts, techniques, and data required for proper execution of procurement
plans are introduced. It looks at the processes and activities involved in purchasing and
managing suppliers according to the procurement plan and looks at issues arising from
international purchasing.
On completion of this lesson you will be able to:
List the purchasing decisions that must be made to execute the material pla n
Identify the necessary information and tools required to ensure efficient interaction
between companies
Identify various types of purchase obligations (such as verbal and contractual)
Explain pricing terms
Identify points for consideration when reviewing supplier prices
List the steps involved in order placement
Explain types of formal purchase documentation, contracts, and long-term agreements
List legal considerations pertaining to purchasing
Identify guidelines for controlling and maintaining ethical standards in procurement
processes
Identify the impacts of currency fluctuation, international transport, and countertrade on
purchasing processes
List the benefits of using supplier rating systems
Purchasing Decisions
Purchasing decisions are made to further the main objective of the purchasing department, which
is to ensure a reliable supply of quality materials and services at the lowest possible cost. In
every decision, consideration must be given to factors such as:
Make or buy Cost/value analysis
Compensation agreements Award criteria
Contractual obligations Placement of orders
Make or Buy
The decision to make or buy will be influenced by the following factors:
Cost Required level of design secrecy
Capacity Level of control over quality and processes
Time Sufficiency of supplier’s knowledge and capability
Required volumes Stability of the workforce

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Cost and Price
The costs of making the item must be compared against the cost of buying the item. The time
frame and available capacity must also be considered. Each element of cost must be included in
the analysis to ensure an accurate cost comparison. The elements include:
Make Buy
Capital costs Purchase price

Managerial costs Purchase management
Factory overheads Follow on costs
Follow-on costs Purchasing costs
Direct labor Receiving & inspection
Inventory carrying costs Transportation
Delivered material costs
Time
As the cost analysis needs to include direct and indirect costs, a long-term time range must be
used. Short term calculations focus on direct measurable costs and overlook indirect costs such
as materials, storage, purchasing and inspections.
Capacity
The use of existing capacity must be considered when analysing the cost of making a part.
Overhead costs relevant to make-buy decision making are the incremental costs that would not
be incurred if the part were purchased. These costs may vary.
For example, where a plant is operating at close to full capacity and expects to continue
production at the same rate, a decision to make a part that was previously purchased will
undoubtedly lead to a requirement for extra capacity, either through the purchase of extra
equipment or outsourcing some part of current manufacture. This adds the overheads associated
with production of this part to the total cost of the make decision along with the variable
overhead costs associated with the production of the part.
Where there is excess capacity, the variable overheads associated with the make decision are
considered, but not the fixed overhead costs as these would be incurred regardless of whether the
part was made or bought.
Where capacity levels are changing, it may be necessary to divide the time horizon into specific
periods and estimate costs for each period. Another approach would be to calculate a weighted
average cost over the entire horizon.
Quality / Production Control
If a high level of production or quality control is required, this will influence the make-buy
decision. When production downtime is very expensive, some companies may not be willing to
trust external suppliers with critical or unique components that require short lead times unless it
is possible to enter into a JIT arrangement with the supplier.

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Additionally, where the quality specification for a component is very exacting, companies may
prefer closer control of production and will tend to make rather than buy the component.
Design Confidentiality
In some instances, such as in very competitive industries, it is desirable to
keep the design of components under wraps in which case it makes more
sense to make the components in- house.
Reliability of Suppliers
Where reliability of delivery dates is important and the company has not sufficient confidence
that these dates can be met by potential suppliers it may be necessary to make the component
instead.
Technical Expertise
If the company requiring the component does not have the existing competencies required to
make it then it may be more sensible to find a supplier that does.
Volume
The quantities required will influence the make or buy decision. Where the part is already
manufactured by several suppliers and the company only requires small companies, it makes
sense to buy rather than make the part.
Stability of the Workforce
When the workforce is routinely expanded or contracted to respond to varying capacity needs it
is often difficult to retain motivated, experienced and trained staff. One method of increasing
workforce stability is to ensure the capacity is slightly below the overall required capacity and
make use of external suppliers when peak demands are higher than overall capacity.
When any of the influencing factors change,
such as changing costs and ownership,
decisions must be re-examined as they may no
longer be valid. Companies may prefer to keep
production levels up in a down-turning
environment. This will influence them to make
rather than buy certain components.
Conversely, they may decide to maintain only
core companies and buy in all other
requirements.
Cost and Value Analysis

There are three levels of evaluation that a company may enter into. The first is simply a price
analysis. More in-depth methods include cost analysis and total cost analysis. Each of these is
explained below.
Evaluation of price and value is employed to:
determine if a price is fair and reasonable.
ensure your company receives the best price.
assess whether reduction of price is possible.
The following methods may be used:
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Price Analysis Cost Analysis Total Cost Analysis
• Is an examination of seller’s • Requires more detail • Examines the supplier’s
prices, without eva luation of from the supplier than costs in great detail
cost elements, to ensure the price analysis
final price is reasonable
• Involves analysis of all
• Is the most straightforward • Examines original cost, direct and indirect costs
method overheads, and profit and overheads associated
• Involves direct comparisons margins with the product in the
between prices supply chain
• Can be used by the buyer
without input from other • Is the least commonly
departments • May be required in
used method
situations where price
• Applies to purchases of any evaluation reveals
value and quantity inconsistencies that
• Uses readily available data cannot be explained
Price analysis may not provide sufficient information to determine the reasonableness of the
price on offer. A more comprehensive route is total cost analysis. This evaluates all actual or
anticipated costs. The buyer should be able to compare all direct and indirect costs and profits for
each competing supplier. Cost analysis is most effective on non-standard items.
Cost analysis is required in the following situations:
Competition has not been obtained.
Competition has been obtained, but nonrecurring costs would significantly affect pricing
and subsequent negotiations.
Competition has been obtained, but cost analysis and initial negotiation will facilitate
related pricing actions, for example, engineering changes.
A valid basis for price comparison has not been established, because of a lack of definite
specifications.
Price comparisons reveal inconsistencies that cannot be explained.
Prices appear excessive on the basis of available information.
The proposed purchase represents a substantial percentage of the supplier’s total sales.
A Cost-Reimbursement, Incentive, or Time and Material contract is negotiated.
Sources of cost data
Cost data is available from the potential supplier. It can also be determined using cost modelling.
If a cost analysis is anticipated, the cost data can be requested from the supplier. Cost data can be
required as a precondition for submitting a bid. It is important to request such information before
beginning negotiations. Where cost data is either unavailable from the supplier or unreliable, the
buyer must develop a cost model to predict what the costs should be.

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Costs will vary between companies depending on the quality of the management, the workforce
and the plant. Plant capacity will also play a part. Well managed companies that use resources
efficiently will provide higher quality products at lower costs.
The three elements of cost to consider are direct costs, indirect costs and profit.
Direct Costs
These are the most important as they contribute most of the total cost. Direct costs include labor
and materials
Direct labor needs will peak and then decline as the item moves through various phases of
design, development and production. The supplier’s direct labor estimate should be analyzed to
ensure that it is reasonable and well planned. Geographical variations in wages will also
influence these costs.
Direct material is material that is incorporated into the final product. It is either purchased or
internally produced. Direct material costs should be examined for internal transfer charges and
mark-ups.
Indirect Costs
These include engineering and materials overheads in addition to general administrative,
manufacturing, sales, and marketing costs. Indirect costs may account for up to 40% of the total
cost. Such costs may include:
Supervision Support labor
Fringe benefits Indirect supplies
Shipping and handling Depreciation
Taxes
These overheads should be allocated to a specific operation based on the products stage in its
lifecycle. Generally an overhead rate will be established through collaboration of engineering
and accounting. The indirect costs that contribute to the overhead and the overhead rate should
be examined carefully by the buyer and regularly checked to ensure they are applied consistently
Total Cost of Ownership
The total cost of ownership is more important than just the price. Missed deliveries, downtime,
additional overtime costs, airfreight to customers must all be considered as part of total cost.
In total cost analysis, all cost elements of the supply chain are examined, for example:
New product release and maintenance
Customer order creation costs
Order entry and maintenance
Contract / Program management
Order fulfilment
Distribution costs
Customer accounting costs
Material acquisition costs

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Total inventory carrying costs
Logistics-related financing and Management Information Systems (MIS) costs
Manufacturing labor and inventory costs
Cost of rejects and return of rejected material
Post sales cost such as warranties, servicing, and field failures
The total cost of ownership should be established by tracking cost improvements, projected cost
improvements, quality levels and rate of rejects, on-time delivery performance, and production
and forecasting performance. These will help clarify expectations for potential suppliers.
Profit
The profit level for a company should be sufficient to keep them in business and encourage them
to accept further business of the same sort. A fair profit is best considered as a flexible figure that
rewards the more efficient producer. Cost structures vary among suppliers so that it is difficult to
determine the overall profit easily by using a one-size fits all formula.
Uncertainty of Cost
The degree of uncertainty associated with the costs of procurement should be reflected in the
type of compensation agreement established between buyer and supplier. This agreement should
detail the cost responsibilities of the supplier, the amount of supplier profit, and supplier
incentives.
1. When deciding whether to make or buy a component, a company must take

into account which of the following factors?
A. Relative costs of each option
B. Importance of design secrecy
Review Q
C. Gantt charts
D. Market conditions for finished product
Compensation
Compensation agreements are drawn up to deal with the potential risks involved. The cost risk
depends on the accuracy of the cost estimate. Where a company is confident in the accuracy of
the cost analysis the risk is reduced. There are three main categories of compensation agreement:
fixed price, incentives, and cost plus fixed fee.
Fixed Price
A fixed price contract is the most common type of compensation agreement, and generally the
most favourable to the buyer. The supplier delivers the product for a firm fixed price. It is the
supplier’s responsibility to cover all costs even if those prove higher than anticipated. However,
if the supplier manages to reduce costs, the profit for the supplier is increased.
Some contracts are fixed price with built in economic adjustments. These may take
contingencies such as changing labor conditions or market conditions into account. Adjustment

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clauses are included in the contract to cover increases or decreases in certain costs. These protect
both the supplier and buyer from changes in economic conditions. High value raw materials are
often dealt with in this way. Often, for such commodities the daily price is readily available in
daily publications. The contract will often contain a pricing formula linked to the published
market rates.
Fixed price redetermination contracts are another type of fixed price contract. These specify a
fixed price for a given period of time but build in a price review clause at a stated time. The
readjustment can be prospective, during the performance of the contract or retrospective. A
prospective adjustment would be used where a fair price can only be assessed for the initial
period. A retrospective adjustment would be used where a fair price could not be determined at
the beginning of the contract.
Incentives
In incentive agreements the cost responsibility is generally shared between buyer and supplier.
The supplier is motivated to improve performance in quality, delivery and customer service
through incentive arrangements.
A target cost is agreed between the buyer and supplier based on normal business conditions. It is
set at a point that both parties agree is fair, where they think that there is a fifty percent chance of
hitting either above or below the target. When the target cost is set, a target profit is set, one that
is considered fair and reasonable by both parties.
Next, the buyer and seller establish best and worst cost cases. These are used to evaluate the
potential cost increases or decreases where the supplier does not meet the target cost. These cost
increases or decreases are then shared between buyer and supplier. The final price paid by the
buyer will be the final cost plus or minus the supplier’s share of the cost savings or cost increase.
Another incentive arrangement often used is the cost plus incentive arrangement. This is used
when the cost risk requires a cost-type arrangement but where an incentive can be used to
motivate the supplier to control costs. When the supplier does well, the agreed cost is paid plus
the incentives. Where the best of worst case is realised, the supplier receives a cost plus fixed fee
payment.
Cost plus Fixed Fee
In a cost plus fixed fee arrangement the buyer agrees to reimburse the supplier for all allowable
costs and a fixed fee. The supplier will receive the fixed fee regardless of costs. Generally,
because the supplier assumes none of the cost risk, the profit is relatively low. This arrangement
pushes all the risk to the buyer and therefore should be avoided by buyers unless there is not
other arrangement available.
Supplier Selection Criteria

The supplier selection criteria should be identified in advance to ensure clear understanding of
what is critically important in the areas of:
Price and Pricing Strategies
Responsiveness
After-sales service
Innovation
Location

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Size
Financial strength
Product Offerings
Past performance
Balance of power in the buyer/supplier relationship
These criteria should be classified as order qualifiers and order winners. Order qualifiers are
characteristics that a supplier must possess in order to be considered for the contract. Order
winners are characteristics that will enable one supplier to win the contract over others.
Evaluation
Evaluation – Criteria
The issues indicated in the table below should be assessed and weighted in importance by the
relevant functional areas of your organization to help evaluate each supplier.
Evaluation - Issues to Consider by Key Areas
Issues to
Responsivenes
Financial and
Consider:
Capabilities
→ Capabilities
References
Technical
Tracking
Capacity
Location
Business
Delivery
Stability
Quality
Project
By
Price
Functional
Areas: ↓
s
Business √ √ √ √ √ √
Technical √ √ √ √ √ √ √
Quality √ √ √ √
Evaluation Criteria - Issues to Consider

Delivery
Consider the following:
• Past Delivery Performance
• Quick Response Capability 100 % On
• Process Flexibility
Time
• Statusing Capabilities
• Risk Management
• Lead Time Early On-Time Late
Price
• Best Value Justification Price ($)
• Value Analysis
• Joint Cost Reduction
• History of No Surprises
Time
Quality

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• Total Quality Management / Continuous
Improvement Quality
• Near Zero Defects Improvement
Innovation
• Quality Assurance Guarantees Innovation
• Evidence of Corrective and Preventive Action Innovation
• Organizational Responsibility Time
• High MTBF, Uptime, Field Reliability
Capacity
• Current v. Forecast 150%
• Preventive Maintenance 100% Planned

• Capital Equipment Investment
• Tracking and Statusing
• Delivery and Responsiveness Current
• Extent of Expediting
Responsiveness
• Philosophy Toward Customer Satisfaction
• Management Commitment
• Technical Support
• Ability to Respond to Sudden Surge in
Demand
Timeliness
• Philosophy Toward Customer Satisfaction
• Management Commitment
• Technical Support
• Ability to Respond to Sudden Surge in Demand
Project Tracking Capabilities

• Reporting and Corrective Action
• Program Management Support
Location
• Service-capable Sites
• Breadth of technical assistance available
• Technical talent available
• Statusing Process
• Potential to expand
• Global presence, local execution
Technical Capabilities
• Leader / follower in technology advances
• Track record for bringing on new technologies / products

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• Quality management in R&D
• Technical and product strategy
• Intellectual depth
References
References play a critical role in the decision to do business with a supplier. If a supplier is
delivering late or poor quality to others customers, you can expect similar problems. Ask for a
list of all similar customers over the last six to twelve months.
References can be received from:
• Other customers
• Suppliers
• Competitors
It is important that all decisions are recorded to assist the final communication with all suppliers,
and also to provide insight into various suppliers for review at a alter stage, should an
opportunity arise.
Based on the specific criteria agreed by the sourcing review group, the replies from the suppliers
should be evaluated into the following categories:
Go / No Go
Where there is a very clear understanding of the supplier’s capabilities, the supplier can be rated
a Go if they fulfill all requirements. Those suppliers that do not fulfill all requirements may fall
into one of the following categories or are designated No Go.
Almost There
The supplier has most components desired and meets key technical requirements.
Might be Able to Meet Criteria

The company has the basic components and exhibits a great interest in the business opportunity.
The following example shows the application of Go/NoGo criteria in the evaluation of 5
potential suppliers.
BCN Alpha Static Percival Cyclops
Yes No Yes No Yes No Yes No Yes No

ISO 9000 certified 1 1 1 1 1
Has the ability to double output over 1 1 1 1 1
the coming 24 months
Fully operational ERP system in 1 1 1 1 1
place for more than 12 months
70% of Senior management team 1 1 1 1 1
with at least 10 years managerial
experience
5 years supporting & demonstrating 1 1 1 1 1
international logistics capability
5 0 5 0 3 2 5 0 2 3
GO? GO GO NO GO NO

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Once this initial screening has been completed, more detailed evalua tion, perhaps using Kepner
Tregoe methods may be employed.
Kepner Tregoe analysis is a method used in making objective decisions. It involves:

• Establishing the evaluation criteria
• Dividing criteria into ‘Musts’ and ‘Wants’
• Weighting the ‘Want’ criteria, giving most points to the most critical criteria
• Scoring potential suppliers on these criteria
Must / Wants - Decide whether the criteria are absolutely necessary (‘Must’) or
desirable (‘Want’).
Weighting - Assign each ‘Want’ criteria with a weight factor. The higher the
weight the more critical the criteria.
Analysis - Score each potential supplier against the essential and weighted
criteria. Then, multiply the scores by their relative weights and
total the results to identify the best suppliers.
The following table provides an example of Kepner Tregoe analysis.

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Kepner Tregoe Analysis Example
Mandatory (Must) Criteria Supplier: PEL ACCURATE BRAWO CERRO CMC ISVAL MIDWEST
1 Supplier "must" agree to supply parts that conform to the Yes Yes Yes Yes Yes Yes Yes
print/specification
2 Supplier "must" agree to support JIT - either through Kanban or Yes Yes Yes Yes Yes Yes Yes
consignment
3 Supplier "must" agree to a cost reduction plan that will yield a 5% Yes Yes Yes Yes No Yes No
reduction in total cost each year.
Weight Raw Cumm Raw Cumm Raw Cumm Raw Cumm Raw Cumm Raw Cumm Raw Cumm
Desired (Want) Criteria Factor Score Score Score Score Score Score Score Score Score Score Score Score Score Score
1 Acceptance of Siebe payment terms 10 8 80 10 100 10 8 7 7 5
2 Ability to support PPAP requirements 10 7 70 8 80 10 8 3 8 3
3 Secondary capabilities (machining, deburring, platting) 9 5 45 8 9 7 3 7 3
Etc…
4 Multiple facilities and/or expansion capacity to support 9 4 36 5 8 9 1 6 1
multiple SIEBE business units
5 Capable of quick response (i.e. quick die changes, number 8 5 40 5 8 6 3 5 2
of presses, customer base)
6 QS 9000 Certified / ISO Certified 8 6 48 7 8 7 3 7 1
7 In-House tool shop for mold production and/or die repairs 8 5 40 8 9 10 2 7 1
8 Demonstrated "lean manufacturing" techniques and/or Six 8 3 24 4 7 4 0 4 0

Sigma qualified
9 Evidence of a strong engineering department/technical 8 5 40 6 8 6 2 6 1
support team
10 Tooling lead times (comparable with competitors/industry) 7 8 56 8 8 8 6 8 5
11 Proven factory and workforce stability 7 8 56 7 9 7 9 9 7

Total Points 535
Figure 1 Example of Kepner Tregoe Analysis

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2. Which type of pricing is least favorable to the buyer?
A. Incentives
B. Fixed Fee
Review Q C. Cost plus fixed fee

D. Fixed Fee with adjustment clauses
Price Principles
The right price should be fair and reasonable to both supplier and buyer. To determine a fair and
reasonable price, the buyer must consider economic conditions, perform price analysis and
evaluate opportunities for discounts.
Economic Considerations
The setting of prices is ruled by the level of competition. Where a monopoly exists and only one
supplier can deliver the buyer is dependent on that supplier and the supplier has complete
freedom to set the price. Where competition is extremely stiff, it is likely that all possible cost
savings have already been implemented and prices are as low as possible. In either case, there is
little the buyer can do to modify the price. However, most situations exist somewhere in the
middle where there is some price flexibility.
Most companies sell a line of products and establish prices that will ensure an overall profit for
the entire line. The average profit margin is used by the seller to price orders. IF the buyer knows
which products are high margin and which are low margin, he can determine whether the price is
too high.
Product differentiation is another factor in pricing. The differences between products can
sometimes appear greater than they are in fact as a result of marketing hype. Buyers should be
able to see the through the hype and objectively weigh each product on its merits.
Price is equal to cost plus profit. Before analyzing the reasonableness of a price, the buyer must
understand the effects of the following cost elements:
Variable costs: these vary with production quantity and generally include labor and
material costs
Fixed costs: these cover building rent, the cost of equipment and depreciation and other
costs that are incurred whether or not the company manufactures product or not
Semi variable costs: these many include maintenance and postage
Total costs: this is the sum of variable, semi variable and fixed costs. Total cost increases
as volumes increase although the cost per unit will drop
Direct costs: these are directly attributed to a production operation and are not variable
Indirect costs or overheads: these cannot be attributed to a specific production activity.
They may be fixed or variable. Examples of indirect costs include utility bills and office
equipment.

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Price Analysis
Price analysis is an examination of the seller’s price in comparison with price benchmarks. It
does not involve an examination of the cost and profit elements that contribute to that price.
Price analysis can be performed using competitive proposals, historical price data or market
prices. When performing a price analysis the purchaser must:
be familiar with market conditions and published information such as supplier price lists,
trade journals, and government publications.
compare bids.
compare price versus quantity relationships.
compare pricing of similar products.
5 Steps for Establishing Comparability
Step Considerations
1. Select items or prices for Is this comparison valid?

comparison Are better comparisons available?
2. Identify product and Are the items or services compared the same?
price-related differences Are there discrepancies in terms and conditions that affect price?
How do the environments shaping the respective prices differ?
3. Determine the precise How do the noted differences affect prices? (Recall earlier
effects of the differences discussion concerning variations in quantity)
How substantial might the differences be?
4. Select and apply method Can resources such as the producer price index be used to
for adjustment establish comparability?
Must more sophisticated manipulative techniques be applied?
5. Make comparison Have all price-related differences been accounted for? Has a
common basis for comparison been developed
If not, to what extent is the comparison still valid?
Should it be discounted?
Discounts
Quantity, trade, seasonal and cash discounts help to reduce prices.
Trade discounts are price reductions from list price that are given to a distributor to
compensate for performing some of the marketing functions of the seller. These are
usually a series of individual discounts applied to various stages in the distribution chain.
To maximise the discount, the buyer must ensure they get to a distributor as close as
possible to the manufacturer.

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Quantity discounts apply to large orders, either in terms of quantity or dollar value.
These are based on the reduction in cost per unit to be gained from longer production
runs. High dollar repetitive purchases should incorporate quantity discounts where
possible.
Seasonal discounts are based on the seasonal nature of goods and services. The buyer
may get reduced prices out of season.
Cash discounts may be offered for prompt payment. For example, it is often possible to
pay a reduced price for a car if paying in cash rather than in instalments.
Contract Types
The types of obligations and purchasing agreements that companies enter into vary from simple
verbal commitments to long-term formalized contracts.
Verbal Commitments
In the United States, verbal contracts are considered just as binding as written contracts for
values of less than $500. When verbal contracts are later confirmed in writing they are
considered binding.
Purchasing Credit Cards

Corporate credit cards can be used to simplify the purchasing process by reducing the need for
purchase orders, thereby reducing cycle time and workload. The buyer must make arrangements
with suppliers to accept the company credit card. The card is then issued to selected operating
personnel with a spending limit.
One disadvantage of such an approach is the loss of control from the purchasing department. A
company may be exposed to petty fraud and unauthorized suppliers. The number of authorized
suppliers should be limited and the dollar limit on each card should be at an appropriate level for
the purchases for which it is to be used.
Purchase Orders
Purchase orders are the most common type of purchase
agreement. A purchase order acts as a legal contract and must
state clearly all relevant product requirements and information
such as the buying firm, the PO identification, internal
information such as the charge code or name of the buyer,
supplier details, account number, shipping information, billing
address, item identification and description, quantities, prices and
due dates.
Blanket Orders
A blanket order is a long term commitment to a supplier to purchase a quantity of material over a
period of time. These are used to minimize problems associated with frequent small orders. The
amount of the blanket order is determined through analysis of past purchases. The buyer selects
an appropriate supplier, negotiates a rate and then issues a blanket order that contains a
description of the items and unit prices along with estimated usage over the period of the blanket

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order. It also contains provisions for the delivery of material upon receipt of a release form from
the company.
Blanket orders are useful because:
They require fewer purchase orders, thereby reducing administration
They permit volume pricing
They improve the visibility and flow of information
They often lead to reduced lead times and inventories
They help develop long-term stability in supplier relationships
Contracts
A contract should comprise four elements in order to be enforceable:
An agreement that has resulted from an offer and acceptance of that offer
Mutual obligations
Competent parties, each over the age of majority, mentally competent and not under
influence of alcohol or drugs
A purpose that is lawful and does not restrain trade or violate price discrimination laws.
The type of contract that is chosen will depend on the level of shared risk and the degree of
commitment between the customer and the supplier. Where there are clear specifications and the
cost risk is low, firm fixed price contracts may be used. Where this is not the case, contracts
based on costs are chosen. Incentive type contracts fall somewhere between the two extremes.
A contract is an agreement between two parties, either verbal or written. As it is easier to verify a
written contract, this will carry more weight in law.
Annual or Multi-Year Agreements

Long term contracts extending over three years are useful in that they reduce the amount of time
required to investigate suppliers. This reduces administration and consequently costs. As a more
stable agreement, a multiyear agreement can provide advantages on both sides. The supplier will
be encouraged to increase investment in research, tooling and training. This in turn can lead to
lower costs. The buyer has a reliable agreement in place and does not have to spend time
continually researching potential suppliers.
Definite Delivery Contracts

Definite delivery contracts are used when the production schedules
over the period of the contract are known. Definite quantities and
associated delivery dates can be specified with a low risk of
change in such cases.
Indefinite Delivery Contracts

In most cases it is not possible to plan production precisely over
the entire period of the contract. In this case the material and
services in support of production should be contracted on an
indefinite delivery schedule. This may be a definite quantity

Unit 2
contract, a requirements contract or an indefinite quantity contract.
Definite Quantity Contracts
This contract type specifies the quantities of material and states that the delivery instructions will
be provided at a later date.
Requirements Contracts
In this type of contract the entire requirements of the buyer over a particular period of time will
be covered. Generally there will be a minimum quantity of material. Neither party will be able to
terminate the agreements as long as the supplier exhibits satisfactory performance and the buyers
requirements continue to exist.
Indefinite Quantity Contracts
Indefinite quantity contracts provide for the delivery of a specific category of material over an
agreed period of time. The buyer commits to purchase quantities that fall within a certain range
but actual quantities and due dates are not specified in the contract.
Legal Issues and Contract Law

The activities of a purchasing department are governed by the law of agency and
the law of contracts. The law of agency governs a purchasing manager acting as an
agent for a firm. When the purchasing department buys materials or services from
another company both parties are entering into contracts that are governable by
contract law.
3. Which of the following statements about price analysis are accurate?

A. It requires familiarity with market conditions
B. It examines price in comparison with benchmarks without consideration of
cost or profit contributions.
Review Q
C. It examines cost and profit breakdown of supplier price against various
benchmark figures
D. It involves comparisons between a wide variety of products

Unit 2
Order Placement Processes
The order placement process begins usually with a requisition form. This is used to generate a
request for proposals. Various suppliers may submit proposals which are then evaluated by the
company. When a suitable supplier has been selected a purchase order is generated and sent to
the supplier. The supplier acknowledges this purchase order and fulfils it. The purchasing
company then verifies receipt of the material ordered. The supplier then invoices and the buyer
approves and pays the invoice. This process is illustrated below.
Requisition Generation Generation of

Evaluation of
of material of RFP Supplier Bids Purchase order
Verification
Reconciliation Approval of of receipt of Fulfillment of
invoice goods purchase order
Purchase Requisition
When a need for a product or service is identified, through the MRP system, a purchase plan, or
an operating department, a purchase requisition is prepared. This is an internal document that
describes the items and quantities to be purchased. A copy of this is sent to the purchasing
department.
Request for Proposal (RFP)

The buyer prepares a Request for proposal (RFP) or request for quote(RFQ). This is a document
that will detail requirements to potential suppliers. The document is sent to appropriate potential
suppliers that have been chosen either from an approved suppliers list or by the efforts of a cross-
functional strategic sourcing team.
Evaluation of Quotations
The potential suppliers return bids or quotes to the buyer and these are compared and contrasted
using predefined techniques and methods such as price analysis, technical evaluation, total cost
analysis and Kepner Tregoe comparisons using pre-defined criteria.
Purchase Orders
When the successful supplier has been selected a purchase order (PO) is prepared to identify the
buyer’s requirements. This becomes a legal contract between the supplier and the buyer.
Acknowledgement
The PO is a legal offer to buy but the purchasing contract is not complete until the supplier
accepts the offer either by simply fulfilling the requirements of the PO or by acknowledging
acceptance of the contract through some form of written notification. The purchasing department
should then focus efforts on follow-up to ensure the supplier is executing the contract as
required.

Unit 2
Material Receipt Inspection
When the goods are received the material received is compared against the purchase order to
verify the correct materials and quantities are there. Subsequently the material is inspected for
quality and condition.
JIT Purchasing
In JIT environments, the purchasing process follows the Pareto principle by paying attention to
the few most significant items. The items of most value to the company should be the target of
the greatest purchasing effort. Finding and evaluating suppliers for JIT purchasing programs is a
time-consuming and costly activity. It can bring great benefits such as lower inventories and
shorter cycle times, lower costs and improved profitability on both sides. JIT purchasing requires
the company to:
Create a specific plan to reduce the number of suppliers
Create conditions where extensive long-term contracts and partnerships with valued
suppliers are set up.
Buyers will need to maintain tighter schedules and higher quality as well as improving
performance and problem solving skills in a JIT environment.
Approving and Paying Invoices

The purchasing department must approve invoices and authorize payment either through manual
or electronic signatures. The invoices are then handled by accounting and any discrepancies
found must be communicated between accounting and purchasing in order to reconcile
differences.
4. When it is not possible to plan production precisely over the entire period of
the contract which of the following contract types is most suitable?
A. Definite delivery contract
B. Definite quantity contract
Review Q
C. Requirements contract
D. Indefinite quantity contract
Procurement Process Control

Control and appraisal of processes should address both problem detection and problem
prevention. Establishing policies and procedures to control the pur chasing process are prevention
techniques. Monitoring that process will help detect any unforeseen problems.
Approval Systems
Purchases should always be approved. Generally the dollar value of the purchase will dictate the
level of approval required. For example, it may be possible to authorize supervisors to approve
purchases of low value operating materials up to a certain value. Purchases of a greater value
may require department head approval or possibly approval from company directors or vice
presidents. Some companies for example, require that all information technology (IT)-related

Unit 2
purchases are approved by the IT department even though that department may not be
responsible for the initial requisition.
Supplier Rating Systems

A rating system to monitor performance and provide timely feedback to suppliers is important
for safeguarding the smooth running of the supplier –customer relationship. Several factors must
be considered when establishing such a system. These are described in the following paragraphs.
Quantitative Methods of Supplier Evaluation

A supplier evaluation system should ensure that the supplier is meeting the needs of the buyer. It
should also contribute to the continuing improvement of the processes and systems in place
between supplier and buyer and create a better understanding of the process and its position in
the supply chain.
Various metrics can be used to evaluate supplier performance, depending on company
requirements. For example, the rate of on-time delivery, the level of process capability, the
percentage of product conforming to specifications, the level of inventory turnover, all may be
used as measures of supplier success. Where possible, measures used should be based on
quantifiable data rather than on subjective judgeme nts. The main aim of such an evaluation
program is to contribute eventually to the improvement of customer service. This ultimate aim
should be borne in mind during the development and implementation of the evaluation process.
Ideally the performance measures used will provide sufficient data to help identify potential and
actual problems in sufficient time to enable corrective actions to be taken before the customer is
affected.
Balanced Scorecard
Many companies use a ‘balanced scorecard’ approach which
combines measurements on financial performance, operating
performance, sales and marketing performance, technical
performance, and performance in other strategic business areas
identified by the company. The balanced scorecard begins by
defining key objectives in each business area, then devising
strategies to meet those objectives and finally linking each
objective with appropriate performance measures. This approach
filters through each level in the company, with each business unit
formulating its own objectives, strategies and measures in line
with the overall business objectives and strategy.
Performance Measurement Standards

Effective measurement of performance depends on the selection of appropriate metrics. These
should promote continuous improvement in the areas they are intended to measure. Additionally,
the performance measurement effort should focus on the most critical areas, such as those
suggested by Mel Pilachowski in Purchasing Performance Measurements (1996, PT Publications
Inc.):
Certification – the supplier earns points for the level of certification

Unit 2
Product quality – ensuring the meeting of customer specifications with zero defects.
This can be measured through monitoring the defect rate, the tolerance, conformance to
specification, and appearance for example.
Delivery performance – This can be measured by looking at the ratio of on time
deliveries compared to late deliveries. Additionally, it can be useful to monitor lead times
Cost performance – This should be measured in terms of return cots, pricing, freight
cost and other costs.
Cooperation – this is a more subjective judgement than objective measurement of
partnership relations. However, a typical measurement might be supplier response time
Quantity – the number or percentage of products delivered to order and or the number of
variations from requirements should be monitored.
Buyer Performance Standards

It is important to measure not only the supplier’s performance but also the company’s own
performance as a buyer. The company is responsible for ensuring that orders of sufficient
quantities are made on time to facilitate production and product flow. This can be measured in
the following ways:
Buyers’ service level – measured by recording the number of stockouts against potential
total sales.
Purchasing workload
Number of documents per year per buyer
Planned number of buyers
Product flow
Input ration: the number of requisitions received compared to the number of orders
placed
Year to date expense variance
The failure to meet customer service levels can lie with the buyer or supplier depending on the
originating problem. Take for example the case where a shipment arrives from a supplier 3 days
after it was required, leading to delays in fulfilling customer orders. This would appear on the
surface to be a problem with late delivery on the part of the supplier. However, by investigating
further it may be found that the order was placed only one week previously and the expected lead
time for the item is 12 days. In such a case the supplier has actually exceeded performance
expectations by reducing the lead time by 2 days. The fault for the late delivery lies with the
purchasing department as they did not place the order in time.
5. What is an RFP?
A. an internal document that describes the items and quantities to be purchased
B. a document that will detail requirements to potential suppliers
Review Q C. a method of systematically comparing the relative strengths and weaknesses

of various suppliers
D. a legal contract to buy material when accepted by the supplier

Unit 2
Contract Management
While the supplier is responsible for satisfactory contract performance, the buyer can not rely on
the supplier alone to ensure that work is progressing on schedule. When the buyer determines
that an active progress monitoring system is necessary to ensure timely delivery the proposed
delivery schedule must be reviewed. Gantt charts and PERT charts are project management tools
used to track performance in such situations. These provide graphical representation of
performance and can be easily evaluated.
GANTT Charts
Gantt charts list each element of a project along with the duration of the task represented by a
horizontal bar. The tasks are listed vertically. The horizontal axis of the chart is the timeline.
Each project activity is entered on the time line sequentially. This shows at a glance which tasks
should be performed in which sequence. Actual performance can be plotted against planned
performance although it is not possible to highlight mission critical activities. However, the
overall critical path to completion can be highlighted.
Critical Path Method (CPM) and Program Evaluation Review (PERT)

The critical path method and program evaluation and review technique (PERT) both look at the
relationships between individual tasks, identifying which tasks are dependent on other tasks. The
probability of a task slipping is also included in the analysis. The result is presented as a network
diagram.
Ethical Issues
The National Association of Purchasing Management (NAPM) in the United States addresses the
ethical standards for purchasing professionals in its Principles and Standards documentation.
Each of the principles is summarized below:
Ethical Perceptions : avoid the intent and appearance of unethical or compromising
practice in relationships, actions and communications. For example, avoid price fixing.
Responsibility toward Employer: Diligently follow the lawful instructions of the
employer using reasonable care and only the authority with which you have been granted.
For example do not split a single order into two or more orders if you have not the
authority to do so.
Conflict of Interest: Refrain from any private business or professional activity that
would create a conflict between personal interests and the interests of the employer
Gratuities: Do not solicit or accept money, loans, credit, prejudicial discounts, gifts,
entertainment or other favors from suppliers that might appear to influence purchasing
decisions.
Confidentiality: Handle all confidential information belonging to employers or suppliers
with due care and proper consideration of ethical and legal consequences
Treatment of Suppliers : Promote positive supplier relationships through courtesy and
impartiality in all phases of the purchasing cycle.
Reciprocity: Avoid reciprocal agreements that have the effect of limiting competition

Unit 2
Federal and State laws : know and obey the letter and spirit of the law regarding
purchasing functions, and be aware of the legal ramifications of purchasing decisions
Small businesses: Encourage all segments of society to participate by demonstrating
support for small disadvantaged and minority-owned businesses. Observe contractual
requirements for total content related to these types of businesses especially government
and military contracts.
Personal Purchases for Employees: Discourage purchasing involvement in employee-
sponsored programs of personal purchases that are not business related. Observe
company policy regarding purchases of computers, printers, and other items for personal
use.
Responsibilities to the Profession: Enhance the proficiency and stature of the
purchasing profession by acquiring and maintaining current technical knowledge and the
highest standards of ethical behaviour. Maintain a program of ongoing professional
development.
International purchasing : Obey the laws, customs and practices of foreign countries in
so far as they are consistent with your country’s laws, your organizations’ policies and
the ethical standards and guidelines.
International Purchasing
In today’s global economy it is increasingly likely that buyers will be dealing with suppliers and
customers in other countries. However, many international companies are making efforts to
manufacture and source locally in order to support the manufacturing efforts in other countries.
The advantages of local sourcing include reduced transportation costs, reduced lead times for
raw materials, and the avoidance of tariffs imposed on international trading. Normally
international procurement would be a strategic sourcing strategy due to the risk factors for
currency fluctuations.
The purchase process for global sourcing is complex. Like the standard process, the first step is
the identification of need and the development of an RFP. After that, it is important to locate a
customs broker. Bid evaluation, selection of the supplier, and the securing of a line of credit must
be completed before a purchase order can be generated. After that the supplier notifies the buyer
of the planned shipment, confirms the mode of delivery and ships the goods. The goods are
subjected to customs inspection at the port of entry to ensure the proper duties, tariffs or taxes
have been addressed and paid. Then the shipment is released for domestic delivery. The
company mus t then verify receipt and approve the invoice for payment. The payment process
will involve a currency exchange. This takes place at the point where the invoice is paid unless it
was fixed in advance.
In the diagram below, the green boxes indicate the extra steps required for international
procurement.

Unit 2
Employ a Secure a line
customs broker of credit
Requisition Generation Evaluation of Generation of

Verification
Perform Cover tarrifs

currency and duties to
exchange clear customs
Possible Pitfalls
Currency fluctuations can increase costs when a PO is issued at one currency rate but the invoice
is paid at another rate. A company can protect itself against such fluctuations by locking in to an
exchange rate in advance. Exchange insurance specifies a given current-day exchange rate for a
future transaction.
International procurement requires additional steps, time, risk and cost. Intermediaries who are
proficient in expediting the import process should be contracted to handle the complexities of
international trade and assist in avoiding potential problems.
International Shipping Documentation

The shipping documentation to accompany goods in international transit must include:
Bill of lading Packing list Customs invoice
Certificate of origin Invoice Arrival notice
Customer entries Insurance certificate Dock receipt
Inspection certificate Delivery order
Freight release Carriers certificate and release order
Trade Cost Issues

Before considering international sourcing it is important to take into account the following
elements:
Transportation and bonded carriers (what are bonded carriers?)
Customs duties, tariffs, and taxes
Insurance and broker costs
Currency fluctuations and exchange valuation management
Communications and language barriers
Inventory holding costs at intermediate points
Fees for documentation, inspection, ports, consolidation and brokerage

Unit 2
Banking costs and line of credit fees.
Credit
Many international suppliers will request that a buyer obtain a letter of credit from their bank
during negotiations. This letter promises to pay a specified amount of money. While not a
method of payment it is an extension of credit from the bank rather like a loan. This transfers the
risk of payment to the bank. Letters of credit may be:
Irrevocable (they cannot be cancelled or changed without the consent of the supplier)
Confirmed (the bank confirms the letter of credit assumes the risk)
Revolving (as the balance owed is paid the amount available to borrow increases. Non-
revolving letters are valid for one transaction only)
Currency Fluctuation and Forward Buying

Buyers should try to use currency fluctuations to their advantage by observing trends and using
forward buying techniques, suc h as hedging to minimize the risks associated with currency
fluctuation. For example, a company may decide to make an agreement with a supplier in
another country when the economy in that country is generally quiet, exchange rates are
favourable and demand for the product is low. They will then reap the benefits if the exchange
rate becomes less favourable later on.
Hedging protects against short term risk through forward buying techniques. The buyer enters
into contracts to sell dollars for foreign currency at a time the supplier is paid. Hedging involves
risk arising from the inaccuracy of forecasts, where unexpected price variation can occur. If a
company underforecasts purchases, some parts must be purchased without a hedging offset.
Countertrade
Countertrade refers to a transaction in which payment is made either in whole or in part with
goods rather than money: a type of barter arrangement. Countertrade links two unrelated
transactions. It may be imposed by foreign governments to preserve foreign exchange.

Unit 2
Summary
This lesson introduced the concepts, techniques, and data required for proper execution of
procurement plans. It examined the processes and activities involved in purchasing and
managing suppliers according to the procurement plan as well as issues arising from
international purchasing.
You should be able to:
List the purchasing decisions that must be made to execute the material plan
Identify the necessary information and tools required to ensure efficient interaction
between companies
Identify various types of purchase obligations (such as verbal and contractual)
Explain pricing terms
Identify points for consideration when reviewing supplier prices
List the steps involved in order placement
Explain types of formal purchase documentation, contracts, and long-term agreements
List legal considerations pertaining to purchasing
Identify guidelines for controlling and maintaining ethical standards in procurement
processes
Identify the impacts of currency fluctuation, international transport, and countertrade on
purchasing processes
List the benefits of using supplier rating systems
Further Reading
Introduction to Materials Management,
JR Tony Arnold, CFPIM, CIRM and Stephen Chapman CFPIM
5th edition, 2004, Prentice Hall
APICS Dictionary
10th edition, 2002
Manufacturing Planning and Control Systems,

Vollmann, T.E.; W.L. Berry; and D.C. Whybark
5th edition, 2004, McGraw-Hill
Production & Inventory Management,

Fogarty, Donald W. CFPIM; Blackstone, John H. JR. CFPIM; and
Hoffmann, Thomas R. CFPIM
2nd edition, 1991, South-Western Publishing Co., Cincinnati, Ohio

Unit 2
Review
The following questions are designed to test your recall of the material covered in
lesson 9. The answers are available in the appendix of this workbook.
6. Which of the following are required in international trade rather than domestic trade ?
A. Reconcile invoices
B. A letter of credit
C. An RFP or RFQ
D. A customs broker
7. Which of the following performance measurement tools can be used to determine the
likelihood that an order will fall behind schedule?
A. Balanced scorecard
B. Supplier certification
C. Gantt chart
D. PERT
8. Which of the following are ethical trade guidelines?

A. Pursue reciprocal agreements that have the effect of limiting competition
B. Diligently follow the lawful instructions of the employer using reasonable care and only
the authority with which you have been granted.
C. Refrain from any private business or professional activity that would create a conflict
between personal interests and the interests of the employer
D. Encourage purchasing involvement in employee-sponsored programs of personal
purchases.
9. Which forecasting technique uses the following formula:

New forecast = old forecast + ? (old forecast – actual demand)?
A. Weighted moving average
B. Seasonal index
C. Exponential smoothing
D. Focus forecasting

Unit 2
What’s Next?
This lesson looked at guidelines and principles for developing and maintaining successful
relationships with suppliers.
You should review your work using the questions in the next section and then revise your
knowledge of the Detailed Scheduling and Planning unit. Before progressing to the final APICS
module, Strategic Management of Resources, you should ensure that you have completed the
following modules:
Master Planning of Resources
Execution and Control of Operations

Unit 2
Appendix

Unit 2
Answers to Review Questions
1. A and B
When deciding whether to make or buy a component, the company should consider the total cost
of each approach and the required volumes. The company should check if making the item is
feasible by examining available capacity, potential quality issues, the time and expertise
required, and the stability of the workforce. When considering outsourcing the item, the
technical capability of the supplier, the trustworthiness of the supplier with regard to design
secrecy, available capacity and workforce stability will all be influencing factors.
Market conditions for the finished product will have little influence on the decision to make or
buy a component of that product. Gantt charts are a useful way of comparing two sets of
information but are not a requirement in this decision making process.
2. C
In a cost plus fixed fee arrangement, the buyer assumes all the risk of rising costs. The supplier
receives a fixed fee regardless of cost, although the profit margin may be relatively low given
that the supplier’s exposure to risk is low. On top of the fixed fee, the buyer agrees to pay the
costs. This type of agreement should be avoided by buyers where possible. The opposite is a
fixed fee arrangement where the supplier agrees to a fixed price for the contract without any
reference to changes in cost. The supplier is therefore taking the risk that costs may rise and
erode profits. An incentive arrangement shares cost increases or decreases fairly between
supplier and buyer. A fixed fee with adjustment clauses allows for changes to be made to the
fixed fee given specified changes in other factors influencing cost. These adjustment clauses are
agreed in advance between supplier and buyer.
3. A and B
Price analysis is an examination of the seller’s price in comparison with price benchmarks. It
does not involve an examination of the cost and profit elements that contribute to that price.
Price analysis can be performed using competitive proposals, historical price data or market
prices. When performing a price analysis the purchaser must be familiar with market conditions
and published information such as supplier price lists, trade journals, and government
publications. Comparisons between bids, between price and quality and between similar products
must be completed.
4. D
In most cases it is not possible to plan production precisely over the entire period of the contract.
In this case the material and services in support of production should be contracted on an
indefinite delivery schedule. This may be a definite quantity contract, a requirements contract or
an indefinite quantity contract.
Definite Quantity Contracts specify the quantities of material and states that the delivery
instructions will be provided at a later date.
Definite delivery contracts are used when the production schedules over the period of the
contract are known. Definite quantities and associated delivery dates can be specified with a low
risk of change in such cases.
With a requirements contract the entire requirements of the buyer over a particular period of time
will be covered. Generally there will be a minimum quantity of material. Neither party will be

Unit 2
able to terminate the agreements as long as the supplier exhibits satisfactory performance and the
buyers requirements continue to exist.
Indefinite quantity contracts provide for the delivery of a specific category of material over an
agreed period of time. The buyer commits to purchase quantities that fall within a certain range
but actual quantities and due dates are not specified in the contract.
5. B
The buyer prepares a Request for proposal (RFP) or request for quote(RFQ). This is a document
that will detail requirements to potential suppliers. The document is sent to appropriate potential
suppliers that have been chosen either from an approved suppliers list or by the efforts of a cross-
functional strategic sourcing team.
6. B and D
When trading internationally there are several extra steps to be carried out in comparison to
domestic trading. These are illustrated in the flowchart below. (International trade steps are in
green, those common to both are in blue).
Employ a Secure a line

customs broker of credit
Requisition Generation Evaluation of Generation of

Verification
Perform Cover tarrifs

currency and duties to
exchange clear customs
7. D
Many companies use a ‘balanced scorecard’ approach which combines measurements on
financial performance, operating performance, sales and marketing performance, technical
performance, and performance in other strategic business areas identified by the company. The
balanced scorecard begins by defining key objectives in each business area, then devising
strategies to meet those objectives and finally linking each objective with appropriate
performance measures.
Supplier certification is used to confirm that suppliers meet buyer criteria.
Gantt charts list each element of a project along with the duration of the task represented by a
horizontal bar. The tasks are listed vertically. The horizontal axis of the chart is the timeline.
Each project activity is entered on the time line sequentially. This shows at a glance which tasks
should be performed in which sequence. Actual performance can be plotted against planned
performance although it is not possible to highlight mission critical activities. However, the
overall critical path to completion can be highlighted.

Unit 2
The critical path method and program evaluation and review technique (PERT) both look at the
relationships between individual tasks, identifying which tasks are dependent on other tasks. The
probability of a task slipping is also included in the analysis. The result is presented as a network
diagram.
8. B and C
Companies should never seek to limit competition. The purchasing department should not
become involved in employee purchase schemes for materials not related to their work.

Unit 2
Glossary
Term Definition
Backward This is a technique for calculating the start dates and due dates of an
scheduling operation. The due date for the order is the starting point. The planner works
back in time to determine the necessary start and due dates for each operation
in the order
Balanced A list of financial and operational measures used to evaluate organizational

scorecard performance. There may be several perspectives on the scorecard, for
example, business processes, customer service, and finance.
bill of material A listing of all the subassemblies, intermediates, parts, and raw materials
(BOM) needed for a parent assembly, showing the required quantity of each. It is
used with the MPS to determine items that must be ordered. Also called
formula or recipe.
Blanket order A long term commitment to a supplier for material against which several
material releases will be issued in order to meet customer requirements.
Bottleneck A resource that cannot cope with the level of demand placed upon it. Such
resources can hold up entire production processes, with queues building up
before them. Effective management involves identifying and ameliorating
issues that cause bottlenecks
Capacity The capability of a system to perform its expected function. This could be the
capability of an operator, machine, work center, plant or organization to
produce output per time period. Available and required capacity must be
measured to assist in planning.
Capacity This is the process of determining the amount of capacity needed to produce
planning the required quantities of product in the future. Resource planning, rough-cut
capacity planning, and detailed capacity planning are performed at different
levels of the planning structure.
Capacity The planning activity that determines the capacity requirements for each
Requirements work center with regard to the material plan. Open shop orders and planned
Planning (CRP) orders from MRP are the main inputs to CRP along with part routings and
time standards. These inputs are converted into hours of work by work center
for each time period in MRP. CRP may highlight insufficient capacity during
some periods.
Capacity- A scheduling principle that increases work- in-process to ensure flexibility in

oriented utilization of capacity. When used appropriately it leads to reduced total cost
materials when taking into account work in process, capacity, and finished goods
management inventory

Unit 2
(Corma)
Cartel A group of companies that agree to cooperate rather than compete in

producing the same product, thereby limiting external competition
Central point A scheduling method that starts at a critical point in production and uses both
scheduling backward and forward scheduling to work backward and forward from that
critical point
Certified A supplier who consistently meets the quality, cost, delivery, and count
supplier objectives of its customer
Consortium A group of companies working together to produce a product
Constraint A factor that prevents the achievement of a targeted level of performance,

such as machine center capacity, lack of raw material, inefficient policy etc.
Constraint- This finite- loading technique is used to plan orders around bottleneck work
oriented finite centers, aiming to maximize total throughput. Small orders are aggregated
loading into one larger lot size and loaded at the constraining work center. Operations
are then backward and forward scheduled as required
Continuous line A production system involving a plant layout that closely follows the
production production process for a product. Material flow is continuous during
production, routings are fixed and setups are rarely changed.
Contract An agreement between two or more companies or people, either oral or

written, to perform or not perform a specified act. A purchase order, once
accepted by a supplier in writing or through performance, is a contract.
Cost analysis A review of actual or anticipated cost values.
Cost plus fixed A pricing method where the seller is paid a fixed fee in addition to acceptable
fee costs for a product or service (up to a maximum).
Countertrade A transaction in which payment is made with goods rather than money. This
is often used in international trade where the alternative is to deal in rapidly
fluctuating currency exchanges
Critical path A project planning technique that determines project completion time based
method (CPM) on the identification of the critical path, which includes the elements that
constrain the total project time
Current ratio Current assets divided by current liabilities
Customer The ability of a company to meet customer needs. The term is also used to
service refer to the measurement of product delivery to a customer within required
time constraints
Delphi method A qualitative forecasting technique where the opinions of experts are
combined in a series of iterations. The results of each iteration are used to

Unit 2
develop the next, so that convergence of the experts’ opinion is achieved.
Demonstrated A level of capacity that is calculated from historical performance data and
capacity therefore proven to be achievable.
Dependent Demand that is directly related to or derived from the bill of material
demand structure for another item or end product. Dependent demand should be
calculated rather than forecast. Some items may have both dependent and
independent demand at the same time.
Distributed A time-phased order point approach that uses MRP logic to determine
requirements warehouse requirements. This approach is useful in multilevel distribution
planning (DRP) networks.
Earliest due A priority rule used in sequencing of queued orders depending on their
date(EDD) operation or order due dates.
Efficiency A measure of actual output compared to standard output.
Exceptions Items that deviate from plan
exponent ial A weighted moving average forecasting technique in which past records are
smoothing geometrically discounted according to their age with the heaviest weight
assigned to most recent data. A smoothing constant is applied to avoid using
excessive historical data.
Extrinsic A forecast based on a correlated leading indicator, for example, estimating

forecast furniture sales based on house builds. Extrinsic forecasts are more useful for
large aggregations like total company sales.
Finite loading A method of loading work centers that ensures the available capacity of the
work station is not exceeded.
Fixed price The seller is paid a set price for services or product without reference to the
cost of producing them
Flow production Uninterrupted flow of material through the production process. May also be
called mass production or continuous manufacturing. The plant layout
usually facilitates the flow of the product through the plant.
Forward buying The practice of buying materials that exceed current requirements but will
eventually be used
Forward A scheduling technique that involves progressing from a known start date
scheduling and determining the completion date for an order.
Incentive A financial or other type of reward for above standard performance. This is
used as a motivation to exceed expectations
Independent Demand for an item that is unrelated to the demand for other items.

Unit 2
demand Examples include finished goods and service part requirements.
Infinite loading Calculation of capacity needed at work centers regardless of the maximum
capacity of the work centers in question
Interoperation The elapsed time between completion of one operation and the beginning of
time the next
intrinsic forecast A forecast based on internal factors, such as an average of past sales.
Inventory The number of times an inventory turns over in a year. It is determined by

turnover dividing the annual cost of sales by the average inventory level.
Job shop A manufacturing environment that produces items to customer specification.

Usually a wide range of product designs are possible and are performed at
fixed locations using general equipment
Joint venture An agreement between companies in the pursuit of a joint business objective
to which each company contributes capital and other resources.
Kieretsu A form of cooperation between companies where they remain separate legal
entities but work closely together in many ways, for example sharing
purchasing and financial processes and setups.
Latest start date The last day upon which a given activity may be started without jeopardizing
the project completion date.
Lead time Lead time is the span of time required to perform a process.
Limited A partnership that comprises partners who contribute assets but are no t
partnership involved in company management and general partners who manage the
company and are responsible for all debts.
Liquidity ratio A financial ratio that highlights a company’s ability to fulfill short term
financial obligations
logistics The art of obtaining, producing, and distributing material in the quantities
and places required.
Management A system, either manual or computerized, that provides a database of

information organized information to a variety of management functions
systems (MIS)
Manufacturing The type of manufacturing strategy currently implemented in a plant. For

environment example, a plant may be laid out according to functional area and covering
several small projects. It is often used to refer to whether a company is make-
to-stock, make-to-order or assemble-to-order
Master The anticipated build schedule for those items assigned to the master

Unit 2
production scheduler. The master scheduler maintains this schedule and it drives
schedule (MPS) material requirements planning. It specifies configurations, quantities and
dates for production.
Multisourcing The procurement of an item from more than one supplier so that risks are
limited and a company is not dependent on any one supplier
Partnership A form of business that is owned by two or more people. It can also refer to a
supply chain relationship based on trust and shared risk to gain competitive
advantage
Program A network analysis technique provides a standard deviation of the estimated

evaluation and project duration, by assigning 3 durations to each activity: pessimistic, most
review technique likely, and optimistic. The critical path method is then applied with a
(PERT)PERT weighted average of the times for each activity.
price analysis The evaluation of a seller’s price proposal in comparison with price
benchmarks. This does not involve examination of the elements of cost and
profit that make up the price.
Profitability The amount of income less expenditure over a given time period
Quick asset ratio This measures cash, securities and accounts receivable against current
liabilities
Request for A document that is sent to suppliers to solicit responses when the functional
proposal (RFP) requirements and features are known to the buyer but there is no specific
product in mind
Resource Capacity planning at business levels, resource planning is the process of

planning establishing, measuring and adjusting long-range capacity. It is based on the
production plan but may be driven by higher level strategic plans beyond the
time frame of the production plan. Resource planning concerns itself with
planning for resources that take a long time to acquire, for example, the
necessity for a new production facility or a new strategic partner.
Rough-cut The process of converting the master production schedule into requirements
capacity for potential bottleneck resources such as labor, machines, warehouse space,
planning and supplier capabilities. These requirements are compared against available
(RCCP) capacity. This helps ensure a feasible master production schedule.
Scheduled An open order with an assigned due date.

receipts
Seasonality A repetitive pattern of demand from year to year or month to month (or other
time period) showing much higher demand in some periods than in others.
Setup time The amount of time between the production of the last item of one run and
the first usable item in another production run for a different product

Unit 2
Single sourcing The opposite of multisourcing, only one supplier is cultivated for the supply
of a particular item. This is the approach often used in JIT manufacturing
Strategic alliance A relationship between two or more companies that involves the sharing of
information, the participation in joint investments and development of linked
processes to mutual benefit. Strategic alliances can lead to better supply
chain performance
Theoretical The maximum output capability for a workstation without considering

capacity maintenance or other down times.
Theory of A management philosophy that incorporates logistics, performance

constraints measurement, and logical thinking
Throughput The total amount of production that flows through a production facility. In
the theory of constraints, throughput is the rate at which the company
generates money through sales. Throughput and output are not the same.
Time to market The total time elapsed between a customer placing an order and receiving the
(TTM) product
trend General upward or downward movement of a variable over time, for example
in product demand.
Utilization A measure of how intensively a resource is used, calculated by comparing

available time to actual time
Vendor A seller of an item in the marketplace
Vendor-owned Also known as consigned stock, such inventory is held at a customer location
inventory (VOI) but remains the property of the manufacturer until it is used.
Work order An order to the machine shop for tool manufacture or equipment
maintenance or an authorization to start work on an activity or product.

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Detailed Scheduling and Planning

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Capital costs Purchase price

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Cost and Value Analysis

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1. When deciding whether to make or buy a component, a company must take

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Supplier Selection Criteria

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Evaluation Criteria - Issues to Consider

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• Preventive Maintenance 100% Planned

Project Tracking Capabilities

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Might be Able to Meet Criteria

BCN Alpha Static Percival Cyclops

Yes No Yes No Yes No Yes No Yes No

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Kepner Tregoe analysis is a method used in making objective decisions. It involves:

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8 Demonstrated "lean manufacturing" techniques and/or Six 8 3 24 4 7 4 0 4 0

11 Proven factory and workforce stability 7 8 56 7 9 7 9 9 7

Figure 1 Example of Kepner Tregoe Analysis

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Review Q C. Cost plus fixed fee

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5 Steps for Establishing Comparability

1. Select items or prices for Is this comparison valid?

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Purchasing Credit Cards

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Annual or Multi-Year Agreements

Definite Delivery Contracts

Indefinite Delivery Contracts

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Legal Issues and Contract Law

3. Which of the following statements about price analysis are accurate?

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Requisition Generation Generation of

Request for Proposal (RFP)

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Approving and Paying Invoices

Procurement Process Control

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Supplier Rating Systems

Quantitative Methods of Supplier Evaluation

Performance Measurement Standards

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Buyer Performance Standards

Review Q C. a method of systematically comparing the relative strengths and weaknesses

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Critical Path Method (CPM) and Program Evaluation Review (PERT)

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Requisition Generation Evaluation of Generation of

Perform Cover tarrifs

International Shipping Documentation

Trade Cost Issues

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Currency Fluctuation and Forward Buying

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