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Introduction to Materials Management

Chapter 7 Purchasing
Purchasing
Click to edit Master title style

the process of buying

Purchasing function requires input from:


Marketing
Engineering
Manufacturing
Manufacturing Planning and Control
what materials to order
when to order them
to acquire the right material, in right quantity and quality,
at the right time
Purchasing
Click to editand Profittitle
Master Leverage
style

Manufacturing firms spend about average 50% of


sales dollars on purchasing of
raw materials
components
supplies

Hence, there is tremendous potential to increase


profits through improved purchasing decisions
How to Improve Profit Through
Click to edit Master title style
Purchasing?

Income Statement

Sales $100
Cost of Goods Sold
Purchases $50
Other expenses 40 90
Profit Before Tax $ 10

assume a profit before tax of 10%


Income
Click to Statement (sales
edit Master titleincrease)
style

Sales $110
Cost of Goods Sold
Purchases $55
Other expenses 44 99
Profit Before Tax $ 11

to increase profits by $1 (10%); sales must


increase by 10%
Income
ClickStatement (reduced
to edit Master purchase
title style cost)

Sales $100
Cost of Goods Sold
Purchases $49
Other expenses 40 89
Profit Before Tax $ 11

to increase profits by $1; decrease costs by 2%


Sales
Click to /edit
Purchasing
MasterLeverage
title style

To compare these two options

A 10% increase in sales

is the same impact on profits as

A 2% decrease in the purchase cost

Leverage effect is 5:1


ClickObjectives of Purchasing
to edit Master title style

Purchasing is responsible for establish the flow of


materials into the firm

Purchasing has 5 objectives:

1. Obtain goods and services:


of the required quantity and quality
at the lowest possible cost
at the best possible service and delivery
while maintaining and developing suppliers
Click Purchasing Functions
to edit Master title style

2. Determining purchasing specifications


right quality
right quantity
right time (delivery)
right place (delivery)

3. Selecting supplier
right source: sole, multiple, single
Purchasing
Click to editFunctions (continued)
Master title style

4. Negotiating terms and conditions


right price, contract, partnership

5. Issuing and administering purchase orders


receiving and payment
Click toPurchasing Cycle
edit Master title style

Purchasing normally consists of the following


steps

1. Receive and analyse purchase requisitions


2. Select suppliers, issue quotations
3. Determine the right price
4. Issue purchase orders
5. Followup to assure correct delivery
6. Receive and accept the goods
7. Approve invoice for payment
1. Receiving and Master
Click to edit Analyzing Requisitions
title style

From planners (MRP system) and all other users


Purchasing will:
Identify originator (user), account number,
approvals
Check material specifications
Verify quantity and unit of measure
Verify delivery date and place
Ensure all supplemental information
Click 2.
to Selecting Suppliers
edit Master title style

Often from a list of approved suppliers

For small items:


internet
catalogues
trade journals

For large items, issue a request for quotation, see


price options
2. to
Click Requesting Quotations
edit Master title style

Written inquiries sent to enough suppliers


to ensure competitive and reliable quotes are received

Quotes are analyzed


price
compliance to specification
technical suitability
often with the involvement of the originator
3. Determining
Click the Right
to edit Master title Price
style

Usually the lowest price is chosen, given others equal

May involve negotiations

Responsibility of the Purchasing Department to do it


4. Issuing
Click to editaMaster
Purchase
titleOrder
style

Legal document between the buyer and supplier

Forms a contract with the supplier upon acceptance

Copies to:
Supplier
Originator
Accounting
Receiving
Purchasing file
5. to
Click Follow-up and Delivery
edit Master title style

Ensure on-time delivery of the supplies

Negotiate any changes (based on needs change)

Take corrective action:


expedite as required
find alternative sources of supply
work with suppliers to resolve problems
reschedule production
6. Receiving
Click to editand Accepting
Master Goods
title style

Receiving inspects goods for correct quantity and any


damage (often user)

Accepts goods and generates a receiving report


send to quality for further inspection
hold goods damaged in transit

Copies to Accounting, Purchasing


7. Approving
Click to edit Invoice
Masterfor Payment
title style

Agreement with several files:

Original Purchase Order


Receiving Report
Invoice
price including discounts
quantity
Send approval to Accounts Payable
Establishing
Click Specifications
to edit Master title style

Purchasing can help to make the best buy, several


factors are included in the purchasing package
specifications of purchasing

Quantity requirements
Price Requirements
Functional Requirements
ClickQuantity Requirements
to edit Master title style

Small volume
find a standard item

Large items
design for economies of scale
reduce cost
satisfy functional needs
Price
Click to editRequirements
Master title style

The amount of economic value the buyer is willing to


pay

Relates to the use of the item

Relates to the selling price of the finished product


ClickFunctional Specifications
to edit Master title style

What the item is expected to do in the manufacturing


process, most important factor

Set by the end user


performance expectations
aesthetic expectations

Example: functional specifications for a car


run reliably? make you look cool? safety?
Functional Specifications
Click to edit andstyle
Master title Quality

Functional specifications are tied to the quality of the


product or service. There are four phases to provide
user satisfaction

Quality and product planning


to meet the expectations of the marketplace, who are the
customers? Which segment?

Quality and product design


determining the specifications

Quality and manufacturing


meeting the specifications

Quality and use


Functional Specification
Click to edit Description
Master title style

Functional Specifications can de describe in the


following ways or a combination of them

1. Brand
2. Physical and chemical specifications
Material and method of manufacturing
Performance
3. Engineering drawings
4. Miscellaneous methods
Click1.toDescription
edit Masterby title
Brand style

Items are patented

Special supplier expertise

Small quantity
not worth the effort of developing specifications

Preferred by
customers
the buyer
Click1.toDescription
edit Masterby title
Brand style

Reputation of the supplier


guarantees / warranties

Limits competition
higher price
easy to inspect

Specify by brand or equivalent


2. Description
Click by Specification
to edit Master title style

Physical and chemical specifications


buyer defined

Material and method of manufacture


environmental or food issues

Performance specifications
state what the item is supposed to do
uses supplier expertise
Click3.toEngineering
edit MasterDrawings
title style

Detailed description of parts


finishes
tolerances
materials used
no other way to describe the item

Expensive to produce for the firm

Can be used for inspection


4. Miscellaneous
Click Specifications
to edit Master title style

Samples: colors / patterns are specified

Combination of methods
e.g. curtains
drawing of the window dimensions
fire or safety rating
type of material to use
samples of pattern desired
Click toSelecting Suppliers
edit Master title style

What are the criteria of a right supplier?

The right supplier:


can supply the quality needed
has the capacity to deliver the quantity need and on time
(JIT deliveries?)
makes a profit, but at a good price
contributes to the improvement of your product
Factors
Click in Selecting
to edit Suppliers
Master title style

Basis for selection and evaluation of suppliers include

Technical ability
Manufacturing capability
Reliability
After-sales service
Location
Other considerations
Price
Click to Technical Ability
edit Master title style

Since their products become part of your product

Do they have the technical capability?

Is there a program of product development and


improvement?

Can they assist in improving your product?


ClickManufacturing Capability
to edit Master title style

Can they consistently meet the specifications and


quality desired?
quality control programs
competent personnel
Technology level

Do they have good manufacturing planning and


control systems?
to supply information on delivery
Click to editReliability
Master title style

Reputable
Stable
Financially strong Were in
this
together
Click toAfter-Sales
edit MasterService
title style

Good service organization

Supply/inventory of spare parts

Technical support after sales


Click toSupplier Location
edit Master title style

Location may effect delivery time

Local inventories, quick response time

May be required for after-sales service


will your customers require service?
Other
Click to editConsiderations
Master title style

Credit terms

Willingness to hold inventory

JIT

Information technology
Price title style
Click to edit Master

Not always the lowest is the best

May include other services and added values


Click toSupplier Selection
edit Master title style

Some elements need to consider when selecting a


supplier

On-going relationship

Mutual benefit

Supplier can depend on future business

Buyer can be:


assured supply of quality products
technical support
product improvements / problem solving
Identifying
Click to Suppliers
edit Master title style

Where to find suppliers?

Internet
Catalogues
Salespeople
Trade magazines
Trade directories
Salespeople of the buyers firm
Supplier Selection
Click to edit Master title
Weighted-Point Planstyle

1. Factors: Things that must be considered as part of


what we will be buying

2. Weights: The relative importance of each of the


factors

3. Rating: How well each supplier compares on each


factor

4. Ranking: The weight times the rating


Weighted-Point
Click to Planstyle
edit Master title

Weighted-Point Plan process

1. Select the factors


2. Assign a weight to each factor
3. Rate the suppliers for each factor
4. Rank each supplier
multiply the weight by the rate for each factor
Click to edit Master Plan
Weighted-Point title style

Figure 7.1 Supplier rating


Price
Click to editDetermination
Master title style

Price has direct influence on companys profit

50% of cost of goods sold (CoGS) is purchased


goods/supplies

Package of:
function
quantity
service
price
you only get what you pay for
Click to Basis for Pricing
edit Master title style

Fair price
competitive
gives seller a profit
allows buyer to make a profit

Upper limit
established by buyers

Lower limit
established by sellers
Click to Analyzing Costs
edit Master title style

Fixed Costs
costs incurred no matter the volume of sales
equipment, insurance, overhead

Variable Costs
costs which vary with the volume produced
direct labor, direct materials
Click to Analyzing Costs
edit Master title style

Total cost = fixed cost + (var cost/unit)(volume)

Unit cost = total cost


volume
= fixed cost + variable cost per unit
volume
ClickBreak Even
to edit Point title
Master Anlysis
style

The volume of sales where total revenue equals total


costs, 0 profit point

A seller must have sufficient volume to make a profit

Knowing the sellers break even point is useful in


negotiations
increased volume may lower price paid
Break
Click EvenMaster
to edit Point - Example
title style

Fixed Cost = $5,000


Variable Cost = $6.50 / unit
Selling Price = $15 per unit
Average Cost = $5,000 1000 + $6.50 = $11.50
per unit

To find the Break Even Point


Let X = Number of Units
$15X = $5,000 + $6.50X
$8.50X = $5,000
X = 588.2 units
The volume must exceed 588.2 units to make a profit
Click toPrice Negotiation
edit Master title style

Buyer needs knowledge of sellers costs

Buyer must have sufficient clout

Should benefit both supplier and buyer, mutual


agreed and benefits

Savings must justify the time and effort required


Negotiations Based
Click to edit on the Type
Master title of Product
style

Commodities
price is determined by the market
concern for future contracts

Standard products
price set by catalogue listings
little room for negotiation

Small value items


try to reduce ordering costs or increase volume

Made-to-order items (negotiation possible)


quotations from a number of sources
Impact
Click of MRP
to edit on Purchasing
Master title style

Purchasing - two categories of activity:

Procurement
establishing specifications, selecting suppliers, determining
price, negotiations
Supplier scheduling and follow-up
same as production activity control
execute the master schedule and the MRP
ensure good use of resources, minimize WIP, provided the
desired level of customer service
ClickBuyer / Planner
to edit MasterConcept
title style

In many firms, PAC and Purchasing are integrated


role

Production activity control


controls the flow of work through the plant
schedules need for components

Purchasing
coordinates the flow of goods from suppliers

Plans are going to change!


ClickBuyer / Planner
to edit MasterConcept
title style

Responsibility of planning and buying

Works with the Master Scheduler and other Planner /


Buyers

Smoother flow of information


knowledge of factory needs
matches material requirements with supplier capabilities
Click to Contract Buying
edit Master title style

Long term contract with a supplier for small volume


items
Authorize releases against the contract when goods are
needed

Supplier may be given a copy of the material


requirements plan

Requires close coordination

Works best with Buyer / Planner concept


Supplier
Click Responsiveness and style
to edit Master title Reliability

Material requirements often change

Suppliers must be able to react to change

Flexibility
in volume
in products needed

Reliable
in delivery promises
Close to
Click Relationship with
edit Master Suppliers
title style

The need to understand each others capabilities and


constraints

Cooperation and team work, cross-functional teams

Very frequent communications

Between the buyer/planner and the suppliers


production planner
Electronic
Click Data
to edit Interchange
Master (EDI)
title style

Electronic exchange of information between


customers and suppliers
purchase orders
invoices
material requirements plans

Reduces time involved

Avoids costly paper work


Vendor
Click Managed
to edit MasterInventory
title style

Supplier maintains an inventory of certain items at


the customers plant

Customer only pays for the inventory when it is


actually used

Usually for standard, small value items


fasteners
electrical components
TheMaster
Click to edit Internettitle style

Internet
open public access to posted information
valuable source of supplier and product information

Intranet
internal to company personnel only

Extranet
between participating companies
Supply Chain Management
Click to edit
Organizational Master
Implications title style

Total cost focus

not just price

includes transportation, storage, handling

mutual value analysis with suppliers

Reduce Bullwhip effect: P&Gs Diaper Problem


Supply Chain Management
Click to edit
Organizational Master
Implications title style

Mutually advantageous supplier negotiations

Information sharing
costs
schedules
inventory levels

Measurement systems
all aspects of the supply chain

Growth in electronic business (Internet)

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