BBIP4103 International Purchasing & Supply Management - Vapr20

BBIP4103
International Purchasing
and Supply Management
Copyright © Open University Malaysia (OUM)

BBIP4103
INTERNATIONAL
PURCHASING AND
SUPPLY MANAGEMENT
Prof Dr Abdul Razak Ibrahim

Project Directors: Prof Dr Widad Othman
Prof Dr Shamsul Nahar Abdullah
Open University Malaysia
Module Writer: Prof Dr Abdul Razak Ibrahim
Moderator: Nor Azian Abdul Rahman

Universiti Teknologi MARA
Developed by: Centre for Instructional Design and Technology

Open University Malaysia
First Edition, April 2020

Copyright © Open University Malaysia (OUM), April 2020, BBIP4103
All rights reserved. No part of this work may be reproduced in any form or by any means without
the written permission of the President, Open University Malaysia (OUM).

Table of Contents
Course Guide ix–xiii
Topic 1 Introduction to Purchasing and Supply Management 1

1.1 What is Purchasing? 2
1.2 Supply Chain and the Roles of Purchasing Function 3
1.2.1 Reasons for Making 4
1.2.2 Reasons for Buying 4
1.3 Evolution and Development of the Purchasing Function 5
1.4 Forms of Purchasing Activities: Operational Purchasing 8
and Strategic Sourcing
1.4.1 Strategic Sourcing versus Purchasing 9
1.5 Four Stages of Purchasing and Supply Management 11
Summary 12
Key Terms 12
References 13
Topic 2 The Purchasing Process 14

2.1 Purchasing Objectives 15
2.2 Steps in the Purchasing and Supply Management Process 16
2.2.1 Steps in the Purchasing Process 16
2.2.2 Supply Management Process 18
2.3 Types of Purchases 22
2.4 Improving the Purchasing Process 23
Summary 25
Key Terms 25
References 26
Topic 3 Purchasing Policy and Procedures 27

3.1 Policy Overview 28
3.2 Purchasing Policy and Responsibilities 29
3.3 Policy and Procedure Manual 32
3.4 Purchasing Procedural Areas 36
3.4.1 Legal Contract Procedures 36
3.4.2 Operational Procedures 36
Summary 37
Key Terms 38
References 38

iv  TABLE OF CONTENTS
Topic 4 Purchasing Policy and Procedures 39

4.1 Position of Purchasing Function within Organisational 40
Structure
4.2 Factors Affecting the Position of Purchasing Function 40
4.3 Organising the Purchasing Function 41
4.3.1 Purchasing Department Activities 41
4.4 Placement of Purchasing Authority: 42
Centralised versus Decentralised Purchasing
4.4.1 Advantages of Centralised Purchasing 42
4.4.2 Disadvantages of Centralised Purchasing 43
4.4.3 Advantages of Decentralised Purchasing 44
4.4.4 Disadvantages of Decentralised Purchasing 44
4.4.5 Centralised-decentralised Hybrid Purchasing System 44
4.5 Boundary Spanning 45
Summary 46
Key Terms 47
References 47
Topic 5 Pricing and Cost Analysis 49

5.1 How Suppliers Establish Price 49
5.2 Method of Price Determination 51
5.2.1 The Purchasing Decision 52
5.2.2 Price Setting Strategy (Economics and Psychology) 53
5.2.3 Market Approach 53
5.2.4 Costs 54
5.2.5 Discounts 54
5.2.6 Government Influence on Pricing 55
5.2.7 Bidding and Negotiations 55
5.3 Documenting a Price Analysis 55
5.4 Cost Analysis within the Supply Area 58
Summary 59
Key Terms 60
References 60
Topic 6 Technology and E-procurement 61

6.1 Computer-based Technology in Purchasing and Supply 62
Management
6.1.2 Electronic Data Interchange 62
6.1.3 Barcoding and Scanners 62
6.1.4 Enterprise Resource Planning (ERP) Systems 63
6.1.5 Warehouse Management Systems 63
6.1.6 Transportation Management Systems 63
6.1.7 Inventory Management Systems 63

TABLE OF CONTENTS  v
6.2 Efficiency Improvements Through Technology 64

6.3 E-procurement Applications 65
6.3.1 Advantages of E-procurement 67
6.3.2 Disadvantages of E-procurement 68
6.3.3 Electronic Data Interchange 68
6.3.4 Radio Frequency Identification 69
6.4 Implications for Purchasing 70
6.5 E-commerce and Global Supply Management 71
6.5.1 E-commerce Trends 72
Summary 74
Key Terms 74
References 75
Topic 7 Sourcing and Supplier Selection 76

7.1 Strategic Resource Plan 76
7.2 Discovering and Evaluating Potential Suppliers 78
7.2.1 Selecting Suppliers 79
7.2.2 Supplier Evaluation and Selection Process 79
7.2.3 Strategic Selection 80
7.2.4 Supplier Relationship Management 81
7.3 Supplier Measurement and Performance Evaluation 81
7.3.1 Cost-ratio Method 82
7.3.2 Categorical Method 83
7.3.3 Linear Averaging Method 84
7.4 Selection of International Suppliers 86
Summary 86
Key Terms 87
References 87
Topic 8 Supplier Quality Management 88

8.1 An Overview of Supplier Quality Management 89
8.1.1 Methodology 90
8.1.2 Advantages of Supplier Quality Management 91
8.2 Roles of Buyer in Managing Supplier Quality Management 92
8.2.1 DemingÊs 14 Points 92
8.3 Factors in Managing Supplier Quality 96
8.3.1 Six Sigma Supplier Quality 97
8.4 Supplier Certification and International Quality Evaluation 98
Systems
Summary 99
Key Terms 99
References 100

vi  TABLE OF CONTENTS
Topic 9 Negotiation and Contract Management 101

9.1 Negotiation 102
9.2 Five Phases of the Negotiation Process 103
9.3 Planning for Negotiation 107
9.4 International Negotiation 108
9.5 Types of Purchasing Contracts 109
9.6 How to Construct a Contract 111
9.7 Settling Contractual Disputes 112
Summary 114
Key Terms 114
References 114
Topic 10 Global Sourcing and Supply Management 115

10.1 Importance of Global Sourcing 115
10.2 Reasons for Global Sourcing 118
10.3 Barriers to Global Sourcing 120
10.4 Global Sourcing Process 121
10.5 Organising for Global Sourcing 122
10.6 Assessing the Need for Global Sourcing 123
10.7 Stages of Global Supply Management 123
10.8 Global Perspective of Supply Management 124
10.9 From Domestic to Global Sourcing: The Five-phase Process 125
10.10 Factors Enhancing Global Sourcing 127
10.11 Global Supply Channel 127
10.12 Information Sources for Locating and Evaluating 128
International Suppliers
10.13 Currency and Payment Issues 129
10.14 The Future of Global Supply Management 129
Summary 130
Key Terms 131
References 131

COURSE GUIDE  ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly, what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend in
order to complete the course successfully. Please keep on referring to the Course
Guide as you go through the course material. It will help you to clarify important
study components or points that you might miss or overlook.
INTRODUCTION
BBIP4103 International Purchasing and Supply Management is one of the courses
offered at Open University Malaysia (OUM). This course is worth
3 credit hours and should be covered over 15 weeks.
COURSE AUDIENCE
This course is offered to all learners taking the Bachelor of Business
Administration programme. This module aims to impart the fundamentals of
purchasing and supply management at the global level, providing a good
understanding of knowledge and analytical skills for decision making.
This course focuses on fundamental principles of purchasing, international

purchasing and supply management. The main objective of the course is to
provide learners with the working knowledge of operational purchasing and
strategic sourcing. This will further enhance learnersÊ ability for pricing and
costing at the global scale.
As an open and distance learner, you should be acquainted with learning

independently and being able to optimise the learning modes and environment
available to you. Before you begin this course, please confirm the course material,
the course requirements and how the course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a two-credit hour course, you are expected to spend
80 study hours. Table 1 gives an estimation of how the 80 study hours could be
accumulated.

x  COURSE GUIDE
Table1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussions 5
Study the module 60
Attend 4 tutorial sessions 8
Online participation 12
Revision 15
Assignment(s) and examination(s) 20
TOTAL STUDY HOURS ACCUMULATED 120
COURSE LEARNING OUTCOMES

By the end of this course, you should be able to:
1. Explain the basic concepts of purchasing, international purchasing and
supply management as well as strategic sourcing;
2. Explain price determination and cost analysis; and
3. Discuss the influence of technology and e-procurement in international
purchasing and supply management.
COURSE SYNOPSIS
This course is divided into 10 topics. The synopsis for each topic is listed as
follows:
Topic 1 provides an introduction to international purchasing and supply

management, starting with the basic terminologies of purchasing and
international purchasing and supply management. This is followed by the
evolution and development of the purchasing function. The topic also explains
the four phases of purchasing and supply management.
Topic 2 explains the various types of purchases that most businesses are involved
in. It goes on to explain the steps in the purchasing and supply management
process and how businesses can improve the purchasing function in order to be
more agile and flexible.

COURSE GUIDE  xi
Topic 3 explores the purchasing policy. Information technology (IT) drives

organisationsÊ policy and procedure manuals. LearnersÊ will understand the
policy implications on the purchasing function at the local as well as
international level.
Topic 4 discusses the position of the purchasing function within the

organisational structure. Factors affecting the position of purchasing function
will be discussed in detail.
Topic 5 discusses how suppliers establish their pricing strategy and the methods
used to determine the price. Moreover, learners will understand how to
document the cost and price analysis within the supply function.
Topic 6 explores the use of computers in the area of purchasing and supply
management. Applications of e-commerce will also be emphasised.
Topic 7 explains the sourcing strategy that companies implement. The selection
and evaluation of suppliers is an important aspect of purchasing. As such,
companies need to develop and manage their suppliers well in order to provide
continuous supply of materials. This will enable companies to compete at a
global scale with less disruption.
Topic 8 explores supplier quality management. The role of buyers in managing

supplier quality will be examined. In addition, global players are required to
have certain certification requirements and adhere to international quality
evaluation systems. These matters will be discussed.
Topic 9 demonstrates the art of negotiation. There are five phases in the
negotiation process. Suppliers need to understand the complexity surrounding
the negotiation process. In addition, the types of contracts and contractual
disputes will be discussed to enhance the principal-agency relationship.
Topic 10 examines the importance of global sourcing. The need to understand the
implications of going global will be discussed. Companies need to assess the
need to go global in purchasing and supply management. The topic also focuses
on the five-phase process from operating domestically to internationally.

xii  COURSE GUIDE
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement will help you to organise your
study of this course in a more objective and effective way. Generally, the text
arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely covered a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your understanding of the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It may be inserted after one subtopic or a few subtopics.
It usually comes in the form of a question. When you come across this
component, try to reflect on what you have already learnt thus far. By attempting
to answer the question, you should be able to gauge how well you have
understood the subtopic(s). Most of the time, the answers to the questions can be
found directly from the module itself.
Activity: Like Self-Check, the Activity component is also placed at various

locations or junctures throughout the module. This component may require you to
solve questions, explore short case studies, or conduct an observation or research.
It may even require you to evaluate a given scenario. When you come across an
Activity, you should try to reflect on what you have gathered from the module and
apply it to real situations. You should, at the same time, engage yourself in higher
order thinking where you might be required to analyse, synthesise and evaluate
instead of only having to recall and define.
Summary: You will find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points in the
summary that you do not fully understand, it would be a good idea for you to
revisit the details in the module.
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargon used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms in the module.

COURSE GUIDE  xiii
References: The References section is where a list of relevant and useful

textbooks, journals, articles, electronic contents or sources can be found. The list
can appear in a few locations such as in the Course Guide (at the References
section), at the end of every topic or at the back of the module. You are
encouraged to read or refer to the suggested sources to obtain the additional
information needed and to enhance your overall understanding of the course.
PRIOR KNOWLEDGE
No prior knowledge needed.
ASSESSMENT METHOD
Please refer to myINSPIRE.
REFERENCES
Benton, W. C. (2013). Purchasing and supply management. New York, NY:
McGraw Hill.
Lysons, K., & Farrington, B. (2012). Purchasing and supply management

(5th ed.). Harlow, United Kingdom: Pearson.
Monczka, R. M., & Handfield, R. B. (2011). Purchasing and Supply Chain

Management (5th ed.). Mason, OH: South-Western.
TAN SRI DR ABDULLAH SANUSI (TSDAS)

DIGITAL LIBRARY
The TSDAS Digital Library has a wide range of print and online resources for the
use of its learners. This comprehensive digital library, which is accessible
through the OUM portal, provides access to more than 30 online databases
comprising e-journals, e-theses, e-books and more. Examples of databases
available are EBSCOhost, ProQuest, SpringerLink, Books24×7, InfoSci Books,
Emerald Management Plus and Ebrary Electronic Books. As an OUM learner,
you are encouraged to make full use of the resources available through this
library.

xiv  COURSE GUIDE

Topic  Introduction to
1 Purchasing and
Supply
Management
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Describe what purchasing means;
2. Discuss the role of the purchasing function;
3. Discuss the evolution and development of the purchasing function;
4. Differentiate the forms of purchasing activities; and
5. Explain the four phases of purchasing and supply management.
 INTRODUCTION
Welcome to this introductory topic on purchasing and supply management. Before
we begin let us ponder on the following situation:
Imagine that ValentineÊs Day is around the corner. However, consumers are
not able to purchase the chocolates that they desire for ValentineÊs Day. What
would happen if ValentineÊs Day chocolates remain unavailable until
September?
It is the focus and responsibility of the purchasing and supply management staff
to ensure that the appropriate products are ready at the right time and the right
place for the buyers.

2  TOPIC 1 INTRODUCTION TO PURCHASING AND SUPPLY MANAGEMENT
To have an impact on the global market, emphasis needs to be given to an effective

purchasing and supply management. The importance of purchasing has been well
documented in view of the ever-competitive environment.
In order for a product from the manufacturing phase to reach the buyer, it has to
go through a long process of crucial decision-making pertaining to costing, quality
and scheduling. These decisions can affect the commercial value of the companyÊs
product and eventually impact the companyÊs sales and income.
In this topic you will first learn about some of the terminologies in purchasing
along with the roles of the purchasing function. We will look at the evolution and
development of purchasing, and discuss the importance of purchasing and supply
management.
1.1 WHAT IS PURCHASING?
Purchasing is the process of buying goods and services that companies need to use
or to create products. Most people are unaware of what purchasing entails.
„Purchasing‰ is a term used in industry, trade and public companies refering to
the financial processes and tasks to obtain materials, supplies and services. It
clearly explains the activity of buying. Nevertheless, in a larger sense, the term
includes deciding the needs, choosing the supplier, determining a proper pricing,
terms and conditions, releasing the contract or order and following up on delivery.
Among the purposes of purchasing are to aalow the company to buy or obtain the
goods in the right quantity, at the right quality, at the right price, at the right time,
from the right supplier and deliver them to the right place.
There are many terms used for purchasing. Among them, are „procurement‰,
„sourcing‰ and „supply management‰. All of these terms suggest the same
function and objective, that is, to obtain materials for the use of organisations in
the short run and the long run.
There are many diverse activities in purchasing. All the activities are to ensure that
the purchasing function is conducted in the most effective and efficient manner.
The following are activities that are common to all purchasers:
(a) Identifying and evaluating vendors;
(b) Selecting specific products;
(c) Placing orders; and
(d) Resolving issues after receiving the ordered goods or services.

TOPIC 1 INTRODUCTION TO PURCHASING AND SUPPLY MANAGEMENT  3
1.2 SUPPLY CHAIN AND THE ROLES OF

PURCHASING FUNCTION
A supply chain is a network between a company and its suppliers to produce and
distribute a specific product to the final buyer. The roles of the purchasing function
in the supply chain are as follows:
(a) Deciding on the Purchasing Identification: Quality, Quantity and Delivery

Organisations have to procure materials. Therefore, there is a need to identify
the quantity and quality of the materials as well as the delivery to the
organisation at a specified time frame.
(b) Choosing Suppliers

Once an organisation identifies its internal needs, choosing a vendor or
supplier is an important task to carry out. The choice of the vendor depends
on the services provided by the various vendors. The selected vendorÊ service
has to match the organisational objective of procuring materials.
(c) Determining Terms and Conditions of Purchase

The organisation must negotiate with the vendor on the terms and conditions
of the purchase. All of the terms have to be stated in a contract so that both
parties agree to enter into a contract that is mutually agreed upon.
(d) Providing and Managing Purchase Orders (PO)

If everything goes well, the next step is to issue a purchase order. The
purchase order is meant to cement both partiesÊ agreement on the terms and
conditions negotiated earlier. The order is now sealed.
Now that we understand the roles of the purchasing function in the supply chain,
let us turn our attention to the objectives of purchasing, which are as follows:
(a) To ensure an uninterrupted flow of raw materials at the lowest possible cost;
(b) To improve the quality of the finished goods produced;
(c) To optimise customer satisfaction;
(d) To source materials from reliable suppliers; and
(e) To work closely with strategic suppliers for improved quality materials
supplied.

ACTIVITY 1.1
How would you evaluate vendors? What are the criteria used to evaluate
vendors? Discuss with your coursemates in the myINSPIRE forum.
1.2.1 Reasons for Making

Whether a company makes or buys is a critical decision as it has an impact on the
organisationÊs profitability over the long run. Making or buying is about sourcing
the materials, goods and services. Therefore, it is paramount that organisations
look at the issues in tactical as well as strategic perspectives.
There are many reasons why organisations make (produce) their materials rather
than outsource the components. The following are reasons for making:
(a) Retain core competency as it is an important process for the company;
(b) Parts needed are expensive to buy or outsource, therefore, organisations
produce them internally to lower the production cost;
(c) Some parts are difficult to source as the suppliers are either overseas or
located at an inconvenient area;
(d) To obtain the right quantity or delivery (to ensure sufficient supply of parts),
coordinated efforts need to be synchronised with the production floor.
Synchronisation is easier if the parts are made internally;
(e) If parts are made within the confines of the facility, excess labour and space
can be fully utilised; and
(f) Finally, with making parts internally, organisation can preserve the
copyrighted design and control the quality of the parts.
1.2.2 Reasons for Buying

There are also many reasons why organisations buy or outsource some of the parts
for production. Among them are as follows:
(a) By outsourcing the parts, management is relieved of the responsibility and it
can focus on the core processes that directly impact the organisation;
(b) Organisations also maintain supplier commitment over the long run;

(c) Since the parts are bought, inventory cost can be lowered for the
organisation. In addition, pilferages, damages and insurance cost for
inventory are no longer organisational concerns;
(d) It is easier to manage as organisations can get the right quantity and quality
of paarts; and
(e) Acquiring inventory is not difficult; there is flexibility and organisations can
be assured of continued supply of inventory from alternate sources.

SELF-CHECK 1.1
1. What is purchasing?
2. Describe the roles of the purchasing function in the supply chain.
3. What are the reasons for making and buying?

1.3 EVOLUTION AND DEVELOPMENT OF THE

PURCHASING FUNCTION
The history and evolution of purchasing has provided an appreciation of the
growth, development and increasing stature of the profession over the last 150
years. Over the past 15 years, many changes can be seen in the function of
purchasing. From mundane activities to the incorporation of more exciting and
challenging processes, purchasing has evolved into a strategic professional career
for those involved.
The evolution of purchasing function can be categorised into seven periods,

spanning over 150 years. Let us trace the various evolutionary history of the
purchasing fumction.
(a) Period 1: The Early Years (1850ă1900)

This period dates back to the textile industry where the selling agents
handled purchasing and all material management during that time.
Customer orders were transformed into purchase orders (PO) and
subsequently the materials went into the production process. A major
contribution of that time was the early recognition of the purchasing process
that contributed to the overall performance of an organisation. In later years,
the purchasing function was organised into a separate entity and functioned
as a corporate strategy that required special skills to manoeuvre.

(b) Period 2: Growth of Purchasing Fundamentals (1900ă1939)

This era witnessed the development of basic procedures and ideas.
Purchasing gained more recognition during World War I where vital raw
materials needed to be obtained. Purchasing focused on buying raw
materials from finished to semi-finished goods. During this time,
procurement became an important function of an organisationÊs operation.
(c) Period 3: The War Years (1940ă1946)

World War II was the beginning of the actual purchasing history. It was
about obtaining scarce resources for the war. Materials were difficult to
source during the war and as such, the purchasing function became crucial
in obtaining the necessary materials such as weapons and ammunition. The
purchasing interest grew during this time. From a mere nine colleges offering
courses related to purchasing the numbers increased in 1933 to 49 colleges
during this period.
(d) Period 4: The Quiet Years (1947ă1965)

Purchasing awareness did not fully take off immediately after the war. John
Hill, a purchasing professional commented, „For many firms, purchasing
was simply seen as inescapable costs of doing business which no one could
do much about. So far as the length and breadth of the American industry is
concerned, the purchasing function had not yet received in full measure the
attention and emphasis it deserved.‰
While another respected purchasing professional, Bruce D Henderson

commented, „Procurement is regarded as a negative function ă it can
handicap the company if not done well but can only make little positive
contribution.‰
Ford Motor Company was the first company that created a purchase analysis
department which provide assistance to buyers on product and price analyses.
(e) Period 5: Material Management Comes of Age (1966ă1979)

It is in this era that the purchasing function grew dramatically. The concept of
material management was debated to include a wider range of processes. The
various functions that fell under the umbrella of material management were
material planning and control, inventory planning and control, material and
procurement research, purchasing, incoming traffic, receiving, incoming quality
control, stores, material movement as well as scrap and surplus disposal.

During that time purchasing managers emphasised multiple sourcing

through competitive bid pricing. Buyers maintained an armÊs length
relationship with suppliers.
(f) Period 6: The Global Era (1980ă1999)

In the global era, the effect of structure and behaviour became prominent.
The way purchasing was practised was different from other activities. The
following are reiterated in many purchasing literature:
(i) Never in our industrial history has competition became so intense so
quickly;
(ii) Global firms increasingly captured world market shares and
emphasised different strategies, organisational structures and
management techniques compared with their American counterparts;
(iii) The spread and rate of technology change during this period was
unprecedented, shortening product life cycles; and
(iv) The ability to coordinate worldwide purchasing activities by using
international data networks and the World Wide Web (via intranets)
emerged.
(g) Period 7: Integrated Supply Chain Management (Beyond 2000)

Purchasing practices changed in this era from the adversarial approach to a
more cooperative approach. The supplier plays a central role in collaborating
the initiatives of companies across networks. Organisations are now aware
that in order to create value, strategy must change to adapt to new practices
of purchasing such as supplier/vendor development, supplier design
involvement, total cost supplier selection, long-term supplier relationship,
strategic cost management, enterprise wide systems, enterprise resource
planning (ERP), integrated Internet linkages and shared databases.
ACTIVITY 1.2
Discuss the following with your coursemates in the myINSPIRE forum.
1. What are the characteristics of purchasing in todayÊs highly

competitive environment?
2. What is the difference(s) between purchasing in the old days

compared to today?

1.4 FORMS OF PURCHASING ACTIVITIES:

OPERATIONAL PURCHASING AND
STRATEGIC SOURCING
Logistics and supply chain managers are looking for methods to extract more
value from their sourcing and procurement management. Regardless of whether
they are intimidated by demanding customers, the emergence of cheaper
competition from foreign sources or the complexity of today's supply chain,
executives are no longer happy with the focus on buying low-cost goods and
services. It is no longer sufficient to stave off margin increment. As a result, aspects
concerning purchasing, procurement, and strategic sourcing are given important
attention as organisations attempt to enhance the overall competence and efficacy
of their supply networks. A better understanding of where the advantages can be
acquired needs a thorough knowledge of the likeness, differences and connections
between purchasing, procurement and strategic sourcing. This is because, many a
time, these terms are used interchangeably.
Strategic sourcing refers to generating supply chain management solutions with

the aim of creating different values in order to achieve a competitive advantage.
Sollish & Semanik (2011) said that it is a former function and has its roots from the
beginning of the purchasing philosophy whereby traditional buying deals with
locating and hiring suppliers rather than recognising the best value-creating party
to the supply chain. Usually, organisations focused on the cost per unit, evolving
from the determinants of large volumes that led to massive discounts. These
methods, however, has led to the collapse of competitive opposition for many
firms as the quality of services and supply chain collaboration have been coloured
(Beaty, 2013).
Here is how we see it:
(a) Purchasing is a transactional function or the act of purchasing the necessary

goods or services. This includes placing and processing orders or purchase
requests. This transactional activity was the formal source solution and the
final selection of the desired resource provider.
(b) Procurement is the management of various processes related to an

organisation's desire to acquire the goods and services required for product
manufacturing, changing input to output or indirectly managing the
organisation. These processes include activities such as product and service
acquisition, supplier selection, pricing and negotiation terms, contract
transactions and processes, supplier performance management, and supplier
sustainability matters.

(c) Strategic sourcing is a larger transformation operation that is carried out at a

higher organisational level. Strategic sourcing brings the procurement
process forward, assessing the entire supply chain, its connections and how
they affect procurement and purchase decisions. The focus is on value
creation, risks and uncertainties in the supply chain, and the overall
responsiveness and durability of the supply chain.
ACTIVITY 1.3
Conduct a brief research on the Internet to find out about well-known

professional purchasing associations and the forms of purchasing
activities that they are engaged in.
1.4.1 Strategic Sourcing versus Purchasing

One of the key distinctions of strategic sourcing that differs from conventional
purchasing is that it extends beyond purchasing and focuses on converging and
maintaining the buyer-supplier relationship (Skjott-Larsen & Schary, 2001). The
goal is to support, use capabilities, combine and complement the core
competencies of several partners in the supply chain to provide value, cost
efficiency and uniqueness for buyers.
Strategic sourcing incorporates strategic dimensions and abilities of suppliers such

as the importance of quality management practices, process capabilities, design
and development and cost reduction capabilities into the decision-making
operation. As such, it is likely for companies to accomplish precise information
and best-in-class market results (Beaty, 2013). In contrast to traditional purchases,
such practices are not followed properly due to the lack of visibility, collaboration
opportunities and cost synergies.
Tanskanen and Aminoff (2015) suggested a common difference between strategic

sourcing and purchasing by showing that purchasing is simply the transaction
between buyers and suppliers, whereas sourcing is the integration and
coordination of all local and global domains and resources, being monetary,
human, material, informational and others. However, they confirmed that
businesses usually start with the basic idea of domestic purchases before moving
on to internationalisation and integrating with a progressive global resource. The
reasons for these developments are, on the one hand, due to non-existing suppliers
and resources in the region, cooperate growth as well as customer-base and
supplier-base growth. On the other hand, efforts to cut costs and, if relevant, defeat

domestic supply chain disruptions or statutory limitation. Figure 1.1 shows the
key differences between traditional purchasing and strategic sourcing.
Figure 1.1: Key Differences between traditional purchasing and strategic sourcing
Source: Benton (2014)
SELF-CHECK 1.2
Describe the differences between traditional purchasing and strategic
sourcing.

1.5 FOUR STAGES OF PURCHASING AND

SUPPLY MANAGEMENT
Purchasing and supply management is a chain of processes that must be
completed to create and distribute a commodity. This commodity may be goods
or services. Either way, there is a necessity for a clean manufacturing path for the
production of goods or services to be offered. Having a powerful supply chain is
important and controlling it effectively is crucial to business health. There are four
stages in the process as presented in Figure 1.2:
Figure 1.2: Four Stages in purchasing and supply management

 Purchasing in the usual sense of the word is the act of buying goods and
services required by the company to operate and/or manufacture the product.
 „Purchasing‰ is a term used in industries, trade and public companies to refer

to financial processes and tasks to obtain materials, supplies and services.
 Supply management is the active management of the supply chain process to

maximise customer value in order to obtain a sustainable competitive
advantage.
 The history and evolution of purchasing can be viewed through seven key
periods beginning from the middle of the 19th century.
 Purchasing can be viewed as the transaction between buyers and suppliers

whereas sourcing is the integration and coordination of all local and global
domains and resources.
 Strategic sourcing refers to making supply chain management decisions with

the purpose to develop unique value and competitive advantages.
 The four stages of purchasing and supply management can be viewed from
the aspects of the clerical, mechanical, proactive and world-class stages.
Buying Supply
Making Supply management
Procurement Traditional purchasing
Purchasing Transactional
Strategic sourcing

Beaty, T. (2013). Strategic sourcing versus traditional purchasing: And the impact
on your bottom line. Insight Sourcing Group.
Benton, W. C. (2014). Purchasing and supply management (3rd ed.). Boston, MA:
McGraw-Hill Irwin.
Ketchen Jr., D. J., Crook, T. R., & Craighead, C. W. (2014). From supply chains to
supply ecosystems: Implications for strategic sourcing research and
practice. Journal of Business Logistics, 35(3), 165ă171.
Skjott-Larsen, T., & Schary, P. B. (2001). Managing the global supply chain.
Copenhagen, Denmark: Copenhagen Business School Press
Sollish, F., & Semanik, J. (2011). Global sourcing best practices. NJ, US: Wiley.
Tanskanen, K., & Aminoff, A. (2015). Buyer and supplier attractiveness in a

strategic relationship: A dyadic multiple-case study. Industrial Marketing
Management Journal, 50, 128ă141.
Wallace, W. L., & Xia, Y. (2015). Delivering customer value through procurement
and strategic sourcing: A professional guide to creating a sustainable supply
network.

Topic  The Purchasing
2 Process
LEARNING OUTCOMES
1. Describe what purchasing means;
2. Discuss the role of the purchasing function;
3. Discuss the evolution and development of the purchasing function;
4. Differentiate the forms of purchasing activities; and
5. Explain the four phases of purchasing and supply management.
 INTRODUCTION
Purchasing can play an important role to give a competitive advantage to
companies. Purchased inputs constitute an enormous component of a companyÊs
resources. Materials make up 60 to 80 per cent of a companyÊs total cost in most
industries. Purchased inputs provide a potential source to help companies
leverage over their competitors. Purchasing actions are designed to reinforce a
company's competitive advantage and can benefit the company over its
competitors.
Purchasing is a highly complex organisational process that aims to reach far

beyond the traditional primary role of acquiring goods and services in response
to internal requirements. The general goals of purchasing can be classified into
five major areas: supply continuity, manage the sourcing process efficiently and
effectively, build supply-based management, build aligned goals with internal
stakeholders and build integrated purchasing strategies to achieve organisational
goals and objectives.

TOPIC 2 THE PURCHASING PROCESS  15
2.1 PURCHASING OBJECTIVES
Purchasing is the act of buying goods and services that a company needs to
manage and/or make products. Purchasing in the context of commerce, industries
and public corporations indicate the financial obligations for procuring supplies,
services and materials. In a larger sense, the term includes deciding the needs,
choosing the supplier, arriving at pricing in terms of rates and terms, issuing or
ordering the contract and following up to ensure timely and accurate delivery. The
aim is to purchase or acquire materials in the proper quantity, with the correct
quality, at the correct price, at the correct time, from the correct supplier and to
deliver to the correct place.
Therefore, the objectives of purchasing can be summarised as follows:

(a) To ensure supply continuity;
(b) To manage the purchasing process effectively and efficiently;
(c) To develop supply-based management;
(d) To develop aligned goals with internal functional stakeholders;
(e) To support organisational goals and objectives; and
(f) To develop integrated purchasing strategies that support organisational
strategies.
ACTIVITY 2.1
In the myINSPIRE forum, discuss the specific objectives of purchasing and

supply management in relation to:
(a) An automobile industry
(b) A hospital
(c) A pizza shop

16  TOPIC 2 THE PURCHASING PROCESS
2.2 STEPS IN THE PURCHASING AND SUPPLY

MANAGEMENT PROCESS
In this subtopic, we will describe in detail the purchasing process, which includes
all the steps that purchasing personnel in organisations go through when
acquiring products, materials or services. As mentioned earlier, purchasing is a
process that is made up of activities associated with identifying needs, locating
and selecting suppliers, negotiating terms and following up to ensure supplier
performance. These activities, or steps, are often referred to as „procure to pay
cycle‰. This term includes all of the steps mentioned, from the initial identification
of requirements to the procurement or purchasing of the item through the receipt
of the goods, and finally the payment to the supplier once the goods are received.
2.2.1 Steps in the Purchasing Process

Companies have a more formal method towards purchasing, in contrast to
consumer buying. Instead of making impulse purchases, companies will
differentiate and compare prices, suppliers and the quality of goods and services
before closing a sale. Even though some companies may take more time on specific
procedures in the purchasing process or skip certain steps altogether, almost all
business-to-business purchases can be categorised into eight different steps as
described in the following:
(a) Problem Identification

The purchasing procedure does not begin until someone recognises a
problem in the organisation, which can be solved by purchasing a good or
service. Anyone in the organisation can highlight the problem, for example,
from a customer service representative who noticed that the office has ran
out of printer paper to the CEO who decides that it is time to move to a larger
facility. In another example, a salesperson may assist someone in the
organisation to identify a demand that no one had previously
acknowledged.
(b) General Needs Description

After the problem is identified, the corporation will decide which product or
service is needed to solve the problem. When a workplace is out of printer
paper, the office manager might decide that extra paper is required. Yet, a
software engineer in the same corporation may suggest that the corporation
go paperless and to provide everyone in the office with tablet computers.

(c) Product or Service Specification

When the general needs are agreed upon by the purchasing controller in that
corporation, then the purchasing personnel will narrow down the product
choices by identifying the exact products and its features. If the companyÊs
decision to resolve the problem is by using tablets, those with the decision-
making power would then decide the size required, how big of memory size
is needed and other considerations. If the company determines that extra
paper is the solution, then the purchasing personnel would decide on the
quality and quantity of paper required.
(d) Potential Supplier Search

The next step of the purchasing process is to search for possible suppliers. If
the company does not have a strong relationship with the retailer that offers
or supplies the product, then the company must conduct an online search,
attend trade shows or contact suppliers by phone. The purchaser will decide
whether the supplier is reliable, financially stable and if it will be around for
future needs or purchases.
(e) Request for Proposals

For big purchases, companies generally issue a formal RFP - Request for
Proposal - and submit it to their chosen suppliers. Otherwise, the company
will likely open the offer publicly so that any interested supplier can submit
a proposal. For smaller purchases, this can be as easy as searching for the
price online.
(f) Supplier Evaluation and Selection

In this step of the process, suppliersÊ pricing recommendations are analysed
to determine who offers the best price and quality of choice. Usually, the
price itself is not sufficient to secure a company's business. The company will
measure the price against financing alternatives, the reputation of the
supplier and whether the supplier can continue to supply the company with
future goods and services.
(g) Establishing Credit and Order Specification

When a supplier has been selected, the company sets the order. This may
include credit configuration with the supplier, agreeing on the terms as well
as reviewing the delivery schedule and any other shipment that may come
with the sale, for example, installation or product practices.

(h) Supplier Performance Review

After the product has been delivered or the service has been performed, the
company will evaluate the purchase to identify if it meets the required
standards. For larger purchases, this could be a formal review including key
decision makers and the sales staff of the supplier. For smaller purchases, it
is usually informal. For example, if the company ordered a box of paper and
the delivery was delayed or the product damaged, the company might
decide not to purchase from that supplier again, without ever notifying the
supplier of the problem.
2.2.2 Supply Management Process

Let us now focus on integrated purchasing and supply management. Refer to
Figure 2.1.
Figure 2.1: Integrated Purchasing and supply management process


In the past 25 years, the supply management function has developed from a
tactical function of purchasing or procurement into a key strategic function within
the organisation. Supply management currently:
(a) Contributes to the bottom line;
(b) Distributes as an information source;
(c) Increases efficiency and productivity;
(d) Enhances the continuous improvement process;
(e) Upgrades competitive position and boosts customer satisfaction;
(f) Impacts the organisationÊs image and social policy; and
(g) Builds the organisationÊs future leaders.
Supply management exists to find business opportunities and implement supply

strategies that bring the most value to the company, its suppliers and customers.
Strategic supply management is a major resource for gathering market intelligence
and developing cost reduction programmes. Given the strategic nature of the
supply function, the top supply management professionals are usually members
of the corporation's senior management team. In this leadership role, supply
management professionals must be knowledgeable in all areas of the business in
order to develop strategies that are consistent with successful corporate goals and
business processes.
With emerging technologies in global operations, supply management is

constantly involved in sourcing resources for products or services from
international suppliers. Therefore, an understanding of the global business
concept is increasingly important for experienced people.
In most companies, functional managers in each area use similar techniques to

make independent decisions. The methods introduced here show that supply
management decisions need to be combined. Integrative materials management
consists of the planning, acquisition and conversion of raw materials and
components into finished goods. In this scenario, each functional manager reports
to the same manager.
Moreover, managers should work towards the overall goal of delivering high
quality products to customers in a timely manner. An important goal of this
method is to provide high quality customer service while reducing the cost of
delivering services.

Integrative supply management is not associated with company size. Realistically,

the purchasing subfunction must be integrated before the supply function will
align with other business functions.
One of the objectives of supply management is to enhance the transformation of

raw materials and the components into shipped or inventory goods. The general
function of the inventory is to separate the entire transformation procedure.
During the transformation process, materials are integrated with labour,
information, technology and capital.
The supply planning system is central to the acquisition of parts and material
requirements planning (MRP) function, which is the most crucial input in a
manufacturing planning and control systemÊs task. During the 1960s to 1980s,
many American manufacturing companies falsify 60 to 80 per cent of their
productÊs value (see Figure 2.2).
Figure 2.2: Manufacturing process (1960s–1980s)

Source: Srivastava & Benton (1998)
Then again, in the past decade, a large number of manufacturing companies

purchased between 60 and 80 per cent of the productsÊ value (see Figure 2.3). Since
the impressive movement in percentages, the intricacy of the manufacturing
system has been greatly reduced. As can be seen in Figure 2.3, the complexity in
the fabrication operation has been shifted upstream to the supplier. Under the
traditional model, the firm significantly transformed more raw materials and
labour into the end product. Today, as industrial companies are increasingly
sub-assembling (component parts), manufacturing focus shifts downstream to
assembly operations. This significant movement has increased the significance
and profile of purchasing professionals.

Figure 2.3: Manufacturing process (1980s–now)

Source: Srivastava & Benton (1998)
The expected economic advantages from the formation and continuous

development of a combined purchasing and supply management process is
supply chain profit maximisation. The global economy has expanded from
entirely manufacturing to services. Thus, it is important to show how the lesson
learned from manufacturing supply management can be applied to service
systems purchasing. The differences between service supply management
systems and traditional supply management systems must be acknowledged. In
service supply management systems, human capital forms a significant source of
the value proposition. In addition, it is more challenging to measure value in
service supply management.

Although many productive companies have embraced the just-in-time (JIT)

philosophy, continuous MRP concepts are needed to enhance the effectiveness of
the manufacturing mission. Perhaps the most important change in the past decade
has been in purchasing.
ACTIVITY 2.2
In the myINSPIRE forum:

(a) Discuss the steps you would take if you are a purchasing manager.
(b) How would you increase the efficiency of the production process
through purchasing functions?
2.3 TYPES OF PURCHASES

Organisations buy many different goods and services. All purchases represent a
trade-off between what an organisation can make itself compared to what it must
buy externally. The make-or-buy decision is quite simple for many items.
Moreover, some organisations can manufacture the items. All organisations need
items to support their operations. The challenge is to decide which suppliers
present the best opportunity for items an organisation must purchase externally.
There are several types of items and they are as follows:
(a) Raw Materials – These are parts that go into the production process, usually
the inputs of production;
(b) Semi-finished Products and Components – These are parts called

work-in-process (WIP), which need further processing before it becomes
finished goods;
(c) Finished Products – These are parts that have gone through transformation
process into a complete set of output;
(d) Maintenance, Operating Items and Repair – These are parts that are kept for
maintenance, operations and repair. They are not in abundance but are
essential for the production manager to utilise when there is a disruption;
(e) Services – These are parts that need servicing, which production has to
address;

(f) Production Support Items – These are parts that are crucial for production
managers to keep, for example, tooling in the production floor;
(g) Equipment of Capital – These are machines that are highly capital intensive
in the production floor. These heavy machineries need to be maintained so
that they can operate at peak performance; and
(h) Transportation and Third-party Purchasing – These are logistics issues that
management has to take seriously. Replenishment of parts require
constant transportation so that inventory is kept at a minimum. Third-party
purchasing utilises third parties to make payment for the services rendered.
2.4 IMPROVING THE PURCHASING PROCESS

The future outlook is that the significance of dollar-valued purchases will resume
to be the central focus. This shift is also the result of increased computer-based
management information systems. As companies become lean, centralised
purchasing will become the main focus. Long-run agreements will be more
regularly compromised to stabilise prices. A recent study shows how
organisations are improving the purchasing process by reducing the effort and
time by lowering the value of goods and services. There are many efforts to
improve the purchasing process, for example:
(a) Online Requisition Systems from User to Purchaser

Most organisations use internal online requisition systems to order products
or services. These systems save time and are more efficient for purchasers.
E-purchase systems give access to purchasers to buy from local and overseas
sources. The e-purchase system also enables the organisation to capture data
in a very efficient manner, thus saving money for the organisation.
(b) Procurement Cards Issued to Users

The use of procurement cards also saves time and money for organisations.
The card system works well when there are no established suppliers.
Therefore, purchasers can use the cards to organise non-established
suppliers for future references. The primary benefits of procurement cards
are faster response to user needs, reduced transaction costs and reduced
transaction time.

(c) Electronic Purchasing Using the Internet

Using the Internet to purchase products generates a diverse set of activities.
E-commerce-based purchasing activities include the following:
(i) Transmiting PO to suppliers;
(ii) Tracing status of order;
(iii) Enabling quotation to be provided online;
(iv) Placing orders with suppliers becomes efficient;
(v) Enabling payment to be made through electronic transfer; and
(vi) Establishing electronic data interchange capability.
(d) Online Ordering Systems to Suppliers and Electronic Catalogues

This is a logical approach for online purchase since there can be a blanket
purchase order agreement or long-term contract with the supplier.
Advantages of online ordering systems include:
(i) Immediate visibility of back-ordered items;
(ii) Reduced order cycle time;
(iii) Reduced order errors;
(iv) Capability to track order;
(v) Speedier order acknowledgement from supplier; and
(vi) Ability to perform multiple batches from single online order.
(e) Electronic Data Interchange (EDI)

EDI can help eliminate some steps involved in the traditional
communication flow and this will reduce time and cost. EDI is a standard
communication, which supports inter-organisational communication.

ACTIVITY 2.3
Discuss the following with your coursemates in the myINSPIRE
forum.
(a) How do companies improve their purchasing methods for low
valued items?
(b) What types of purchase products or services do companies
usually source? Provide examples from the automobile and
F&B industries.
• The purchasing process does not start until someone recognises a problem within
the organisation, which can be completed by purchasing a good or service.
• There are a variety of purchases that a typical purchasing department is

responsible for buying.
• Supply management exists to explore business opportunities and implement

supply strategies that can convey the most possible value to the organisation,
its suppliers and its customers.
• Much efforts to improve the purchasing process have been made over the past
several years to improve low value purchasing activities.
Centralised purchasing Purchasing administration

E-procurement Special purchasing applications
Integrated purchasing Stakeholders
Materials management Supply management process
Purchasing

Antonette, G., Sawchuk, C., & Giunipero, L. (2002). E-purchasing plus (2nd ed.).
New York, NY: JGC Enterprises.
McGraw-Hill Irwin.
practice. Journal of Business Logistics , 35(3), 165–171.
Srivastava, R., & Benton, W.C. (1998). Purchase quantity discounts and open order
rescheduling in an assemble-to-order environment: The hidden economic
trade-offs. European Journal of Operational Research, 110(2),
261–271.
network. Upper Saddle River, NJ: Pearson.

Topic  Purchasing
3 Policy and
Procedures
LEARNING OUTCOMES
1. Explain purchasing policy;
2. Describe policy and procedure manual; and
3. Identify purchasing procedural areas.
 INTRODUCTION
Purchasing involves all procurement processes including leasing and hiring, and
may include, where appropriate, other activities that accompany the product life
cycle (or service contract) and disposal of the final goods acquired (whether or not
they remain in our possession). A purchasing policy is legally binding where
individuals are concerned and is also considered a corporate authority. Violation
of a wilful policy or an unauthorised release of the procedure derived from such
a policy can be considered a disciplinary offense.
ACTIVITY 3.1
Conduct an Internet research on what is considered a disciplinary offense
for breach of a purchasing policy. Discuss your findings in the myINSPIRE
forum.

28  TOPIC 3 PURCHASING POLICY AND PROCEDURES
3.1 POLICY OVERVIEW

Policy means the set of purposes, principles and rules of actions that guide
companies in the purchasing process. Purchasing policies and guidelines are
written for individuals with departmental and governmental responsibilities in
purchase and payment activities of the company. The standard contains references
to the state code of that company which governs the purchasing and payables
processes. The purchasing department should welcome any such policy or
procedural inquiries.
A typical purchasing department is responsible for the extensive purchase of

materials and supplies. Based on the sales volume, employee numbers and the
functional sophistication, the purchasing procedure can be either difficult or easy.
In many cases, large divisional companies like IBM, Ford and Toyota typically
start a systematic set based on their overall corporate missions.
The driving force behind any corporate purchase policy takes into account the
following:
(a) Wise corporate financial spending;
(b) Defined top management objectives;
(c) A framework for decision consistency and action;
(d) Defined rules and procedures that apply to all staff;
(e) Managing purchases professionally;
(f) Buying the right materials in the right quantity, at the right time and price
from the right source; and
(g) Implementing the highest ethical standards to ensure that confidence is
achieved between all parties.
The responsible application of the professional purchasing principles listed can

positively and dramatically influence company expenditure, supplier goodwill
and employee cooperation.
ACTIVITY 3.2
Write a brief policy statement that presents a position on the need to
utilise more diverse suppliers. What are the features or characteristics
that your policy statement should have? Discuss with your tutor and
coursemates in the myINSPIRE forum.

TOPIC 3 PURCHASING POLICY AND PROCEDURES  29
3.2 PURCHASING POLICY AND

RESPONSIBILITIES
Effective policy serves as a guide that is action-oriented, meaning it provides a
comprehensive description of the path to a specific goal. Applying the principles
of professional purchasing helps ensure that quality goods and services are
delivered timely at a price that minimises the companyÊs overall cost and provides
the supplier with a reasonable profit.
Purchasing management develops policies to provide guidance and support for

purchasing and professional support staff. These policies outline the purchasing
managementÊs position on the subject. Although there are many purchasing
policies, they are typically derived from the following five categories:
(a) A policy that defines the role of a purchase;
(b) A policy that defines the conduct of the purchasing personnel;
(c) A policy that defines social and minority business objectives;
(d) A policy that defines buyer-seller relationships; and
(e) A policy that defines operational issues.
Companies will also develop policies to ensure their unique operating needs. It is
the companyÊs objective to buy products and services based on the merits and
needs of the company, regardless of the source. The overall requirements include
the balance of cost, timeliness, quality, technical suitability and a variety of
economies of scale. Most purchasing policies will include information on how to
use a purchase order to purchase goods or services. Employees are responsible
for completing purchase orders, obtaining management approval and
submitting the documents to the purchasing department.
Companies can use a purchasing policy to improve the quality of goods and
services in the company while reducing acquisition costs. The purchasing
manager will always consult with the vendor or carry out an offer activity that
will allow the vendor to participate in the project proposed to them by the
company.

The following are the responsibilities of those in charge of purchasing:

(a) To achieve the companyÊs goals and objectives by ensuring that the best
value is guaranteed in a fair, transparent and timely purchase of goods and
services;
(b) The purchasing aims focus on the procurement department. The manager of
the procurement services is in charge of supervising the purchase of all
supplies, equipment and services including rental of equipment needed by
the company;
(c) Only the procurement department is authorised to carry out the companyÊs
purchasing activities financially, except in circumstances where this control
has been specifically assigned by the vice president, administration and
finance managers;
(d) In the case of a supplier receiving an order from an individual or department
that does not refer to the official purchase order number, and subsequently
payment of the invoice, payment cannot be made for the order received from
the unauthorised source because it does not have a purchase order;
(e) The company is maintained primarily by funds and all suppliers are allowed
to submit their tender when the company is in the market for competing
goods and services;
(f) As the principal of the government, orders and contracts will be given to the
bidder who best suits the company;
(g) The purchasing department of the company will consider the impact on the
environment in which the product or service is available, and will suggest
replacement or alternative solutions;
(h) The authority for environmentally responsible purchases is from the initial
purchase to the disposal; and
(i) Purchasing will be in force alongside government rules and controls as well
as considering how they will affect the company.
Management in any company must understand the art of acquiring products and
services. The procurement cycle comes after specific steps to identify the needs or
requirements of the company to the final step of the product or contract.
Responsible management of public and corporate funds is essential when
handling this necessary process, regardless of whether it is in a difficult or weak
economic market. Following a proven step-by-step process will help management
achieve its goals. Figure 3.1 shows the purchase order cycle (procurement cycle
standard documentation):

Figure 3.1: Purchase order cycle (procurement cycle standard documentation)


ACTIVITY 3.3
Why is it important to include a policy that outlines the origin and scope
of purchasing authority? What might happen if such a policy did not
exist? Discuss with your tutor and coursemates in the myINSPIRE forum.
3.3 POLICY AND PROCEDURE MANUAL

Procedures are detailed operating instructions or tasks and the procedure manual
is the manual that shows the purchasing process. A large purchasing department
may have hundreds of procedures detailing acceptable practices for carrying out
an activity. It is beyond the scope of this discussion to give a brief overview of the
purchase procedure, mainly because there is no uniform principle to guide the
development of the purchase procedure. Each organisation develops a unique
operating order to meet its specific needs.
The procedure manual serves several important purposes. Firstly, this manual is
a guideline for purchasing personnel and is very valuable for new employees who
need clarification on how to fulfil various tasks or activities. For experienced staff,
the manual provides clarification and strengthens knowledge of different topics.
Secondly, the manual provides consistency and instructions by documenting the

steps and activities needed to carry out the task. Documented procedure manuals
support efficient operation and are generally more comprehensive and detailed
than policy manuals.
With reference to the typical purchase order cycle as shown in Figures 3.1 earlier,
let us now consider a simple example of the purchasing practices for a medium-
sized company in purchasing 2,000 three-hole binders:
(a) Work area included: Purchase Department
(b) Material need: Three-hole binders
(c) Specifications: Three holes, inside pocket, company logo
(d) Point of requirement: Purchase Department
(e) Procedure: Purchasing Manager determines the need for the binders and
provides a material request.

This type of simple transaction is repeated daily in most companies. The typical
practice of this type of transaction is an important motivation for building system
contracts. However, this example shows the distinction between buying and
purchasing. Overall, the buying process refers to purchasing goods and services
for use through purchasing organisations. Buying usually means getting
something for resale. Naturally, the terms are sometimes used interchangeably.
A particular documentation for the procurement cycle is shown in Figure 3.2.
Information for the third purchasing purpose becomes evident when the material
requirements arise as follows for our example:
(a) The right material: Vinyl three-hole binder
(b) The right quality: Standard
(c) The right quantity: 2,000 units
(d) The right place: Purchase department
(e) The right time: Immediate

Figure 3.2: Procurement order cycle standard procedure (documentation)


Thus, based on the above characteristics specified by the using department

manager, the main purpose of the purchasing department is to:
(a) Decide the supplier;
(b) Discuss the real price; and
(c) Decide the date of delivery.
This process is also used for other items, not just binders. What other items can we
use this purchasing method? More than 75 per cent of a companyÊs procurement
activities are common. Unfortunately, many companies spend 75 per cent of the
time buying low value common supplies. This level of commodity purchasing
involves automation. All purchasing professionals must understand the
information of the standard purchasing cycle.
When the requirements, for example, for the binders are clear, the supply of the
binders will be refilled from the training material storage area. The storeroom
attendant is normally in charge of maintaining inventory levels. Many storerooms
are full of low value items and 90 per cent of store transactions are for low value
materials related to non-productive needs. Purchasing of supplies from company
storerooms in most situations is a relatively easy process. A three-digit number is
normally used to post the order charge. Because of human handling of the request,
it is difficult to maintain record and budget accuracy. The cost of the manual
purchase system may also lead to productivity losses. For example, if each of the
30 employees makes three round trips to the store, we could estimate some
productivity loss. Assume that each employee takes an average of 20 minutes
(including waiting time) and with a labour cost of 10 dollars per hour, the total
cost is 300 dollars per day (30 hours × 10 dollars).
Materials and supplies are usually received by the procurement department in less
than 24 hours. Subsequently, the inventory system will be upgraded. This process
is continued until a set point of restructuring has been set and the replacement of
the storeroom takes place. A travel request is used to request a recurring supply.
Source of supply, previous costs settled and order quantity are some of the
information on the travelling acquisition. Many purchasing departments also
serve as surrogate procurement operations.
In summary, it is simple to see that even with the most developed system,
purchase activities can be expensive and imprecise.

3.4 PURCHASING PROCEDURAL AREAS

There are procedures to deal with in almost any areas that involve a purchase.
Existing procedures normally document the steps you should follow during each
stage of the cycle or purchase process.
3.4.1 Legal Contract Procedures

The development of a legal purchase contract may require dozens of pages and
descriptions of many topics. Most organisations have specific procedures for
contracting with suppliers and outsiders for goods and services. It is the
responsibility of the purchasing staff to know and comply with the procedures
involved in the legal contract. Some of the topics covered in the legal contract
procedures include the following:
(a) Standard purchase contract basic features;
(b) Basic contract principles;
(c) Execution and administration of agreements;
(d) Essential elements of the contract;
(e) Compliance with contract terms and performance assessment;
(f) Formal competitive contracting procedures;
(g) Contract development process;
(h) Examples of sample agreements;
(i) Legal definitions; and
(j) Use of formal contract clauses.
3.4.2 Operational Procedures

Operating procedures provide instructions and details across a wide range of
topics. It is advantageous to follow a certain set of steps, requiring consistent
actions to promote efficiency and consistency or to perform functional or executive
policy directives. The following topics on operational procedures appear in a
Fortune 500 company materials manual:
(a) Authority of the materials provided to the supplier;
(b) Storage of purchase documents;

(c) Supplier eligibility process;

(d) Use of purchase computer systems;
(e) Competitive quotations analysis;
(f) Single source selection usage;
(g) Requirements for pricing and order analysis;
(h) Cost analysis procedures;
(i) Acceptable cost reduction techniques and documentation;
(j) Intra-company transactions;
(k) Processing and handling of over-shipments;
(l) Purchase order acknowledgement provider;
(m) Disposal of purchased material; and
(n) Transfer of company-owned appliances from suppliers.
The topic on buying procedures is broad and general. Yet, a powerful set of
procedures can lead to an effective professional purchase. Procedures serve as a
ready reference for various queries. They also ensure that employees follow the
same basic steps when performing the same tasks.
ACTIVITY 3.4
What about the concept of ethics in purchasing policy and procedures?
Do you think that the purchasing profession would/should be
particularly sensitive in this context? Discuss with your tutor and
coursemates in the myINSPIRE forum.
• Understanding policies and procedures is important to know how an

organisation operates.
• A policy is based on the idea that guidelines are documented and apply to all
internal and external relationships in an organisation.

• As organisations grow their global sourcing activities, they also review their
purchasing policy and procedures in order to make sure that they keep abreast
of the rapid associated changes.
Accounts payable Purchasing policy

Materials or supplies Purchasing procedures
Price cards Purchase requisition
Procedures Requisition
Procurement Storeroom requisition
Policy Travelling requisition
Purchasing
McGraw-Hill Irwin.
Baumer, D. L., & Poindexter, J. C. (2002). Cyberlaw and e-commerce. New York,
NY: McGraw-Hill.
Baumer, D. L., & Poindexter, J. C. (2004). Legal environment of business in the

Information Age. New York, NY: McGraw-Hill.
Handfield, R., & Edwards, S. (2006). Minority supplier development: WeÊre not
there yet. Inside Supply Management, 17(5), 20–21.
Ketchen Jr, D. J., Crook, T. R., & Craighead, C. W. (2014). From supply chains to
practice. Journal of Business Logistics, 35(3), 165–171.

Topic  Organisation for
4 Effective
Purchasing and
Supply
Management
LEARNING OUTCOMES
1. Explain the position of the purchasing function within an
organisational structure;
2. Identify factors affecting the position of the purchasing function;
3. Explain how the purchasing function is organised around
purchasing activities;
4. Explain the activities involved in organisational boundary
spanning; and
5. Compare the advantages and disadvantages of centralised,
decentralised and hybrid purchasing systems.
 INTRODUCTION
Purchasing is an important activity in any organisation and must be managed
efficiently and effectively. Organisational effectiveness is accomplished through
efficient purchasing and best practices. This topic discusses the determinants of
the purchasing function in facilitating organisational effectiveness.

40  TOPIC 4 ORGANISATION FOR EFFECTIVE PURCHASING AND
SUPPLY MANAGEMENT
4.1 POSITION OF PURCHASING FUNCTION

WITHIN ORGANISATIONAL STRUCTURE
Purchasing refers to an organisationÊs attempt to obtain goods or services to fulfil
its objectives. Few organisations strive to establish guidelines in the purchasing
process. Lyson (2006) and Oakland (2012) stated that even if purchasing is clearly
a crucial area of managerial activity, it is being overlooked by many organisations.
Prior to the current practice, the norm has been for the purchasing executive to
report to the production and operations manager. Only recently has purchasing
entered the boardroom and is involved in the strategic decisions of the
organisation. The purchasing function has changed drastically and purchasing
executives now report directly to the president, group vice president or among
those in senior positions in the organisation. The higher the purchasing executive
is in the corporate structure, the greater the role purchasing plays in supporting
organisational objectives.
ACTIVITY 4.1
Why is a functionÊs position in the organisational hierarchy important?
Discuss with your coursemates in the myINSPIRE forum.
4.2 FACTORS AFFECTING THE POSITION OF

PURCHASING FUNCTION
Let us now go through the factors that affect the position of the purchasing
function in the organisation.
(a) History
Up until recently, organisations placed less emphasis on purchasing. The
purchasing position was not considered an important function. In recent
years, however, this trend has begun to reverse. Gradually, organisations
started to develop policies and procedures that enabled the purchasing
function to have a more direct impact on cost and, thus, impacting the
operational bottom line. Top management today understand the importance
of involving the purchasing function in strategic decision-making.

TOPIC 4 ORGANISATION FOR EFFECTIVE PURCHASING AND  41
SUPPLY MANAGEMENT
(b) Type of Industry

Some industries are not as driven by materials or external technological
changes compared to others. The need to continually innovate and improve
always puts material-related activities at a higher level than those of mature
industries or those with a history of purchasing as low-level functioning. In
a rapidly changing industry or where goods and services are purchased
covering a significant portion of the cost of a product or service, management
generally recognises the need to position the purchasing function higher in
the organisational hierarchy.
(c) Total Value of Goods and Services

Companies, such as Honda, spend 60 to 70 per cent of their sales dollars on
purchased goods and services. In the computer and telecommunications
industries, companies such as Solectron, IBM, Cisco, Hewlett-Packard and
Sun depend on suppliers for parts as well as new technology, which means
that purchasing plays a key role.
SELF-CHECK 4.1
What are the factors that contribute to the increasing importance of
purchasing within the organisational hierarchy?
4.3 ORGANISING THE PURCHASING FUNCTION

Each functional group and department has its own organisational structure. Purchasing
departments in large organisations usually group themselves to support specialised
purchasing activities. They are usually grouped into four major areas:
(a) Sourcing and negotiating;
(b) Purchasing research;
(c) Operational support and order follow-up; and
(d) Administration and support.
4.3.1 Purchasing Department Activities

Department purchases are now more than just purchases of traditional materials,
parts and services. Purchasing responsibilities are expanding to reflect the
importance of purchasing and the contributing performance of suppliers. The
responsibilities are usually performed by modern purchasing groups. However,

SUPPLY MANAGEMENT
not all purchasing departments carry out these activities. The trend is for more of
the activities to become part of the purchasing departmentÊs responsibility. Some
of the purchasing departmentÊs activities are as follows:
(a) Buying;
(b) Expediting;
(c) Inventory control;
(d) Transportation;
(e) Managing countertrade arrangements;
(f) Outsourcing/insourcing;
(g) Value analysis;
(h) Purchasing research or materials forecasting; and
(i) Supply management.
SELF-CHECK 4.2
List and briefly discuss the purchasing departmentÊs activities you have
just learnt about.
4.4 PLACEMENT OF PURCHASING

AUTHORITY: CENTRALISED VERSUS
DECENTRALISED PURCHASING
Centralised purchasing involves coordinating all purchasing activities for the
whole organisation through one central location. That means purchasing
department is the only place in the company where suppliers are decided and
requests are processed. In decentralised purchasing, control and responsibility for
supply-related functions are dispersed across the organisation.
4.4.1 Advantages of Centralised Purchasing

In most cases, centralised purchasing decisions are based on a lower cost because
of the reduced quantity of the purchase. If most uses of the materials are associated
with an important purchase, the supplier will work harder to serve the purchasing
company. Huge dollar purchase quantities are equivalent to buying power. Most
manufacturing companies spend most of their total income on materials and
components. Therefore, the effectiveness of a centralised organisational structure
will have an important effect on profit. For example, consider a company with
SUPPLY MANAGEMENT
multiple departments that use the same components, they can actually fight
against each other for limited materials or buying separately in smaller quantities,
resulting in higher prices for each department.
Centralised purchasing promotes the effective use of purchasing professionals as

it equips managers with more power and credibility. Each buyer can become a
specialist for associated purchases (commodities and non-commodities). Expertise
will be develop when there is an acute mass. GM and IBM use centralised
purchasing and have in-house expertise for purchases ranging from engine parts
to rental cars to office equipment to pharmaceuticals.
Centralised purchasing enables the buying company to do a better job of

monitoring various changes across the industry. Centralised purchasing is also
involved in the purchase of periodic reviews and training programmes. In
decentralised purchasing, this important strategic activity cannot be achieved.
Centralised purchasing is more preferable from a supplier's point of view. The

selling company can decide whom to contact. This enhances efficiency for both
parties. According to a recent study by the Centre for Advanced Procurement and
Supply (CAPS), 59 per cent of companies used a combination of centralised-
decentralised structure while 28 per cent used centralised purchasing and only
13 per cent of the companies responded used decentralised purchasing.
4.4.2 Disadvantages of Centralised Purchasing

There are several arguments against centralisation. Most of the resistance comes
from companies where there are decentralised profit centres. The three main
arguments are as follows:
(a) High engineering involvement in procurement decisions. In the early stages
of product development, engineers would have had to be engaged with the
design team;
(b) High demand for coordination of purchased parts with production schedule.
This is especially true when small numbers are ordered frequently. The
supply company must be attached to the geographical distance or JIT
delivery guarantees. It may not be cost effective to have a centralised
purchase operation based on some JIT conditions;
(c) High demand purchasing for the local community. Sometimes, it makes
good political sense for a company to make a purchase in the community in
which the plant is located; and
(d) Given the profit-maximising emphasis, profit centre managers feel the need
to control their purchases if they are to take responsibility for their profits.
SUPPLY MANAGEMENT
4.4.3 Advantages of Decentralised Purchasing

Decentralised purchasing prepares for further streamlined processes based on the
department managerÊs purchasing requirements and decisions can be made
straightaway. As an example, if a manager needs to buy 10 laptops for the business
unit, the unit manager can just make the purchase online or from a local computer
store.
4.4.4 Disadvantages of Decentralised Purchasing

The downside of decentralised purchasing is that there might be duplication of
efforts in purchasing, receiving, inspection and accounts payable. Decentralised
purchasing also prevents the buying organisation from taking advantage of the
discounted pricing for higher quantity purchases.
4.4.5 Centralised-Decentralised Hybrid Purchasing

System
Some organisations maintain a hybrid system that combines both centralised and
decentralised purchasing. They use centralised purchasing for certain inter-
organisational purchases but give individual business units the autonomy to buy
small purchases for their subsidiary or department.
Table 4.1 summarises the advantages and disadvantages of the three approaches:
Table 4.1: Advantages and Disadvantages of theThree Approaches in Purchasing

Decentralised Hybrid Purchasing Centralised Purchasing
Purchasing System System System
Advantages Business Business responsiveness, Increased cost savings,
responsiveness increased leverage in enhanced talent management,
some processes consistent processes
Disadvantages Loss of leverage, Priority given to business Significant focus on cost
lack of consistent requirements, difficult to savings, less focus on business
sourcing process control and coordinate requirements
activities
Example of Major highway Universities Major retailers, automotive
organisations construction manufacturers, and
technology-intensive
organisations

SUPPLY MANAGEMENT
4.5 BOUNDARY SPANNING

Boundary spanning is an attempt to involve activities that are focused at bridging
one or more recognised organisational boundaries to ease the stream of
information across such boundaries. There have been many instances over the
years where boundary spanning has happened and benefitted the organisations.
The term was created after World War II. The development has been faster and
more organised where boundary spanning was used.
There are three ways that boundary spanning can be used by an organisation. They
are as follows:
(a) In the Department – As an individual, a worker can approach another

individual from the same department to resolve a complicated situation. For
example, a salesperson communicates with a senior salesperson to solve a
problem. The limitation in this example is just the difference in their seniority
in the organisation and it must not be a barrier to their work.
(b) In Business Units – There can be details and resources switched in strategic
business units. The most common example can be seen in advertising and
marketing costs which are usually limited by the different business units in
an organisation. These units will synchronise within themselves to utilise the
budget properly. For example, the R&D unit may cooperate with sales
unit, product management could coordinate with service and others.
(c) With Other Businesses – Often this boundary is created when two different
businesses need the same thing. For example, if two businesses have the
same customer and the customer needs something different, then the
business can work with each other to offer better solutions.
TodayÊs purchasing department do more than traditional buying. The role of

purchasing has expanded to include global purchase. The responsibility of
purchasing goes beyond the local boundaries. The following are the boundary
spanning activities of purchasing:
(a) Buying
It involves acquisition of raw materials, components, finished goods or
services from suppliers. The purchase can be a one-time purchase or
intermittent purchase. The buying process requires supplier evaluation,
negotiation and selection.

SUPPLY MANAGEMENT
(b) Expediting
It is a process of personally or electronically contacting suppliers to
determine the status of overdue shipments. The use of enterprise systems
such as ERP can assist in expediting and inventory control.
(c) Inventory Control

Monitor day-to-day management of inventory. It helps organisations to
balance inventory for short-term and long-term objectives.
(d) Transportation
Purchasing plays a role in the evaluation, negotiation and final selection of
transportation services and carriers.
(e) Insourcing/Outsourcing
Purchasing evaluates whether a new or existing purchase requirement
should be internally/externally sourced. Purchasing also needs to conduct a
simple analysis on cost estimates and to source for qualified suppliers in the
marketplace.
(f) Value Analysis

It is a continuous improvement methodology developed by Larry Miles at
General Electric during the late 1940s. It studies the functions of value and
cost. The objective of value analysis is to enhance value by reducing the cost
of goods and services without sacrificing quality, enhancing functionality
without increasing cost, providing greater functionality to the user above
and beyond any increase in cost.
(g) Supply Management

It is a progressive approach to manage supply. Purchasing professionals
work directly with suppliers in providing superior performance. Supply
management involves purchasing, engineering and supplier quality
assurance.
• The purchasing function is an important activity in any organisation and must

be managed efficiently and effectively.
• Organisational effectiveness can be achieved through other means of efficient

purchasing function.

SUPPLY MANAGEMENT
• Factors that affect the important position of the purchasing function in the
organisation are history, type of industry and the total value of goods and
services.
• Management should organise the purchasing function in a method that is

intended to fulfil the purchasing objectives of the management.
• Organisational purchasing can be organised according to a centralised,

decentralised or centralised-decentralised hybrid purchasing system.
• Boundary spanning is an attempt to involve activities that are focused at

bridging one or more recognised organisational boundaries to ease the stream
of information across such boundaries.
Boundary spanning Materials or supplies

Centralised purchasing system Procurement
Decentralised purchasing system Purchasing authority
Hybrid purchasing system Purchasing function
McGraw-Hill Irwin.
Chase, R. (2006). Operations management for competitive advantage (11th ed.).

New York: McGraw-Hill.
Anderson, J. A. (2002). Organizational design: Two lessons to learn before

reorganizing. International Journal of Organization Theory and Behavior,
5(3–4), 343.
Johnson, P. F., Leenders, M., & Fearon, H. (2006). SupplyÊs growing status and
influence. Journal of Supply Chain Management, 42, 38–48.

SUPPLY MANAGEMENT
Leenders, M. R., & Johnson, P. F. (2002). Major changes in supply chain

responsibilities. Tempe, AZ: Center for Advanced Purchasing Studies.
Lyson, T. A. (2006). Big business and community welfare. American Journal of

Economics and Sociology, 65(5), 1001–1023.
Oakland, J. (2012). Oakland on quality management. London, United Kingdom.

Routledge.
Handfield, R., & Edwards, S. (2006). Minority supplier development: WeÊre not
there yet. Inside Supply Management, 17(5), 20–21.

Topic  Pricing and Cost
5 Analysis
LEARNING OUTCOMES
1. Explain how suppliers establish price;
2. Identify the methods used for price determination;
3. Explain how to document a price analysis; and
4. Identify the cost analysis within the supply area.
 INTRODUCTION
One of the most essential and difficult decisions that a company deliberates on is
how much to pay for its services and items. Purchasing experts are in charge of
these tough decisions. Pricing decisions should be carefully deliberated on when
buying industrial services and products. The experts have to take into account,
among other things, all the costs of production, marketing and promotion, and
distribution before determining the price of the companyÊs goods and services.
Basically, the price of a product or service is determined based on the various costs.
5.1 HOW SUPPLIERS ESTABLISH PRICE

There are many ways to determine the price. Establishing pricing strategies takes
a lot of effort. The biggest challenge is running on low operating profit margin.
Other challenges are setting the right price for your products and ensuring that the
pricing strategy does not turn customers away.

50  TOPIC 5 PRICING AND COST ANALYSIS
The following are factors to consider for distribution companies:

(a) Fixed and variable costs;
(b) Competition;
(c) Organisational business objectives;
(d) Organisational proposed positioning strategies;
(e) Organisation target group; and
(f) Willingness to pay.
Based on the five factors mentioned, the following are the five pricing strategies
for companies to consider:
(a) Competitive Pricing/Price Matching

Competitive pricing is setting the price based on what the competitor is
charging. This pricing method is usually used once the products have
reached the level of equilibrium. A company may set the price below, at or
above the competition, each with their own benefits. Above-competitor
pricing requires companies to justify the premium pricing while setting it
below competitors will have the company absorbing the loss in return for
more product purchases.
(b) Cost-based Pricing

This is similar to cost-plus pricing but it also considers other factors such as
market conditions when setting prices. This type of pricing is useful for
companies in industries where the price changes regularly but still base their
price on costs. There is usually a range of price that the company sets and
subsequently decides a price within that price range after taking into account
the various factors.
(c) Psychological Pricing

Psychological pricing should either strike a note with the thrifty person with
respect to a good bargain or bring up feelings of pride and prestige with
higher-priced items. One method is to use odd pricing strategy such as
ending the price with „.99‰, for example, instead of RM8.00, the price will be
RM7.99. In this way, customers will perceive that it is cheaper than RM8.00
even though the difference is only one sen! Another method is bundling of a
few items with a cheaper price. Yet another method is offering flash sales that
gives a temporary discount so it evokes a sense of urgency with a deadline
attached to the discount eligibility.

TOPIC 5 PRICING AND COST ANALYSIS  51
(d) Value-based Pricing

This is about determining how much money or value the product or service
will generate for the costumers. It includes factors such as increased
efficiency, convenience, time saving, happiness or stability. It provides real
„willingness to pay‰ which points the company towards a profit generating
price and allows for price segmentation to capture a greater portion of the
market. Value-based pricing is the most recommended pricing technique by
consultants and academicians.
(e) Penetration Pricing

Penetration pricing sets a low initial introductory price, which is much lower
than the intended future price in order to attract customers. This in turn
generates word-of-mouth recommendation due to the attractive pricing. In
the short term, it will result in lower profits but will allow for significant
profitability benefits and market share in the future. This pricing is used for
new product launches but it has its drawbacks. It may create an expectation
of permanent low price or attract customers who are looking for a bargain. It
also risks retaliation from established competitors.
5.2 METHOD OF PRICE DETERMINATION

Price determination is the purchasing expertÊs responsibility. The purchasing
expert has to ensure that he is familiar with the market conditions and that the
pricing elements are linked to the quality required for the buying organisationÊs
needs in order to get the best price. For the effective buyer, he must become a
specialist for the items that he is buying. An effective buyer in a competitive
environment may buy goods and services purchased at a market price that
provides the right delivery, quality and quantity. The company will become less
competitive if they buy half the items at market price without having the right
quality, delivery or quantity. Price is important but other variables are included in
the purchase decision.
Price determination becomes the most crucial competitive weapon required to

ensure endurance in the business environment. Most companies tend to use up a
bigger percentage of their income for the acquisition of goods and services. Ten
year ago, manufacturing companies produced more than 60 per cent of component
parts in-house but today, more than 70 per cent of the component parts are
purchased from external suppliers.
Price indicates more than profit and cost. Price decisions must be based on the
level of competition and buyer-seller relationship. The competitive pressures of
price should consider the quantity of sellers in the market and the general

environment of the economy as shown in Figure 5.1. For buying firms, the change
in the number of buyers, the number of sellers and general economic conditions
will affect price determination.
Figure 5.1: Competitive pressure

ACTIVITY 5.1
Why should a purchaser evaluate the cost of producing an item instead of

simply evaluating the purchase price? Is this true for all types of products?
5.2.1 The Purchasing Decision

The aim of the purchasing department is to purchase the right materials from the
right supplier at the right time and at the right price. Sometimes it fails to consider
the interaction between the various variables, although the purpose seems simple.
Perhaps the most important factor that accompanies the purchase decision is the
work environment and the power imbalance between the buying and supplying
companies. There are examples where the supplier will participate in short-term
strategic pricing in order to obtain market share or to throw unwanted items. If
there is a need, buying at a competitive market price is a better business decision
to make. However, if the provider cuts costs to keep the door open, it may offer
poor service and may adversely affect the ability of the company to meet market
demand.
The purchasing expert must be ready to analyse each significant buying situation
on the basis of conceptual and economic effect of many buying decisions. The
decision maker needs to investigate at least two potential sources of supply at the
analysis phase. The purchasing process needs continuous monitoring and
adjustments to the changes in the operations environment. Purchasing experts
must have enough understanding of economics and psychology in order to
survive as effective buyer.

5.2.2 Price Setting Strategy (Economics and

Psychology)
There is no magic formula for setting the price for goods and services. Price setting
will be differ from one industry to another. For example, the price setting appears
to be firm and precise for the chemical industry but for the computer industry, a
more responsive market-based approach is needed.
In the short term, the company can sell its products lower than its total cost but at
the same time, the company will be required to make profits or else it has to close
its business. In other words, cost-based methods cannot do well in a competitive
market if the product is unacceptable to the buying company. Typically, a smart
buyer will perform a price-cost analysis by differentiating the cost and price from
two or more suppliers.
SELF-CHECK 5.1
1. How is pricing included in the negotiation process?
2. Discuss the purchasing decision.
5.2.3 Market Approach

The market pricing is the most popular method because of the competitive
situation in which buyers are requesting extra service and quality. Market pricing
is the focus of both the selling company and the buying company. Buyers will be
able to adopt a range of competitive priorities based on real needs at market price.
In addition, the buying company must decide whether the purchase price is
appropriate for a competitive cost structure. This is called the target price. It may
be compulsory for buyers to consider applying value analysis methods to products
in need if the target price is too low to generate interest from suppliers.
The purchasing expert must try to foresee changes in the industry in order to
become an effective buyer. The biggest psychological effect in a buyer-supplier
relationship is authority. It is possible that the powerful buyer can force a supplier
to remove its overheads from the ultimate price. The risk for the buyer is that the
supplier might be driven to push for huge price increases in the long term. No
matter how powerful the buying firm is, it should always try to get a fair price and
a good agreement. It will be forced to enter into a new business if the buyer drives
the supplier out of the market.

5.2.4 Costs
The components of the price determination cost can be divided into direct and
indirect costs. Direct cost applies to the actual units of production. Direct materials
and direct labour can be categorised as direct costs. Direct cost is not considered if
the unit is not produced. Indirect cost is connected with non-manufacturing
related costs. Examples of indirect cost are property taxes, insurance and
depreciation expenses.
5.2.5 Discounts
One of the first question that the supplier will be asked by the purchasing expert
is, „How much discount can I get if I buy from you‰. Let us look at some common
types of discounts, which are trade discounts, cash discounts and quantity
discounts.
(a) Cash Discounts

The selling company will offer cash discounts if the payment for goods and
services is immediate. The total cash discount given is based on the industry
and items purchased. For example, if a buying company offers a 4/10 cash
discount, net 40, this means that if the buyer pays the purchased item within
7 days from the invoice delivery date, the seller will deduct 4 per cent from
the invoice price. Cash discount can be easily seen as a reduction onside item
cost and the buyer can consider the cash discount when comparing against
competing suppliers.
(b) Trade Discounts

A trade discount can appear as a compensation for the buyer who removes
a distributor or other intermediaries from the transaction. To protect a
unique selling option, trade discounts are normally used by the
manufacturer by offering the buying company an incentive to purchase
directly from them. In short, the buying company splits the wholesaler profit
margin.
(c) Quantity Discounts

The quantity discount is given to the buyer for big quantity purchases. The
supplier can indicate the quantity discounts based on the increased income
received from selling a larger quantity. There might be savings in
manufacturing and scheduling together with prolonged production runs.
The buying company must review its total cost of receiving a quantity
discount. In particular, the holding cost together with conveying larger
quantities should be compared to the predicted benefit of the discounts.
Quantity discounts must relate to the buying companyÊs cost structure.
5.2.6 Government Influence on Pricing

Sometimes there are situations where the government sets a price on certain goods
and services. The government may determine a range of prices that companies
must follow. The reason that the government would do this is sometimes to
stabilise the price in order to prevent rapid fluctuations of important goods such
as food or make certain goods cheaper to allow more people to be able to afford it.
At times, it is to make some goods become more expensive in order to help a
certain sector of the economy to be more profitable. Taxation by the government
is also used to influence how pricing will be set for consumers as companies
usually pass down the tax to their customers.
5.2.7 Bidding and Negotiations

Bidding and negotiations between suppliers and companies have an impact on
price as a result of factoring into the cost of production and overheads. Thus, the
process of negotiations with vendors must be done to ensure the best price possible
so the savings could be passed on to the customers.
5.3 DOCUMENTING A PRICE ANALYSIS

It is important to use market analysis to understand the factors that influence the
level of pricing in a particular market. There are variables that directly and
indirectly affect the price of an item, namely:
(a) Market structure;
(b) Economic conditions; and
(c) SellerÊs pricing strategy.
Purchasing companies must consider the price variations associated with

purchasing high price components to understand the various design specifications
and affiliated costs. In addition, the buyer must obtain a reasonable cost
comparison based on the same equipment or productÊs data history or based on
his experience in the industry. To make a careful approximation of the estimation
cost is a good practice for buyers. A per unit cost estimation must be made after
conducting research and analysing the production process.
Multiple requests for proposals (RFPs) must be submitted at the same time.
Initially, using a RFP would have a lower cost estimate than the estimated
in-house price.

Examples of proposals and solutions are given in Table 5.1 and Table 5.2.
Table 5.1: Example of Price-Cost Analysis Solution I
Expenses Company A Company B

Direct labour hours 6 hours 7 hours
(DLH)(average)
Hourly rate $5/hour $4.50/hour
Direct labour cost (DLC) 6 x $5 = $ 30.00 7 x $4.50 = $ 31.50
Direct materials cost $10.00 $10.00
(DMC)
Tooling cost (TC) $2.00 $3.00
Manufacturing overheads 50% x DLC = $15.00 75% x DLC = $23.62
(MO)
General and 5% x (DLC + DMC + TC + 7% x (DLC + DMC + TC +
administration expenses MO) = $2.85 MO) = $4.78
Total cost $59.85 $72.90
Profit 7% x Total cost = $4.19 5% x Total cost = $3.64
Selling price $64.03 $76.54
(a) Direct labour for Company A is probably too high and to reconcile Company
AÊs labour cost, certain measures should be made.
(b) The tooling cost for Company B is too high and the buyer must negotiate a
change.
(c) The manufacturing overheads for Company B is remarkably higher than

Company A. This matter must be discussed and the buyer should ask for the
relevant data to support the claim if the selling company insists on the rate.
Before agreeing to perform the audit process, the supplier might make some
adjustments (see Table 5.2).

Table 5.2: Example of Price-Cost Analysis Solution II
Expenses Company A Company B

Direct labour hours 6 hours 6 hours
(DLH)(average)
Hourly rate $4.50/hour $4.50/hour
Direct labour cost (DLC) 6 x $4.50 = $ 27.00 6 x $4.50 = $ 27.00
Direct materials cost (DMC) $10.00 $10.00
Tooling cost (TC) $2.00 $2.50
Manufacturing overheads 50% x DLC = $13.50 75% x DLC = $13.50
(MO)
General and administration 5% x (DLC + DMC + TC + 7% x (DLC + DMC + TC +
expenses MO) = $2.62 MO) = $3.71
Total cost $55.12 $56.71
Profit 7% x Total cost = $3.86 5% x Total cost = $2.84
Selling price $58.97 $59.54
Lastly, think about the buyer who buys on motivation. There will be an urgent
competitive disadvantage if a buying company fails to negotiate. Price-cost
analysis is an essential information in the negotiation process. The negotiation
process is a practice or learned behaviour. Both the buyer and the seller must win
in order to negotiate effectively.
SELF-CHECK 5.2
1. What are the elements of price analysis?
2. Explain why price analysis is often overlooked by purchasing

managers.

5.4 COST ANALYSIS WITHIN THE SUPPLY AREA

More organisations are turning their attention from price management to cost
management. By doing so, there might be an opportunity to minimise cost which
is not available when the discussion only focuses on price. There are a few cost-
based pricing models available, as explained in the following:
(a) Cost Margin Pricing Model

The supplier easily takes the estimated costs and adds a mark-up percentage
to derive the required profit. The mark-up percentage can only be added to
the product cost (normally only includes direct materials, direct labour plus
production overheads), in which case the mark-up would have to provide
for profit, plus all other indirect costs of operating the business.
However, if the mark-up is applied to total costs (product costs plus general,
administrative and sales costs), then the mark-up would benefit the supplier.
Example:
A supplier who wanted a 20% mark-up over its total cost of $50 would quote
a price of $60 ($50 + (20% of $50) = $60), which would leave a profit of $10.
(b) Margin Pricing Model

The supplier is still attempting to obtain a profit related to its cost but the
supplier establishes a price that will provide a profit margin that is a
predetermined percentage of the quoted price instead of adding a mark-up
to the cost.
Equation:
Cost + (Margin rate × Unit selling price ) = Unit selling price
Solving the equation for unit selling price results in the following formula:
Cost/(1 – Margin rate) = Unit selling price

(c) Rate of Return Pricing Model

The desired profit is added to the estimated cost. The supplier bases the profit
on the targeted specific desired return on the financial investment, instead of
on the estimated cost.
Example:
If the supplier wanted a 15% return on its investment of $400,000 (which
might include R&D, equipment, engineering and other elements), in order to
make 3,000 parts with a total cost of $45 each, the quoted price would be $65,
using the following approach:
Unit cost + Unit profit = Unit selling price
$45 + ((15% x 400,000) / 3,000) = $65
• Price determination is one of the crucial decisions that a successful company

must make.
• The purchasing expert must become an expert on the product or services that
he is responsible for and must be prepared to conduct an analysis process
based on the conceptual and economic effects of various buying decisions.
• It is important to use market analysis to understand the factors that influence

the level of pricing in a particular market.
• There may be opportunities for minimising costs that are not available when
discussions focus only on pricing when performing the cost analysis.

Cash discounts Price-cost analysis

Competitive pricing Pricing strategy
Cost-based pricing Psychological pricing
Cost margin pricing model Quantity discounts
Direct costs Rate of return pricing model
Indirect costs Trade discounts
Margin pricing model Value-based pricing
Penetration pricing
McGraw-Hill Irwin.
Dubois, A. (2003). Strategic cost management across boundaries of firms.

Industrial Marketing Management, 32(5).
Ketchen Jr, D. J., Crook, T. R., & Craighead, C. W. (2014). From supply chains to

Topic  Technology
6 and
E-procurement
LEARNING OUTCOMES
1. Explain how computers are used in purchasing and supply
management;
2. Describe how efficiency is improved through technology usage;
3. Discuss the application of e-procurement; and
4. Explain e-commerce and global supply management.
 INTRODUCTION
The development of information technology (IT) and communication technology
in purchasing and supply management is an important aspect in optimising
decisions in the supply chain network flow for achieving organisational
competitiveness, lowering inventory, improving higher service level, and also
reducing supply chain costs and electronic risks. To enable integration and
effective information sharing through and beyond the organisation, IT is needed
in purchasing and supply management. Organisations are moving towards a
virtual supply chain with the help of rapid changes in technology and IT
applications. Such applications include electronic data exchange (EDI), radio
frequency identification (RFID), barcode, electronic commerce, decision support
system, enterprises resource planning (ERP) and many more.

62  TOPIC 6 TECHNOLOGY AND E-PROCUREMENT
6.1 COMPUTER-BASED TECHNOLOGY IN

PURCHASING AND SUPPLY
MANAGEMENT
There are many instances of the usage of computers in purchasing and supply
management today. It has become an integral part of the business transaction. The
following subtopics will discuss some of the computer-based technology that has
become integral in purchasing and supply management.
6.1.2 Electronic Data Interchange

Electronic data interchange (EDI) technology has been widely used by
organisations in supply chain management to facilitate transactions and
information exchanges. EDI is defined as computer-to-computer exchange of
structured data for automatic processing. EDI is used by supply chain partners to
exchange essential information necessary for the effective running of their
businesses. These structural links are usually set up between organisations that
have long-term trading relationships.
The main advantages of using EDI include the speed of transaction; reduce cost
and error rates; quick process of information; good customer service; less
paperwork; increased productivity; improved tracing and expediting; cost
efficiency; and improved billing.
Through the use of EDI supply, chain partners can overcome the distortions and
exaggeration in supply and demand information by improving technologies to
facilitate real time sharing of actual demand and supply information.
6.1.2 Barcoding and Scanners

Barcode is the representation of a series of number or code in a form that is suitable
to be read by machines or scanners. Barcodes are widely used throughout the
supply chain to identify and track goods at all stages in the process. Barcodes
contain a series of different line widths presented in a horizontal order called
ladder orientation or a vertical order called picket fence orientation.

TOPIC 6 TECHNOLOGY AND E-PROCUREMENT  63
6.1.3 Enterprise Resource Planning (ERP) Systems

Enterprise resource planning (ERP) systems are enterprise-wide information systems
that are used to automate all activities and functions of a business. These are transaction-
based information systems that are integrated across the whole business. They allow
data for the whole business to be captured into a single computer package, providing a
single source of information for all the key business activities such as inventories,
customer orders and financial information.
Many companies now view ERP systems from vendors as the core of their IT
infrastructure. ERP systems are enterprise-wide transaction processing tools
which capture the data and reduce the manual activities and tasks associated with
processing inventory, financial matters and information regarding customer order.
ERP systems gain a high level of integration by utilising a single data model,
developing a common understanding of what the shared data represents and
establishing a set of rules for accessing data.
6.1.4 Warehouse Management Systems

Warehouse management systems are systems that control all the traditional
activities of warehouse operations. Areas covered usually include receipt of goods,
allocation or recording of storage locations, replenishment of picking locations,
production of picking instructions or lists, order picking, order assembly and stock
rotation. Some systems are used in conjunction with radio frequency (RF)
communication equipment. This equipment can be mounted on forklift trucks. The
warehouse management system communicates with the RF system and directs the
activities of the warehouse staff.
6.1.5 Transportation Management Systems

Transportation management systems provide more visibility into shipments and
orders. Scheduling issues are also addressed on time. Multiple transportation
options can be explored as a result of earlier visibility into the supply chain. Timely
communication and status reports can also be obtained. By having control on its
supply chain, businesses can make efficient routing decisions.
6.1.6 Inventory Management Systems

Retailers began implementing modern inventory management systems in the mid
to late 1990s. This is made possible by advances in computer and software
technology. The systems work according to a circular flow, from purchase tracking

to inventory monitoring to re-ordering and back again. Modern inventory

management systems must have the ability to track sales and communicate with
suppliers in real time, track availability of inventory and receipt, and incorporate
other data such as seasonal demand. They must be flexible, allowing for a
merchant's intuition. Moreover, they must be able to inform the storeowner how
much to purchase and when it is time to re-order.
6.2 EFFICIENCY IMPROVEMENTS THROUGH

TECHNOLOGY
The use of technology has allowed for improved efficiency in supply management.
One way it does this is through increased control over production. Use of
information technology in supply chain management provides improved visibility
and accountability. In order to see an efficient total production process, it is
important that manufacturing companies have a clear understanding of the
current stage of in-production products, foresee any potential problems or delays
that they might face and be able to align production schedules accordingly. The
use of technology can highlight the necessary transparency in the whole process.
It allows manufacturing companies to have better control over product flow and
information flow across the supply chain.
Another use of technology is to facilitate inventory management. Maintaining an

optimal level of inventory is a challenge faced by all businesses. While excess
inventory leads to risk of wastage and increased need for working capital funds,
low inventory may lead to stoppages in the production cycle and loss of business
through stock-outs. With the use of technology, manufacturers can create
adaptable business processes that provide flexibility to handle varied demand
situations. The analytics will help achieve financial goals with predictable success
by managing inventory and sales orders effectively.
With technology in the supply chain and real-time information sharing,

manufacturers can increase collaboration with their key partners. This is another
way that the supply chain can be efficiently managed. Manufacturers can also
track activities through the whole supply chain, with visibility into supplierÊs end
and distributor processes. Such information can help the manufacturers in making
more informed decisions and better forecast future demand. This helps to control
the manufacturing process and leads to lower costs through more effective
decisions in procurement and contract management.
Timely delivery of product is an important factor in ensuring customer satisfaction.

Higher customer satisfaction levels leads to higher customer retention and repeat
business. Technology solutions can play a vital role in increasing the speed of delivery

and in keeping the customers informed of the product delivery schedule. Processes can
be designed to keep customers informed throughout the process, from order
confirmation to order fulfilment. Companies can also provide a platform for the
customers to track their orders, increasing the customersÊ sense of self-sufficiency and
control while at the same time transferring customer service tasks to the customer, thus
saving manufacturers time and money. Manufacturers can also develop mechanisms to
interact with their logistic providers and get real-time updates on shipments of their
inventory and product delivery.
6.3 E-PROCUREMENT APPLICATIONS

Electronic procurement (EP) is usually defined as the sourcing of goods or services
electronically via the Internet. EP is usually referred to as using electronic means
(the Internet, web, e-mail) to purchase products and services via the Internet. It
includes electronic data exchange (EDI), radio frequency identification (RFID),
barcode, electronic commerce (e-commerce), decision support system, enterprises
resource planning (ERP) package and many others. EP also includes the use of
purchasing cards, reverse auctions or integrated automatic procurement systems
to ease the corporate buying process.
EP means the business-to-consumer or business-to-business purchasing and selling of

supplies and services via the Internet and other information and networking systems
such as EDI and ERP. Kameshwaran (Kameshwaran et al., 2007) perceived EP as „an
Internet-based business activity for securing materials and services, and controlling
their movements into the organisation.‰ Normally, EP Internet pages allow qualified
and registered users to search for buyers and/or sellers of goods and services. Relying
on this method, buyers or sellers may mention or put forth costs or take up offers and
the transaction will then be established and completed.
EP software automates the transactional process. Participating companies can

benefit by decreasing the overheads for the buying agent and enhancing the
manufacturing process. Internet-driven electronic marketplaces (IEMPs) must
allow companies to deal and collaborate more effectively and to produce valuable
savings and revenues for participants and the society as a whole (Larsen et al.,
2003). EP is predicted to merge in tandem with the momentum of having a
computerised supply chain management. EP can be summarised as conducting
procurement activities electronically with suppliers using the Internet.
SELF-CHECK 6.1
List some of the examples of computer-based technologies in
purchasing.

Online or e-procurement technology has become an essential part of purchasing

and supply chain management. Table 6.1 summarises the biggest EP applications
across the supply chain.
Table 6.1: Adoption and Use of E-Procurement Technology (Percentage of Respondents)
Adoption of E-Procurement Types/Systems

At least one e-purchasing technology 39.6
No e-purchasing technology 64.4
E-procurement software 24.6
Internet B2B auctions 5.2
Internet market exchanges 8.2
Internet purchasing consortia 1.5
E-Procurement Uses
Purchasing operations 28.3 Obtain price quotes/bids from 1.4
Inventory management applications 23.1 vendors
Purchases from catalogues 17.1 Vendors raw materials stock levels 0.0
JIT delivery programmes 9.4 Production scheduling applications 1.4
Communicate with vendors 15.3 Provide vendors information from 0.7
queries
Communicate out-of-stocks situations 13.9
Coordinate schedules with 0.7
Negotiate with vendors 2.1
vendors/field depots
Track orders and ship-date delays 4.2
Vendor ratings on overall 1.4
Check vendor price quotes 18.6 performance
Manage supply inventory levels 6.3 Exchange data with vendors/field 0.0
Warning damages/expiration notification 0.7 depots
Field warehouse/depot inventory levels Process returns/damage products 1.4
0.0 Coordinate with JIT vendors 0.7
Transportation applications
2.9 Ratings of on-time carrier 1.4
Emergencies affecting inventory
4.7 performance
Pickups, regionals distribution centres
1.4 Coordinate schedules with affiliated 1.4
Field depots on out-of-stocks situations
0.7 units
Drop offs, regional distribution centres
1.4
Ordering processing applications
1.4
Monitors on-time arrivals of carriers
0.7
Monitors vendor order efforts
0.0
Manage claims and overall performance
0.7
Check vendor credit
0.0
Vendors deliveries to depots
0.7
Likert scale: 1 =Totally disagree; 5 = Totally agree. Adopters versus non-adopters: p Ì 0.001

6.3.1 Advantages of E-procurement

In the real world, e-procurement (EP) is better in enhancing supply chain
management to a higher tier, preparing real-time data to the vendor as requested
by the customer. One example is that the vendor can automatically ship materials
to its customer when the customerÊs stock level is low. Thus, the customer does
not need to request for it as it is stated in the agreement or contract.
Advantages of EP can be summarised as follows:
(a) Decreased Costs

EP is used across suppliers. It centralises tracking and decreases cost for the
buyer. This allows companies to keep track of cost reductions on an ongoing
basis as well as to recognise and identify any gaps. It also helps to ensure
contract submission and execution of scorecards, contribute to higher
savings and increase efficiency from suppliers.
(b) Operational Execution

EP helps to automate internal procurement activities such as purchase order
tracking, RFX events and supplier estimation, leading to higher operational
productivity. As these activities can be completed without human
interference, it can reduce transaction time and help speed up downstream
activities.
(c) E-catalogues and Standardisation Growth

Electronic catalogues make supplierÊs product offers obtainable
electronically and provide price and product information to buyers.
Suppliers are moving towards offering a more standardised product along
with the increased popularity of these catalogues, giving buyers the potential
to compare offers with other suppliers more easily.
(d) Internal Integration

EP removes information asymmetries and enhances collaboration within
internal departments, giving maximum value to companies. EP also reduces
engagement turnaround time by making reusable templates available,
moving as a repository of current supplier contracts and decreasing the time
usage in recurring tactical processes with increased automation in order to
simplify the procurement activity.
(e) Increased Data Accuracy

Streamlining will decrease the risk for error when the process runs
electronically. The repository of documents makes it easy to refer to earlier
orders and contracts in order to ensure contract conformity, therefore,
increasing data accuracy.

(f) Global Procurement

EP applications support different languages, currencies and logistics
selections, making it easier to source materials and products from various
countries throughout the world. Web-based procurement would link the
buyers to suppliers all over the world, giving access to a broad range of
services and products to select from. The EP system conforms to make
workflows standard and this decreases divergence from procedure.
6.3.2 Disadvantages of E-procurement

The biggest disadvantage of EP is that suppliers could possibly take advantage of
buyers given the fact that they have way more information about the customer
than during a normal supply chain management. The growth of global
cooperation, vertical disintegration and focus on core process have led to the
impression that companies are connected in a network supply chain. This strategic
viewpoint has created a problem of coordinating efficiently with the whole supply
chain, from upstream to downstream processes (Chen & Paulraj, 2004).
Poor execution of EP has cost companies billions of dollars and can result in serious
consequences, often leading to destructive shortages of supplies and delays
because of over-reliance on technology.
SELF-CHECK 6.2
1. How has the Internet changed the purchasing function?
2. What are the advantages and disadvantages of purchasing

technologies?
6.3.3 Electronic Data Interchange

Electronic data interchange (EDI) is the direct computer transmission of orders and
other transactions of information. EDI is normally used for payments between
buyers and sellers, invoiced using electronic transmission of orders. The important
elements of EDI systems are computer software, hardware, subscription to a
network and computer compatibility between the seller and the buyer.
Advantages of using EDI are many. For example, EDI can assist in retaining a
valued trading customer and possibly get new customers for smaller companies.
Meanwhile for bigger companies, the main advantage is cost savings.

A simple example of what EDI can do for a company is when a buyer takes a
request from an individual from an organisation, makes a purchase order (PO) and
mails it to the supplier to take charge and ship the purchase. This process can be
expedited by the buyer when he enters the PO into the computer interface. Based
on the traditional way, the company will collect the order on that day and only
submit the order at the end of the day. On the other hand, the EDI system and
software enable the order to be morphed into a standard format and translate the
order directly to the supplierÊs system that can be accessed by its partner. The
supplier needs to have a computer to receive the communications and messages.
The information received has to be converted into a format that can be read once
the data is received. The data is useless if the format of the data is not the same.
Usually, the trading groups in the industry would have developed the format of
the data that would allow various systems to communicate with each other.
The main advantage of using the EDI is decreased labour requirement especially
in terms of handling the documents. This will free up time for data analysis. EDI
also contributes to higher information quality due to the reduction of errors during
data entry as well as enhancing long-term relationships between customers and
suppliers.
However, there are also risks in using EDI. Even though the EDI itself is not
expensive, the training and machine cost will add up to a big amount, which can
cost a company more than what it can save.
SELF-CHECK 6.3
1. What is EDI?
2. How has EDI changed the purchasing function?
6.3.4 Radio Frequency Identification

Radio frequency identification or RFID is a technology that uses radio waves to
recognise, identify and track items. Examples of the items are products, animals,
persons and containers; all can be tracked and identified using RFID. The RFID
technology can be built in various ways but the most common procedure is to
retain a serial number in the microchip and attach it to the antenna that is being
coiled. Using this process, the inlays or RFID is produced.
Inlays in production applications can be made directly into the product, attached
with adhesive paper to form smart labels or integrated into packaging in a number
of ways. The radio waves from the tags are decoded into data and transformed
into information from the readersÊ conversion devices although they are of
different designs. Many of the problems associated with barcoding can be solved
through the production of these tags and implementation of various
infrastructures, for example, readers and the RFID software. RFID systems can
provide many benefits for companies, suppliers and retailers, namely reducing
labour costs, easing business process, improving the control of inventory,
decreasing shrinkage and increasing company sales.
However, some of the disadvantages of RFID include the high cost for readers,
usually ranging from USD1,000 upwards. Companies that intend to implement the
RFID system may need to buy thousands of readers to cover all their facilities,
stores and warehouses. RFID tags are also quite expensive. The active tags use
battery for coverage and for other functions, this can cost more than the price of
passive tags.
To use RFID, companies must ask themselves many questions before

implementing the system. For example, does the company need RFID to keep track
of its competitors? Are there any advantages that the RFID company can offer?
Can RFID save the company money in the long term?
Therefore, to implement a RFID system, the company must understand the basic
elements of the system. EDI implementation can determine the success or failure
of the project. Training is crucial in the planning stage of the RFID implementation
and strong support from the top management of the company is needed.
6.4 IMPLICATIONS FOR PURCHASING

TodayÊs enhanced and automated business solutions require businesses to remain
flexible and open to the adoption of new technology that can optimise the way
benefits are delivered to both internal and external stakeholders. The use of smart
analytics and technology can bridge the gap between the value created from
strategic sourcing initiatives and the bottom line. The high degree of granularity
offered by advanced technologies enhances business agility, drives continuous
process improvement and supports an operating model that advances business
excellence within the procurement and supply chain functions.
Better metrics for procurement, contract compliance, process efficiency and

invoice accuracy should be identified in order to bring about best-in-class
procurement and enhanced supply chain capability and resource management.

Technology can also help usher in successful strategy execution on the business
level when the competitive advantage of an organisation is properly identified.
This is because procurement and supply chain leaders can more readily tie cost
drivers to the value proposition in order to eliminate wasteful processes.
Technologies are able to promote a synergetic relationship between different
business units such as procurement, IT, legal and finance, allowing for better
collaboration and budget control.
Lean process improvement, derived from the symbiosis created between business
units through the implementation of technology can also alleviate universal pain
points. This is achieved through the use of real-time dashboards, document
sharing and tracking software, e-signature capability and standardised workflows
for optimised business operations. In turn, this establishes stakeholder confidence
that will drive more reliable information, providing the foundation for additional
insights, enhanced engagement and more effective governance.
Although a robust talent management plan is needed to deploy more advanced

technology such as artificial intelligence and blockchain, recruiting high-calibre,
change-oriented professionals with business acumen, creativity and a strategic
mind-set as well as a strong background in business analytics will far outweigh
the cost of having such individuals on board.
By streamlining tactical activities to free up capacity for strategic sourcing,

procurement and supply chain functions can significantly enhance the overall
source-to-pay experience. E-sourcing tools for instance are commonly used to
bring about faster negotiation and contract cycles, better supplier relationships,
increased efficiency and accelerated revenue from cost savings.
6.5 E-COMMERCE AND GLOBAL SUPPLY

MANAGEMENT
The rapid change in computing service systems, information and communication
technologies (ICT) during the 1990s has significantly changed the way companies
are using logistics and supply chain operations to attain competitive benefit. This
has led to the emergence of the e-commerce system (Turban et al., 2015). Obtaining
competitive benefits in e-commerce means discovering a balance of the right item
price, delivery time and customer service. E-commerce involves innovative and
extremely scalable e-commerce platforms (Chen, 2012). The effect of e-commerce
deals with both business-to-consumer (B2C) and business-to-business (B2B)
transactions. Simply put, e-commerce is managed via the Internet which includes

products, payment, trading, services and other economic activities. There is also a
merger of inter-company and intra-company functions, in which financial,
physical and information flow of the supply chain are impacted by e-commerce.
E-commerce makes use of communications such as EDI, electronic ordering

system, file transfer, e-mail, video conferencing and interaction with a remote
computer to enhance the efficiency in the activities of logistics and supply chain.
It also improves the entire supply chain management decision function. E-
commerce is also connected to tools and solutions such as e-marketplaces, portals,
e-auctions and virtual inventory.
Logistics and supply chain operations have been affected irreversibly by the
e-commerce process. Hence, the likelihood of bigger changes could take a lot
longer to happen. For organisations, the inclusive goals of e-commerce involve the
following (Yang, 2012):
(a) Expanding worldwide sales network and logistics infrastructure to support
efficient online order fulfilment;
(b) Providing enterprises with information and data from different business
activities, sales and production information to resolve difficult problems and
decrease market entry connection that helps organisations open up the
market to reduce the movement of goods;
(c) Decreasing the cost of sales and reducing the transaction cost of goods;
(d) Assisting negotiations for all trading and online materials;
(e) Supporting online purchasing including secure online payment systems;
(f) Providing the most dependable quality assurance; and
(g) Supplying customers with the most appropriate way for receiving their
purchases.
6.5.1 E-Commerce Trends

E-commerce is changing both B2C and B2B transactions. The percentage has
doubled during the past three years, thus companies are developing strategies so
that they can gain an advantage from these changes. Establishing an online
existence is one of the main ways to give companies an opportunity to grow. Many
physical retailers have begun to create and multiply their online presence.
A platform for e-commerce does not only enable Internet transactions but also
helps in stabilising the development of an online connection.

In recent years, the arising trends of using e-commerce systems have been a topic
of discussion. The following are several e-commerce trends in logistics and supply
management:
(a) Cloud Computing

Consists of four basic service configurations, namely Software-as-a-Service
(SaaS), Infrastructure-as-a-Service (IaaS), Platform-as-a-Service (PaaS) and
Supply Chain-as-a-Service (SCaaS). The cloud user can access a software
application hosted by an external provider over the Internet in a SaaS
configuration, for example, Google Apps and Salesforce. PaaS configuration
can be described as a virtual platform which includes the usage of an
externally provided infrastructure to host applications such as Apprenda
and Google App Engine. IaaS produces a virtualised computing resource
through the Internet such as Cisco Metapod, Amazon Web Services and
Google Compute Engine. SCaaS is a framework for service-oriented Supply
Chain Management such as HCL SCaS and OpenPMF SCaaS.
(b) Mobile Applications

Customer shopping habits have changed because of the increased use of
mobile devices. Constant developments in the tablets, smartphones and
handheld devices have increase the total time that customers stay online and
the possibility of them shopping online. With the emergence of the Internet
in our daily life activities and decreasing data charges, customers can access
mobile applications easily and shop from any locations such as the airport,
home, cafe or even while waiting for a service delivery. Organisations are
investing in optimisation of mobile platforms in order to allow customers to
enjoy a smooth shopping experience through their sites.
(c) Customisation for Customer Engagement

Customising a customer experience is an important customer engagement
tool and is driving e-commerce development. Brands are growing more
advanced in their ability to gather information about customers and using
this information to convey personalised recommendations, customised offers
and delivering distinct experiences with the increasing trend towards online
shopping.
(d) Big Data

Big data is the outcome of web and e-commerce activities. Special market
transformations have been achieved by leading e-commerce vendors such as
E-bay and Amazon via innovative and highly scalable e-commerce platforms
and product recommended systems. Google, Amazon and Facebook (the
main Internet organisations) continue to lead the growth of cloud
computing, web analytics and social media platforms.

(e) Social Networks

Social media has proven to be an effective platform for customers to
communicate and give opinions about products and brands as well as for
businesses to connect with their customers (DHL, 2015). Social media plays
a crucial factor in e-commerce platforms.
• Organisations are approaching the virtual supply chain due to the presence of
rapid development of technology and IT applications such as electronic data
exchange (EDI), radio frequency identification (RFID), barcode, electronic
commerce (e-commerce), decision support system, enterprises resource
planning (ERP) package and many more.
• E-procurement is becoming an important part of purchasing and supply chain

management.
• E-commerce utilises ways such as EDI, electronic ordering system, file transfer,
e-mail, video conferencing, interaction with a remote computer to enhance the
efficiency of activities in logistics and supply chain, and to improve the whole
supply chain management decision function.
Purchasing Radio frequency identification

(RFID)
E-catalogue
Global supply management
Information technology (IT)
Business-to-business (B2B)
E-procurement (EP)
Business-to-consumer (B2C)
E-commerce
Cloud computing
Electronic data interchange (EDI)
Social networks

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Larsen, C. W., Hirst, E., Alexandre, C., & Vincent, J.P. (2003). Segment boundary
formation in Drosophila embryos. Development, 130(23), 5625–5635.
Robinson, A. (2014). E-commerce logistics: The evolution of logistics and supply

chains from direct to store models to e-commerce. Retrieved August 14, 2015,
from http://cerasis.com/2014/04/30/e-commerce-logistics/
Turban. E., King. D., Lee. J. K., Liang, T. P., & Turban, D.C., (2015). Electronic
commerce: A managerial and social networks perspective (8th ed.). New
York, NY: Springer.
Yang, J. (2012). A review of earnings management in China and its implications.

Asian-Pacific Economic Literature, 26(1), 24–92.

Topic  Sourcing and
Supplier
7 Selection
LEARNING OUTCOMES
1. Discuss the phases of the strategic sourcing plan;
2. Explain how to select potential suppliers; and
3. Describe the methods for performance-based evaluation of
suppliers.
 INTRODUCTION
Supply managers and executives are expected to face many challenges in the
future. Companies compete for limited supplies of materials while stockholders
demand for profits from the companies. The internationalisation of the supply
market brings with it challenges. However, the challenges can also be viewed as
opportunities. These opportunities should be pursued but they could also herald
the collapseof companies if there are no proper strategies in place. The function of
purchasing must be combined with the companyÊs strategic planning in order to
take full advantage of the challenges.
7.1 STRATEGIC RESOURCE PLAN

In order to develop a strategic resource plan, companies need to fully understand
their corporate strategy and marketing plan in order to provide a good integrated
purchasing system. This includes studying the existing suppliers, how to measure
the performance and expectations of suppliers in the industry. Furthermore,
companies need to grab the global purchasing opportunities and identify the total
costs that are associated with existing purchasing departments such as functions,

TOPIC 7 SOURCING AND SUPPLIER SELECTION  77
staffing, budgets and so on. The strategic planning team must respond to aspects
related to technological changes, supply sources and specific cost structures.
There are four phases in the strategic resource plan. They are as follows:
(a) Phase 1: Sourcing Audit

The diagnostic process that identifies the opportunities to increase profit is
used by the sourcing audit and it must be systematic, broad and serve to
reconfirm the companyÊs objective, determine how good the current sourcing
strategy is performing and recognise the area that needs urgent management
attention. Some of the issues associated with procedures, policies and the
organisation that should be addressed are as follows:
(i) Senior managementÊs evaluation to identify increased benefits and
profits from the effective sourcing system;
(i) Purchasing departmentÊs effective involvement in long-range
planning;
(i) Interdepartmental communication on the advantages of the joint
sourcing requirements;
(i) Cost effectiveness and the efficiency evaluation of current sourcing
policies;
(i) Cost-effective exploration of current organisational purchasing;
(i) Examination of the advantages and disadvantages of centralised and
decentralised organisation;
(i) Determine if the strategic planning has been carefully developed and
documented;
(i) Purchasing managerÊs support from senior management;
(i) Analysis on whether the process of small purchases are cost effective;
(i) Determine whether it is understandable and adhere to the current
purchasing decision by reviewing the current purchasing manual; and
(i) Promoting purchasing manual compliance by senior management in
the company.

78  TOPIC 7 SOURCING AND SUPPLIER SELECTION
(b) Phase 2 : Organisational Development

In this phase, the company needs to determine the sourcing strategies,
outline areas to reduce cost and increase profit, and develop a sourcing
control system based on continuous analysis and a systematic method. In
addition, incentive programmes and provisions for training need to be
developed by learning from local in-person seminars and in-house sessions
on how to set up the monitoring purchasing system.
(c) Phase 3: Implementation and Evaluation

The plan of the execution and evaluation includes:
(i) Sourcing strategy through indoctrination of the company;
(i) New procedure implementation;
(i) Sourcing process monitoring;
(i) Feedback mechanism development; and
(i) Sourcing process refinement.
(d) Phase 4: In-house Training Sessions

In groups of about 15 persons, the classes should be conducted and attended
by the appropriate purchasing officers and other management personnel
from the organisation. They will learn about negotiation strategy, cost
containment techniques and purchasing techniques.
ACTIVITY 7.1
Discuss how you would implement the four phases of the strategic
sourcing plan with your coursemates in the myINSPIRE forum.
7.2 DISCOVERING AND EVALUATING

POTENTIAL SUPPLIERS
Many purchasing experts would agree that there is no one best way to evaluate
and select vendors. As such, businesses use a variety of approaches. Regardless of
the methodology used, the overall objective of the evaluation process should be to
reduce the purchasing risk and optimise the purchaser's total value.

A company must select vendors with whom it can do business with over a longer
period of time. The degree of selection-related effort should be based on the quality
of the goods or services desired. The method can be an intense undertaking
involving a major resource commitment (such as time and travel), depending on
the supplier evaluation approach used. We will discuss the many concerns and
decisions involved in assessing and choosing suppliers effectively and efficiently
as part of our supply base for customers in the following subtopics.
7.2.1 Selecting Suppliers

One of the strategic issues is the selection of appropriate suppliers for specific
components or materials and the purchasing company must know where to look
for the items. Industry experts for specific raw materials or component parts are
the buyers themselves. There are many sources to consider by buyers before
finding the potential supplier. Valuable sources of information regarding potential
suppliers include trade journals and all other accessible sources through the
Internet.
7.2.2 Supplier Evaluation and Selection Process

Companies must choose suppliers that can do business in the long run. The level
of effort associated with the selection is related to the interests of the goods or
service. Depending on the use of the supplier evaluation approach, the process can
be an intensive venture that requires serious resource commitment (in terms of
time and travel). Figure 7.1 highlights the important steps involved in the supplier
evaluation and selection process.

Figure 7.1: Supplier evaluation and selection process

Source: Monczka et al. (2009)
7.2.3 Strategic Selection

Purchasing, production control, logistics and inventory management are all
connected under materials managements units. They must work together as a
cohesive strategic unit as they need to complement each other. The selection of the
supplier must be based on capabilities in the future, not based on the past
performance. Identical grounds should exist in management styles, controls
systems, technology capability and quality philosophies in order to promote good
amicable relationship between the buyer and the supplier.

7.2.4 Supplier Relationship Management

The development of suppliers is a natural way to further improve the interaction
between the buyer and the seller as the relationship matures. Development of
suppliers is any activity that a buyer undertakes to improve the ability of a supplier
to meet short-term and long-term supply needs of the buyer. Organisations rely
on a variety of methods to enhance supplier efficiency, including exchanging
technologies, rewarding suppliers for improved performance, fostering supplier
competitiveness, providing required resources and directly engaging their
employees with suppliers through activities such as training and process
improvement.
The supply chain management process is based on the idea of teamwork and
coordination of efficient resources. The relationship between supplier and buyer is
increasingly important for many reasons. There is a trend towards contract
manufacturing and specialisation aside from manufacturing the entire product. In some
market segments, it is estimated that 80 per cent of the total product revenue usually
passes directly to suppliers as payments for materials, labour and equipment.
Maintaining a strong relationship between contract manufacturers and suppliers

is crucial for the buying organisation to stay competitive in aggressive market
sectors. The importance of supplier relationship management cannot be
underrated when the business purchases a big percentage of the product value.
Buying companies are under a great deal of pressure from competitors and
customers to remain in the business, therefore, they need to constantly improve
their product, reduce cost, improve service quality and maintain continuous
improvement. Simultaneously, companies will try to decrease their number of
suppliers on their list. Keeping a good relationship between buyer and supplier
will secure a supply of high quality materials from highly qualified suppliers and
the ability for possible cost reductions. Supplier relationship is also important
because of the increasing shortages of skilled suppliers because many of the
commodity and resources will become more expensive to purchase.
7.3 SUPPLIER MEASUREMENT AND

PERFORMANCE EVALUATION
There are two primary categories of supplier evaluation, namely process-based
evaluation and performance-based evaluation. Process-based evaluation is an
assessment of the service process and production of the supplier. Normally, the
buyer will carry out an audit at the supplierÊs site to assess the supplierÊs ability
and to identify non-value added processes that should be removed in order to
enhance the efficiency of the business.

On the other hand, performance-based evaluation involves the assessment of

actual performance of the supplierÊs cost, quality of defect rate and reliability of
delivery. This evaluation measures the day-to-day performance of the supplier
and it is more of a tactical assessment. The performance-based evaluation is a more
common evaluation compared to process-based evaluation because the data is
easily available and measured.
There are three common performance evaluation systems, namely cost-ratio

method, categorical method and linear averaging method. Generally, the guiding
factors will determine which system is the best to be applied in terms of ease of
implementation and system reliability as a whole.
7.3.1 Cost-ratio Method

This method evaluates the performance of the supplier by using a standard cost
analysis. The total cost of each purchase is figured as its selling price plus the buyer
cost of internal operating together with delivery, quality and elements of the
service of the purchase. There are four steps in this approach:
Calculation:
Step 1: Determine the internal costs (quality, delivery, service - see Table 7.1);
Step 2: Convert each to cost ratio (percentage of the value);
Step 3: Add the three individual cost ratios (quality, delivery, service) to obtain
the overall cost ratio; and
Step 4: The overall cost ratio (refer to Table 7.2) is used to obtain the net adjusted
cost figures.
Table 7.1: Example of Performance Characteristics for the Cost-Ratio Method
Supplier: AA
Element Cost ($)
Plant visits 200
Sample approval 25
Incoming inspection 75
Reworking costs 225
Paperwork inaccuracies 100
Lost time due to rejected parts 375
Total additional quality costs 1,000
Total value of purchase 100,000
Quality cost ratio (Total quality cost/Total purchase) 1%

Table 7.2: Cost Comparison Utilising Cost-Ratio Method for Supplier Rating
Quality Delivery Total Quoted Net

Service
Cost Cost Penalty Price/Unit Adjusted
Company Cost
Ratio Ratio
Ratio (%) (%) ($) ($)
(%) (%)
AA 1 3 -1 3 86.25 88.84
BB 2 2 3 7 83.24 89.08
CC 3 1 6 10 85.10 93.61
DD 2 1 2 5 85.00 89.25
Use the net adjusted cost figure as the basis for performance comparison for all
suppliers. All the costs of running a business with suppliers are assessed when
applying this evaluation method. The supplier with the lowest net adjusted cost
will be selected as the best supplier. The benefit of using this cost-ratio method is
that the results are based on cost provided that the other costs must be known.
This method is costly compared with the categorical method. There is a hybrid of
the cost method which is called the total cost of ownership rating developed by
Sun Microsystems Company (Ken, 1991). It consists of five performance factors
which are delivery, quality, price, technology and service.
7.3.2 Categorical Method

This method involves categorising each of the supplier performance in specific
areas that can be defined by a list of relevant performance variables. Each area is
tagged with terms like „neutral‰, „good‰ and „unsatisfactory‰ in order to gauge
the performance of the supplier (refer to Table 7.3). The buyer will discuss the
supplierÊs performance every time they meet. This method is simple and easy as
the detailed achievements of the performance and shortcomings are not measured.
It is mostly used as an evaluation method between top managers in selling and
buying organisations that focus on long-term plans, future planning and past
performance.
The benefit of this evaluation method is that it can be executed immediately.

Moreover, it is cheaper compared to the cost-ratio and linear averaging methods.
The main disadvantage of this method is its user judgment dependence. There is
no strong supporting data as the system depends largely on the personal
experience of what is good or unsatisfactory.

Table 7.3: Example of Performance Characteristics for the Categorical Method
Supplier Cost Product Quality Speed Total

A Good (+) Unsatisfactory (-) Neutral (0) (0)
B Neutral (0) Good (+) Good (+) ++
C Neutral (0) Unsatisfactory (-) Neutral (0) -
7.3.3 Linear Averaging Method

This method is the most commonly used evaluation method. To evaluate the
supplier performance, specific quantitative factors of the performance are used
and the most common are service, delivery, price and quality. For a manufacturer
of complex components like electronics, quality is the most crucial element. Highly
competitive manufacturers use pricing as an element by giving it an equal or
greater value as a weight in the evaluation system. The steps of the linear
averaging method and an example are presented in the following:
Step 1: Assign an appropriate weight to each performance sector. Add up to 100
the total weights of each factor to be used as multipliers for rating the
individuals on each of the performance factors;
Step 2: Individual performance ratings are determined by totalling the score for
each factor;
Step 3: Multiply each performance rating with its respective weight as a
percentage; and
Step 4: The results from Step 3 are added to produce a numerical rating for each
supplier.
Example:
Buyer A wishes to rate its vendors on quality, service and price, and have assigned
each weighting factor of 50, 35 and 15, respectively. Quality is rated as a direct
percentage of the number of acceptable lots received in relation to total lots
received. The service rating is a direct percentage of the lots delivered on time in
relation to totals lots received. In rating the price, the lowest price obtained from
any supplier is used as the base price and prices from other suppliers are rated as
a ratio of this figure. Example of the rated supplier is as follows:

Table 7.4: Example of Linear Averaging Method
Supplier 1 Supplier 2
Quality (weight = 50)
Acceptable lots 50 35
Total lots received 58 40
Quality rating 86.2 87.5
Service (weight = 35)
On time deliveries 52 38
Totals lots received 58 40
Service rating 89.7 95.0
Price (weight = 15)
Lowest price $75 $75
Price submitted $75 $82
Price rating 100 91.5
Total performance rating 89.8* 90.7**
* 89.8 = (0.5 x 86.2) + (0.35 x 89.7) + (0.15 x 100)
** 90.7 = (0.5 x 87.5) + (0.35 x 95.0) + (0.15 x 91.5)
Based on Table 7.4, Supplier 1 is the better supplier. The benefit of this type of
evaluation is that the weight has been stated and it is relatively simple to execute
based on all the performance factors. In addition, this evaluation offers the buyer
a great deal of flexibility in deciding the measured performance factors. If there are
any other performance factors, it can be included in the evaluation system. This
type of evaluation system is relatively inexpensive to execute and constructs
reliable data.
Lastly, the correct supplier selection is a crucial phase in determining whether the
buying company will be making profit or otherwise from the selection.
ACTIVITY 7.2
In the myINSPIRE forum:
1. Discuss the sources of supplier information.
2. Discuss three common supplier evaluation systems.
3. Discuss how supplier selection and evaluation strategy vary in

different industries.

7.4 SELECTION OF INTERNATIONAL

SUPPLIERS
International supplier selection, which is becoming the main strategy in an
increasing number of sectors, is a multi-criterion decision process. The
development of analytical methods for international supplier selection has been
limited compared to methods for evaluating domestic suppliers.
Examples of systematic analyses for international supplier selection are the

categorical method, weighted-point method, matrix approach, vendor
performance matrix approach, vendor profile analysis (VPA), analytic hierarchy
process (AHP) and multiple objective programming (MOP), which focuses on goal
programming. Find out more about this by carrying out research online.
• The supplier selection is a complex and demanding process that has no right
answer. Each company must weigh the advantages and risks of each supplier.
• To develop a strategic sourcing plan, the company must understand corporate

strategies and marketing plans completely in order to prepare a well-
integrated purchasing system. This includes studying the existing supplier, as
well as measuring the performance and expectations of suppliers associated
with the industry.
• There are two primary categories for supplier evaluation which are
performance-based evaluation and process-based evaluation.
• Three common performance-based evaluation systems are cost-ratio method,

categorical method and linear averaging method.

Cost-ratio method Process-based evaluation

Categorical method Performance-based evaluation
Linear averaging method Strategic sourcing plan
International supplier Supplier evaluation
McGraw-Hill.
DÊAvanzo, R. et al. (2003). The link between supply chain and financial
performance. Supply Chain Management Review, 27(6), 40–47.
Handfield, R. (2006). Supplier market intelligence. FL: Auerbach Publications.
Handfield, R., Elkins, D., Blackhurst, J., and Craighead, C. (2005). 18 ways to guard
against disruption. Supply Chain Management Review, 9(1), 46–53.
Monczka, R. M., Handfield, R. B., Giunipero, L. C., & Patterson, J. L. (2009).

Purchasing and supply chain management (4th ed.).Mason, OH, South-
Western.

Topic  Supplier
8 Quality
Management
LEARNING OUTCOMES
1. Discuss supplier quality management;
2. Explain the purchasing role in supplier quality management; and
3. Identify supplier certification and international quality evaluation
systems.
 INTRODUCTION
Supplier quality management (SQM) is a set of activities that is initiated by the
management to improve performance of the organisation. Some of the example of
the activities include computing and tracking the cost of supplier quality through
performance-based scorecards to evaluate supplier performance, managing
supplier audits and developing effective communication lines with suppliers, with
the objective of reaching customer satisfaction (Carr & Pearson, 1999). Forker
(1999) argued that the effect of supplier quality on an organisationÊs performance
is direct and huge. The general understanding is that an organisationÊs quality
performance depends on the quality performance of its suppliers. Many studies
have proven that a supplier is considered to having enhanced its performance of
the purchasing system when it emphasises its buyerÊs expectations.

TOPIC 8 SUPPLIER QUALITY MANAGEMENT  89
8.1 AN OVERVIEW OF SUPPLIER QUALITY

MANAGEMENT
Supplier quality management (SQM) can enhance organisational performance
across the supply chain by reducing operational costs, shortening the process
cycle, purifying quality performance and improving customer satisfaction (Shin
et al., 2000). The supply chain is a set of methods used to efficiently unite
manufacturers, suppliers, stores and warehouses so that merchandise is produced
and distributed to the right location, at the right quantity and at a right time in
order to reduce system costs while meeting all the service requirements (Simchi-
Levi et al., 2009).
A tendency towards supplier development is higher in organisations because the

supplier quality integration is an important aspect of determining quality.
According to Fernandez (1995), supplier quality management (SQM) refers to the
supplier development, supplier selection and supplier integration, which can be
categorised as developing an SQM system together with the management duty as
the lead of the system.
The concept of SQM is a consequence of an increase in strategic practices. These

practices need to be built across inter-organisational boundaries in order to satisfy
both new and existing buyers (Harland et al., 1999). In terms of managerial efforts,
SQM is needed for developing operational surroundings in which a manufacturer
can merge its supplierÊs abilities into its operational processes (Yeung & Lo, 2002).
The managerial effort can be categorised into management responsibility, supplier
selection, supplier development, supplier integration, quality measurement and
supplier audit.
Measuring supplier performance is a crucial means of adjusting management

behaviour and structuring the strategic relationship and operational objectives of
the buyer companies (Paul et al., 2008). The information obtained from
performance measures are necessary for decision makers to control, plan and
manage the ongoing activities of the organisation. It allows managers to weigh
performance, to educate and signal suppliers on the crucial dimensions of
performance, and to manage advancement activities by recognising standard
deviations. Many well-known frameworks have evolved to support these
objectives, including the balanced scorecard (Kaplan & Norton, 1992).
For purchasing managers, the monitoring and evaluation of supplier performance

is also an important responsibility. Traditionally, price is often the most important
factor in supplier evaluation and monitoring. Other factors of performance such
as quality, delivery and flexibility have become increasingly important due to the

90  TOPIC 8 SUPPLIER QUALITY MANAGEMENT
fluctuations of competitive priorities. In order to sustain a strong partnership, the

buyer has to observe the opposing performance through various facets and to
provide reports and suggestions for enhancements. These dimensions may be
intangible like relationship status as well as tangible-like operational performance.
Purchasing managers should also prepare up-to-date information for suppliers
that will show the buyersÊ wants and allow course correction to deal with it, where
necessary.
Many have argued that the measurement structure of convenient performance for
suppliers is enclosed in the concept of the „perfect order‰. The perfect order is
made up of three parts, namely on time, complete and error-free invoice. Many
supermarkets expand this to include correct address delivery, undamaged
product and quality standards conformance. The supplier will have to survey
various other related organisational factors to reach the six mentioned customer-
focused targets.
8.1.1 Methodology
Figure 8.1 shows the relationship between supplier quality management and its
outcomes.
Figure 8.1: Relationship between supplier quality management and its outcomes
The supplierÊs capabilities in quality, cost and new product development (NPD)
should complement the buyerÊs performance capabilities in product innovation,
quality and competitive pricing. The three domains are important because
innovation, cost and quality are core competitive preferences of companies.
Moreover, the resource-based view (RBV) suggests that the ability to select a
supplier with capabilities in strategically critical domains can affect the buyerÊs
performance capability in that same domain. For example, suppliers can improve
the buyerÊs product innovation capability because collectively, suppliers have

wide access to know-how and a great ability to process related information. In

addition, suppliersÊ knowledge and resources in the domains of quality and cost
efficiency can affect the pricing capabilities and quality of the buyer, respectively
(but not the buyerÊs product innovation capability).
The second crucial issue is the supplier integration. Managing suppliers in an

integrative manner may be mandatory to ensure dependability and trust, and to
reduce supply risk (Forslund & Jonsson 2009; Matook, Lasch & Tamaschke, 2009).
Supplier collaboration represents a close and long-term relationship with
suppliers (Lao et al., 2010). Intense partnership and close ties promote
trustworthiness that can reduce concerns about opportunistic behaviour
(Granovetter, 1985), thus increasing the chances of maintaining long-term ties
(Kogut, 1989).
ACTIVITY 8.1
Why should a buyer be concerned with supplier quality performance?
8.1.2 Advantages of Supplier Quality Management

In the past, it was common to have many suppliers for the same raw materials
because of concerns of running out of stock or a desire to pit suppliers against each
other for price reductions. This has given way to working more closely with a
smaller number of suppliers for longer-termed and partnership-oriented
arrangements. The benefits of supplier partnerships include the following:
(a) Working with fewer suppliers will reduce variations in vital process inputs; and
(b) Reducing the requirements for constant monitoring of suppliers and
products if the suppliers have proven to be effective at controlling their
output.
An effective supplier management process requires:

(a) Mutual trust and relationship building to share expertise and resources to
minimise risks;
(b) An understanding of both organisationsÊ unique responsibilities in the
process; and
(c) Support from upper management or executives of both organisations
involved.

8.2 ROLES OF BUYER IN MANAGING

SUPPLIER QUALITY MANAGEMENT
The buyer is the supplierÊs direct customer in a buyer-seller relationship in the
supply chain. Supply managers have to work with engineers and various internal
division personnel to provide precise specifications and clarify performance
requirements with regard to the operation of a product or design and with any
other relevant information that will eventually affect the quality or delivery of a
desired input.
Another essential aspect of this relationship is sharing of end requirements of

product, which at times may be incomplete or too general. Here, the flow to
determine the final requirements has to be developed and agreed between the
supplier and the buyer. Leading quality expert, Keki Bhote argued that inaccurate
communication of specifications has an unbalanced effect on supplier quality.
There are two dimensions in developing a precise knowledge of customer

expectations and requirements. Firstly, it is the ability of the buying party to
precisely identify, define, quantify or specify the sourcing and technical
requirements. Secondly, it is the ability of the buyer to communicate clearly what
his requirements are, so that both sides totally understand the requirements.
Buyers should clearly specify their requirements via the contract negotiation
process, give detailed requests in proposals and hold regular or scheduled
performance feedback meetings, using a system to measure and quantify the
companyÊs performance expectations and requirements. The power of the
supplying company to satisfy requirements is a function of the buyer indirectly
notifying the supplying company of the buying companyÊs expectations.
8.2.1 Deming’s 14 Points

Dr W Edwards Deming, broadly considered to be the father of the modern quality
movement, produced a complete 14-point management philosophy as the basis for
his views on attaining performance excellence in the modern organisation. It is
applicable to service and manufacturing industries as well as government and
education sectors. Despite this, DemingÊs quality philosophy has always been
criticised because it does not dictate specific actions and programmes for
management to comply with. One of the unique features of the Deming
philosophy dictates that all 14 points are necessary and compulsory for successful
implementation of the SQM culture. Let us go over the 14 points now.

(a) Vision Creation and Demonstrate Commitment

Senior managers and executives in the organisation are in charge of directing
the future strategic path of the organisation, which include the mission,
vision and values. They should also consider the social and physical
environments in operation and not just focus on establishing the economic
goals of owners and shareholders.
(b) New Philosophy of Learning

Quality has to be learned continuously throughout the entire organisation in
order to serve as the ubiquitous thread that runs through its structure. The
focus of the Deming philosophy is that the whole organisation must
concentrate in fulfilling customer demands, be it internal or external. Quality
does not only refer to the aspect of manufacturing.
(c) Understanding of Inspection

Since the Industrial Revolution, inspection for defects is the usual process to
ensure quality. The fundamental idea has been that irregularities are unavoidable,
so companies have to conduct inspection to identify them. Deming specified that
the right way to deal with defects is to operate as if the defects never happen. This
requires everyone, from the workers in the production line to the executives, to
understand the concept of process variation and the way it effects each production
process. Disposal effort or rework is also known as the „hidden factory‰ that
decreases productivity and increases cost.
(d) Stop Making Decisions Purely on the Basis of Price

The cheap purchase price of an item might be good for the supply
management department in the short term but can increase costs somewhere
else in the production system over the long term, for example as scraps,
defects, warranty claims and others. The focus should be on minimising total
system costs, not just the purchasing price. The supply manager should
concentrate on building trust, collaborative relationships and supplier
loyalty while enhancing quality in purchased goods and services by working
with fewer suppliers. Communication between buyer and supplier should
also be improved.
(e) Improve Constantly and Forever

The quality-oriented organisation should understand its customersÊ demands
and wants as they grow. Continuous enhancement must be developed into each
single process in the organisation. There is always room for enhancement
regardless if the organisation is a market leader or otherwise.

(f) Institute Training

It is very essential that management prepares its employees and suppliers
with the required skills, knowledge and tools to perform their work
effectively. Training can improve the quality and worker productivity as well
as improve morale especially if the workers are provided with well-
developed and specifically-targeted training. Based on quality, the focus of
training should be to handle diagnostic and analytic tools, as well as improve
decision-making and problem-solving skills.
(g) Institute Leadership

There is a significant gap between leadership and management or
supervision. Managers and supervisors are more involved in employee
supervision and day-to-day instructions. Leadership runs smoothly from
management and supervision by guiding and training employees to improve
their skills and abilities with the goal of becoming more productive and
delivering higher quality.
(h) Drive Out Fear

Fear is obvious in many situations in the workplace. Employees may be
afraid to make a mistake and be punished for it. Many people have a fear of
failure, therefore, they do not want to try anything new or different. They do
not like to make changes to their habits and routines. Managers can be afraid
of letting go of their traditional control-based authority and departments
might not want to cooperate with other departments. Fear-free organisations
are uncommon because it takes a long time to establish a culture that
encourages change and risk-taking. Removing fear encourages employee
and supplier trial-and-error attempts, which can lead towards better
productivity and higher quality processes.
(i) Optimise the Efforts of Teams

When executed and operated correctly, teams can be useful in removing
cross-functional obstacles by including people from different departments
and having them work together on a common activity or project. Working in
a cross-functional or cross-departmental team might actually have the
opposite effect when members build additional obstacles and/or add to
existing ones if they are a dysfunctional team. One of the serious obstacles in
Western organisations that limits the potential effectiveness of teams is the
mutual distrust between unions and management.
(j) Remove Exhortations

Slogans, signs and posters aim to change peopleÊs behaviour. However, they
are rarely effective because most, if not all, quality problems are caused by
human behaviours. „Doing the right thing for the first time‰ and „Zero
defects‰ are interesting motivational slogans, however, they do not help
workers to know what to do or how to do it better. The lack of quality is

based on the innate design and operation of the system that creates goods
and services, not on employee motivation. The systematic changes planned
are management concerns, not labour issues.
(k) Remove Numerical Quotas and Measurement by Objective

Employees can bypass the system and set their production and output goals.
These goals do not provide the necessary incentives for employees or
suppliers to enhance quality. Why would employees stop to fix or adjust a
part of equipment if it means that they will not achieve their production
quota? In addition, many numerically-based objectives are usually random
and outside the control of the employees. Goals should be developed
together with the skills and means to accomplish them.
(l) Remove Barriers to Pride in Workmanship

When given the proper situation in which to work, most people want to do
a good job. Unfortunately, the evaluation and reward systems in many
organisations do not encourage the right type of culture to allow the
employees to take pride in their efforts. As an example, we designate people
to work in teams but reward and pay them based on individual performance.
(m) Encourage Education and Self-improvement

Education and self-improvement are much broader in nature and focus on
enhancing the quality of life of individuals by teaching them new skills and
building higher levels of self-worth compared to training, which aims to
teach skills related to a particular task. Organisations that invest in education
and self-improvement always find that their employees are more motivated
and this brings additional advantages to both the organisation and the
individual in terms of productivity and quality.
(n) Take Action

Top management should invest in ongoing activities that can improve the
quality, productivity and quality of work life. The efforts shown by the
employees of the organisation will ultimately fail if there is no top
management support and commitment. The right support includes
investments in time and finance during the design process, education,
training, reward and compensation systems as well as organisational culture.
The way to succeed is to keep up the momentum over the long run.

SELF-CHECK 8.1
1. Give an overview of supplier quality management.
2. Briefly discuss DemingÊs 14 points on attaining performance

excellence.
8.3 FACTORS IN MANAGING SUPPLIER

QUALITY
Supply management should consider primary organisational quality when
dealing with its external suppliers. Some factors that affect the management of
supplier quality are as follows:
(a) Ability of Supplier to Affect BuyerÊs Overall Quality

Some suppliers provide very critical items for a companyÊs success. Supply
management must manage the suppliers of these critical items more wisely
than those that provide lower or more easily available items or commodities.
(b) Resources Available to Support Supplier Quality Management and

Improvement
Companies with restricted resources and minimum expertise in quality
management and supplier enhancements must choose carefully where to
obtain their resources. The availability of resources will greatly affect the
overall scope of the organisation's quality management efforts. The resources
normally include the staff, budget, time and information technology.
(c) Ability of Buying Organisation to Practice World-class Quality

The buying organisation can help its suppliers to understand the use and
application of techniques, quality concepts and tools only after it
understands and uses these concepts and tools internally.
(d) SupplierÊs Readiness to Work Together to Enhance Quality

Not all suppliers are ready to work closely with the buying organisation.
Rather, some suppliers might select a traditional purchase arrangement
characterised by a finite buyer engagement and a better management style.
Others will vigorously embrace long-term partnership collaboration.
(e) SupplierÊs Current Quality Level

The current level of performance of the supplier affects the amount and type
of attention required by the buying organisation.

8.3.1 Six Sigma Supplier Quality

When total quality was first popularised during the 1980s, many organisations
trained their workers in TQM principles without the appropriate resources or time
needed to modify a culture that believed "close enough is good enough.‰ It was
not a surprise that many organisations failed to reach the benchmark performance
enhancements that they had visualised from the total quality efforts. Moreover,
few purchasing organisations extended their internal total quality efforts to their
suppliers.
The reality that many organisations were disappointed in their total quality
programmes does not mean that we should eliminate the competitive need to seek
total quality enhancement all together. Six Sigma is a new version of total quality
management.
Six Sigma minimises many of the difficulties present in early TQM models. One
expert estimated that TQM involves more than 400 varying techniques and tools.
Six Sigma depends on a fewer number of proven methods and trains people,
known as Six Sigma Black Belts. An example of quality improvement approach
made by Black Belts is the designing of experiments aimed at locating and
removing defects before the final design is set out.
Six Sigma quality applies to supply management in several ways. Suppliers that
operate at 3 and 4 sigma quality levels normally spend between 25 and 40 per cent
of their income on fixing problems. This level of quality does not support longer-
term competitive success in the span of endless cost-reduction pressures. On the
other hand, suppliers that operate at 6 sigma level, normally use less than
5 per cent of their incomes on fixing problems.

Figure 8.2: Six Sigma performance improvement model (DMAIC - D (efine),

M(easure), A(nalyse), I(mprove) and C(ontrol) model)
8.4 SUPPLIER CERTIFICATION AND

INTERNATIONAL QUALITY EVALUATION
SYSTEMS
A supplier certification programme is another prime means of avoiding defects. It
is a formal process of rigorous cross-functional site evaluation to ensure reliability
and conformity to quality is provided by the processes and methods of a supplier.
Certification requires suppliers to demonstrate process flexibility, use of statistical
process control and compliance with other agreed TQM practices. The purpose of
the provider certification is to ensure that non-conforming products do not escape
the facilities of a supplier. Supplier certification usually only applies to a particular
part, process or site, rather than the whole company or product.
Current performance monitoring and measurement methods for the buying and
supply chain contain various steps. Most of these steps fall into two broad
categories, namely measures of effectiveness and measures of performance.
Effectiveness refers to the degree in which the management can achieve a
previously established target or norm by following a certain course of action.

Efficiency means the relationship between planned and actual sacrifices made to
achieve a previously agreed goal. Measures for efficiency usually relate inputs to
a performance outcome.
• Supplier quality management (SQM) is a set of activities that are initiated by

the management to improve performance of the organisation.
• SQM can enhance organisational performance across the supply chain by

reducing operational costs, shortening cycle of the process, purifying quality
performance and improving customer satisfaction.
• To achieve total quality, supply management needs to have those who

understand the principles and tools of TQM including the Six Sigma and must
work effectively with suppliers to make sure that zero defect is the common
situation rather than the exception.
• Supply management can effectively enhance supplier quality practices and set
a standard for excellence through the use of the TQM principles.
DemingÊs 14 points Supplier certification

Quality Supplier integration
Quality Supplier quality management (SQM)
Six Sigma Zero defect

McGraw-Hill Irwin.
Carr, A. S., & Pearson, J. N. (1999). Strategically managed buyer-seller

relationships and performance outcomes. Journal of Operations
Management 17 (5), 497–519.
Columbus, L. (2007). Quality partnerships with your customers. Quality Digest,

44–48.
Evans, J. R., & Lindsay, W. M. (2008). Managing for quality and performance
excellence (7th ed.). Mason, OH: South-Western.
Fernandez, R. R. (1995). Total quality in purchasing and supplier management.

Delray Beach, FL: St. Lucie Press.
Forker, L. B. (1999). Examining supplier improvement efforts from both sides.

Journal of Supply Chain Management, 35(2), 40–50.
Harland, L., & Walker, P. (1999). Supply management: Is it a discipline?

International Journal of Operations and Production Management,
26(7): 730–753.
Kaplan, R. & Norton, D. (1992). The balanced scorecard·Measures that drive

performance. Harvard Business Review, 70(1), 71–79.
Monczka, R. M., Handfield, R. B., Giunipero, L. C. & Patterson, J. L. (2009).

Purchasing and supply chain management (4th ed.). Mason, OH: South-
Western.
Reid, D. R. (2002). Purchaser and supplier quality. Quality Progress, 35(8), 81–85.
Smith, B. (2003). Lean and Six Sigma: A one-two punch. Quality Progress,
36(4), 37–42.
Stundza, T. (2007). Assured quality critical in global sourcing. Purchasing,

136 (11), 32.

Topic  Negotiation and
9 Contract
Management
LEARNING OUTCOMES
1. Discuss supplier quality management;
2. Explain the purchasing role in supplier quality management; and
3. Identify supplier certification and international quality evaluation
systems.
 INTRODUCTION
All purchasing and supply managers must possess negotiation skills, which is
essential for handling their duties. Everyone is engaged in several negotiations
daily, from dealing with other vehicle drivers on the road to interacting with
another company. Negotiation is a very complicated and dynamic process. Many
books have been written and articles penned to recommend how to negotiate
effectively in various situations.
In this topic, we will discuss the concept of negotiation and take a look at the five-
phase process in negotiation. We will also differentiate the types of contracts and
how to construct a supplier and buyer contract.

102  TOPIC 9 NEGOTIATION AND CONTRACT MANAGEMENT
9.1 NEGOTIATION
The most essential process performed by supply managers includes negotiating
agreements or contracts with their suppliers. Even though supply management is
surely not the only group in an organisation that negotiates, negotiation is a core
part of the sourcing process. Negotiation is the perfect way to execute supply
management strategies and plans that a business unit develops. It is also always a
good way to express the buyerÊs specific sourcing requirements and specifications
as the basis of supply.
Negotiation has been defined in several ways. Negotiation is an interactive

communication process that happens whenever we want something from
someone else or vice versa. In another definition, negotiation is the process of
communicating back and forth for the purpose of reaching a mutual agreement
about different requirements or ideas. Negotiation also means decision-making
process by which two or more people agree on how to allocate limited resources.
And lastly, negotiation defined as the final game of the sales process.
In general, negotiation refers to a process of formal communication, be it through

face-to-face or electronic means. This means two or more people work together to
reach a mutual agreement about an issue. Negotiation requires the management
of time, information and authority between individuals and organisations in a
relationship that relies on each other. Every party has demands that usually the
opposing party have or can fulfil. At the same time, both recognise that there is no
straightforward way towards agreement to satisfy those demands.
The crucial aspect of negotiation is noticing that the way forward involves
connections between real people, not just the organisations. Here, each side is
trying to win over the other side to do something that is in its best interest – that is
the central part of the negotiation process. With the right training and experience,
the proper negotiation skills can be learned and improved upon. Negotiators are
not born skilful; they polished the skill through consistent practice and insights
through the years.
A negotiatorÊs position could be reasoned of the opening offer, itself a

representation of the ideal value of the issue currently in negotiation. A position is
the stated demand that is placed on the table by a negotiator. The negotiatorÊs
interest is unstated, it is the underlying reason in any given negotiation position.
The negotiatorÊs underlying interests are impossible to be acknowledged, often
because they might not be directly applicable to the stated position or may be
personal in nature. Hinting at the core interests that is driving the position can
cause a negotiatorÊs authority to deviate towards the other side, making it a less-

TOPIC 9 NEGOTIATION AND CONTRACT MANAGEMENT  103
than-desired result as the outcome. The negotiator should try to investigate and
deduce the other sideÊs interests through a series of open-ended, probing
questions. A negotiator should always try to focus on the other partyÊs true
interests, not their stated position in order to be able to achieve a negotiated
agreement using negotiation principles.
The sharp negotiator must also be able to differentiate between the other partyÊs
needs and wants. Needs are considered to be the negotiated outcomes that the
negotiator should have in order to achieve a triumphant outcome in the
negotiation. On the other hand, wants refer to the negotiated outcomes that a
negotiator would like to have as against to those outcomes that must be
accomplished. Wants can also be exchanged as concessions to the other party
during a negotiation because they are not as acute to reach a successful outcome
in the negotiation. When a negotiator plans a future negotiation, it is essential to
prioritise all the potential issues to be negotiated into needs and wants, by
recognising what must be reached and what can be exchanged for something else
of value.
9.2 FIVE PHASES OF THE NEGOTIATION

PROCESS
The best way to come near a buyer-supplier negotiation is by presenting it as an
interactive, give-and-take procedure with five major phases:
(a) Identify or anticipate a purchase requirement;
(b) Determine if negotiation is required;
(c) Plan for the negotiation;
(d) Conduct the negotiation; and
(e) Execute the agreement.

Figure 9.1 shows the five phases of the negotiation process in more detail.
Figure 9.1: Five phases of the negotiation process
(a) Phase 1: Identify or Anticipate a Purchase Requirement

The purchasing cycle starts with the identification of a material need or
requirement for a component, raw material, service, equipment or finished
product. Often, supply management can identify new requirements during new-
product development in tandem with the different internal customers within the
buying organisation such as operations, marketing, design and/or research and
development. For many existing items, there may not be a requirement to
recognise a supplier because an existing sourcing agreement is already in place.
However, new sourcing requirements usually require supply management to
identify, evaluate and qualify new potential suppliers.
(b) Phase 2: Determine If Negotiation is Required

A common misconception for buyers and sellers is that all purchase
negotiations are closed and detailed affairs. For the most part, a competitive
bidding process will be able to satisfy the needs of the buyers, especially in
the case where an item is of low value or a widely available commodity.
Sometimes there are standards that must be followed.

Negotiation is the way of choice when elements other than the price is the
issue or when the bidding process itself cannot fulfil the buyerÊs
requirements on various issues. In any case, the buyer can still hold a
competitive bidding process to recognise a few other sources of supply. The
buyer may have to initiate negotiation with the selected supplier to settle
other non-price issues that influence the sourcing agreement after
recognising a potential supplier through the bidding process.
The question every supply manager should ask today is, „How much will
the development of information technology systems modify the landscape of
negotiation?‰ For example, how much will reverse auctions, Internet-based
and electronic-based communication media usage modify the landscape of
negotiation due to its different requirements or possibly change face-to-face
communication of parties involved? The use of reverse auctions has probably
minimised the need for face-to-face communication or negotiation between
buyers and sellers. However, it also possible that the item types and services
acquired by reverse auctions do not validate higher-level negotiations in the
first place. In any case, for many items that are important to the buyers or
present many non-price issues, there will still likely be face-to-face
negotiations due to the sensitivity of the negotiations.
(c) Phase 3: Plan for the Negotiation

Negotiation planning includes a sequence of steps developed by the parties
when approaching a negotiation. Normally, negotiations between the parties
are straightforward and often do not need complex preparation and
planning. Sometimes, negotiations prove to be difficult and complicated, and
require months of meticulous preparation. Anyhow, it is always good for
supply managers to plan and prepare for the negotiation as it will usually
give them better results, in comparison to their counterparts who rush into
negotiations with no prior planning. Planning is so essential to reaching the
preferred negotiation results.
New technologies result in a decreasing number of face-to-face negotiations,

be it domestically or internationally. This alternative choice is very attractive
because more companies that participate in global supply management
require international travelling, which can be time consuming (not to
mention expensive); hence travelling can be reduced significantly. In the
future, the way a supply manager plans and conducts negotiations will also
change. More emerging technologies are becoming available for companies
to facilitate negotiations and to discuss issues that go beyond the price with
multiple suppliers, no matter where they are located. These technologies will

enable the buyer the ability to negotiate with more than one supplier at a
time. This brings with it greater competition, which in turn will lead to
greater bidding competence and reduced prices.
(d) Phase 4: Conduct the Negotiation

When a buyer feels confident about the planning level and preparation put
forth, negotiations with a supplier should take place. However, bear in mind
that planning is not an open-ended process; buyers must often meet
deadlines that fulfil the requirements of internal customers within the
buyerÊs organisation. As a result, the buyer feels pressured to begin, conduct
and finalise the negotiation within a reasonable time. Effective planning also
requires hard work like defining the issues, interests, oneÊs own objectives
and analysing the other side, among others.
Choice of location is an important part of negotiation planning. A home

location can give the negotiator many advantages. This is especially true for
international negotiations. Some negotiations happen online rather than
physically. Experts agree that a less formal negotiating environment should
be chosen to establish mutual trust in the relationship and secure a long-term
obligation.
During the negotiation, both sides will present their strategies along with
tactics to accomplish a better outcome. Tactics are the action plans used to
further the desired end results of a negotiation. In the end, both parties will
reach an agreement and conclude their negotiation.
(e) Phase 5: Execute the Agreement

Arriving at an agreement is not the final piece of the negotiation. An
agreement is actually the very start of the contents of the agreement, where
both parties need to fulfil their desired wants and needs that have been
agreed upon during the negotiation. The important part of following through
on a negotiated agreement is to put the agreement into a corporate contract
system so that others within the organisation sphere have visibility of the
agreement. The two parties in agreement should let each other know when
one of them is not meeting the contractual requirements agreed upon during
the negotiation. Both sides should work towards the success of the
negotiation. Implementing the agreement as agreed shall reaffirm the
commitment of the parties to collaborate further in the future.

SELF-CHECK 9.1
1. Why is negotiation such an essential part of the purchasing process?
2. Discuss the resources necessary to support the effective

negotiation planning and execution.
3. Develop a profile of a skilled or effective negotiator.
4. Contrast a win-win negotiator with a win-lose negotiator.
9.3 PLANNING FOR NEGOTIATION

Negotiation experts agree that planning might be the single most crucial part of
the negotiation process. Unfortunately, many negotiators fail to plan and prepare
before entering an official negotiation. A plan is a tool or method designed to
achieve the desired goal. Everyone wants to achieve his desired goals. Thus,
planning is the act of designing appropriate methods to achieve said results. Start
to plan for necessary actions or tactics needed to go through the plan so that
negotiators can execute their plans and strategies. Successful negotiation planning
is about being proactive and contains the following nine steps:
1. Develop specific objectives;
2. Analyse each partyÊs strengths and weaknesses;
3. Gather relevant information;
4. Recognise your counterpartÊs needs;
5. Identify facts and issues;
6. Establish a position on each issue;
7. Develop the negotiation strategy and accompanying tactics;
8. Brief other personnel; and
9. Practice the negotiation.
ACTIVITY 9.1
Discuss the nine steps of a successful negotiation with your coursemates
in the myINSPIRE forum.

9.4 INTERNATIONAL NEGOTIATION

The ability to negotiate beyond culture and language has increased in importance
in international business, especially due to the growth of the industry via
outsourcing and global sourcing activities. A myriad of negotiation skills are
needed to navigate and reach purchase agreements in places where there is a
different culture.
There is an added complication in negotiations with suppliers around the world

due to the fact that different cultures, languages, customs and laws are involved.
A lot of effort and time must be dedicated to plan for these negotiations.
Companies have to plan for translations, travel and other business requirements
so that the negotiations can proceed as smoothly as possible. An important thing
to expect or be wary of during negotiations for global sourcing agreements is
culture shock. Culture shock occurs when negotiators are sent to a place where
their traditional norms are challenged and invalid. In such cases, the values,
beliefs, rules and schemes that the negotiator hold on tightly to might not apply in
the new situation. Consequently, emotions may run high and they may have
greater anxiety and confusion. This willaffect the negotiation process and it might
even reach a dead end.
Various obstacles can change the flow of international negotiations. A major

barrier to good international negotiation involves miscommunication due to
differences in culture, time constraints, language and restricted authority of the
negotiators. Effective international negotiators must show certain personal
characteristics that can help them rise above these complications. These
characteristics include patience, having knowledge of the contract agreement,
being honest, having a polite attitude and being well-informed of the foreign
culture.
International negotiation needs more planning and preparation for a higher

success rate. The level of the negotiation skills will increase over time as the
relationship between organisations in different countries also grow as their
business increases.
ACTIVITY 9.2
Discuss the challenges of international negotiation in addition to those

mentioned in this topic with your coursemates in the myINSPIRE
forum.

9.5 TYPES OF PURCHASING CONTRACTS

Purchasing contracts can be categorised into different types based on their
purposes and characteristics. Mostly, purchasing contracts are based on several
forms of pricing methods and can be categorised into two basic types, which are
fixed-price contracts and cost-based contracts.
(a) Fixed-price Contracts

There are four types of fixed-priced contracts, as follows:
(i) Firm Fixed-price Contract
The most basic contractual pricing method is called the firm fixed price.
In this type of purchase contract, the price stated in the agreement does
not change, regardless of fluctuations in general overall economic
conditions, industry competition, levels of supply, market prices or
other environmental changes. This contract price can be acquired
through any number of pricing processes. Fixed-price contracts are the
simplest and easiest for purchasing to control because there is no need
for extensive auditing or additional input.
(ii) Fixed-price Contract with Escalation
This is a variation of the basic firm fixed-price contract. If the item to be
purchased will be supplied over a long period of time, the probability
that the prices will increase is high. Companies involved might want to
include a clause to increase or decrease the price over time in their
negotiation, leading to fixed-price contract with escalation. Escalation
clauses will allow the base price to increase or decrease based on the
situation at hand.
(iii) Fixed-price Contract with Redetermination
A fixed-price contract with redetermination may be more appropriate
when the parties cannot accurately assume the labour or material costs
and quantities to be used when implementing the purchase agreement.
The buying and selling parties will negotiate an initial target price
based on best-guess estimation of the labour and materials usage in the
manufacturing of a new product.
(iv) Fixed-price Contract with Incentives
The final type of fixed-price contract is the fixed-price contract with
incentives. This type of contract is similar to the fixed-price contract
with redetermination except that the terms and conditions of the
contract permits sharing of cost savings with the supplier. In
redetermination contract, it is difficult for the buying and selling parties
to settle at a firm price due to actual production. If the supplier can

show the cost savings on their end through production efficiency or

substitution of materials, the resulting savings from the initial price
targets are shared between the supplier and the buyer at an agreed
upon rate.
(b) Cost-based Contracts

Cost-based contracts are appropriate for conditions where there is a risk that
a large contingency cost might be included using a fixed-price contract. Cost-
based contracts usually represent a minimum level of risk of economic
mislaying for suppliers but they can also result in minimum overall costs to
the purchaser through careful contract management. It is important for the
purchaser to have provisions on the contractual terms and conditions that
require the supplier to be more wary of the costs. Both parties must agree to
what costs are put into the calculation of the price of the goods or services
received. Cost-based contracts are usually applicable when the goods or
services involved are expensive, complex and essential to the purchasing
party or when there is an increased amount of uncertainty regarding labour
and material costs. Cost-based contracts are for the most part less beneficial
to the purchasing party because the danger of financial risk is shifted from
the seller to the buyer.
There are four types of cost-based contracts, as follows:

(i) Cost Plus Incentive Fee
Another cost-based contract is the cost plus incentive fee contract. This
contract is similar to the fixed-price plus incentive fee contract except
that the base price relies on allowable supplier costs instead of a fixed-
price basis. Just as before, if the supplier can increase efficiency or
material usage compared to the original target cost, then both parties
will reap the rewards of the cost savings at a predetermined rate. This
type of contract is appropriate when both parties are relatively
comfortable about the accuracy of the initial target cost estimation.
(ii) Cost-Sharing Contract
Allowable costs are shared among the parties on a predetermined
percentage basis with pure cost-sharing contracts. Central to a
successful negotiation is the companyÊs set of operating guidelines,
goals and objectives for the contract. When there is uncertainty, the two
parties to a cost-sharing contract must speak out their expectations as
detailed as possible in order to avoid any misunderstandings in
relation to everyoneÊs role and responsibilities. Cost-sharing contracts
are paramount when there is a period of rising raw material costs. A
contract schedule that outlines how both parties can share in the
increasing cost can help to avoid serious problems, not to mention

ensuring that the supplier does not go bankrupt due to its own
incompetence in making a product at a fixed price while material cost
is on the rise.
(iii) Time and Materials Contract
Another cost-based contract is the time and materials contract. This
type of contract is usually used in plant and equipment maintenance
agreements, where the supplier cannot decide on the accurate cost due
to the repair service. The contract should state the appropriate labour
rate (normally calculated on a per hour basis) plus an overhead and
profit percentage, resulting in a „not-to-exceed‰ total price. With these
terms and conditions, the purchaser has a minor control over the
estimated maximum price. As such, labour hours spent should be
cautiously audited throughout the life of the contract.
(iv) Cost Plus Fixed-fee Contract
In a cost plus fixed-fee contract, the supplier receives repayment for all
of its allowable costs up to a predetermined amount with a fixed fee,
which normally represents a percentage of the targeted cost of the
goods or service being obtained. Although the supplier is promised at
least a minimal profit for its allowable costs, there is a slight motivation
for the supplier to increase its costs throughout the life of the contract.
SELF-CHECK 9.2
What are the associated risks to suppliers with each of the different
types of purchase contracts (fixed-price and cost-based contracts)?
9.6 HOW TO CONSTRUCT A CONTRACT

New contracts are usually derived from earlier contracts that are then modified to
fit into the present situation. Though this process reduces the administrative
efforts needed every time a contract is written, there is a risk in assuming without
thinking that all previous contracts can be relevant. This is especially worrying in
a dynamic landscape where technological changes occur rapidly or where there
are legal advances.
The purchase manager must save the contract file and refer to the previous part of
the contract to create a unique contract according to the situation at hand. The most
proper procedure when creating a brand new contract is to start with a general
form and take samples of previous contracts where the situation best matches the

current one. The purchasing managers can always get guidance or help from the
legal department or appropriate counsel to help draft a few varieties of the general
form for the many types of purchase situations that could happen. Verifying the
following information will help to make sure that the contract is proper:
(a) The contract recognises clearly what is being purchased and the price;
(b) The contract shows how the item will be shipped and delivered;
(c) The contract states how the items will be installed;
(d) The contract has an acceptance provision that shows how and when the
purchaser will receive the product;
(e) The contract includes the proper warranties related to the product at hand; and
(f) The contract describes remedies that include indefinite damages and clauses
that state what happens to sluggish performance.
The purchasing manager must review arbitration or other conflict resolution

mechanisms that will be included in the contract. The benefits of arbitration are
important because arbitration is fast and private, and there is less uncertainty in
the results or even damages and cannot be appealed. It is a good habit to review
all contract attachments because there will be a lot of technical details in it. The
technical section is a common source of misunderstanding of the terms and
conditions. Therefore, managers also need to check all the information in this
aspect to make sure that the contract is appropriate.
9.7 SETTLING CONTRACTUAL DISPUTES

No matter how carefully crafted, all contracts could be subjected to some form of
disputes or disagreements. It is impossible to negotiate a contract that accurately
foresees every possible source of dispute between the buyer and seller. Often with
increasing difficulty on the nature of the contract and higher amounts of monies
involved, there is more possibility that a future schism could occur due to the
different interpretations of the terms and conditions between the two parties.
Therefore, purchasing managers should try to predict the potential future conflicts
and be prepared with any appropriate conflict resolution methods to deal with the
problems. Some of the methods are described in the following:

(a) Legal Alternatives

New methods to resolve the buyer-seller dispute have evolved over the past
few years. These techniques, although varied in form and nature, have a lot
of the same features, as follows:
(i) They fall along the lines of the alternative which is doing nothing and
also increasing the conflict;
(ii) They usually have increased confidentiality compared with settling
disputes in court and are less formal;
(iii) They allow people with disagreements to have more vital participation and
domination over the procedure to clear up their own problems compared
to traditional techniques of conflict dealing; and
(iv) Almost all of the new methods originate from the private sector while
courts and administrative agencies have now begun to borrow and
tweak some of the methods with higher resolution rates.
Nevertheless, perhaps the easiest technique of resolving contractual

disagreement is the straightforward, face-to-face negotiation among the two
parties involved. Usually, there are various conditions around the dispute
that can be considered by the parties, although these conditions are not
directly involved in the dispute.
(b) Arbitration
The use of external arbitrators or third parties to assist in resolving
contractual disputes is the fastest method of conflict resolution among
contracted parties, both in the United States and abroad. Due to the inability
of the parties to achieve a negotiated settlement, emotional reactions to the
problem (frustration and anger) can prevent a rational examination of the
true causes of disagreement.
In crafting a purchase contract, many purchase managers insert arbitration

clauses as part of the terms and conditions. Such clauses explain how a party
might choose an arbitrator and the type of dispute liable for arbitration. It is
of importance that the arbitratorÊs opinion binds both parties to the dispute.
One important thing to keep in mind here is that adequate early planning for
potential disputes can prevent significant issues that can arise in the event of
unforeseen conflicts. Lastly, when both the buying and selling companies
include an arbitration clause, the arbitration will be part of the entire
agreement.

• An organisationÊs commercial success is normally due to the negotiatorÊs skills,

from both its buying and selling processes.
• Professional supply managers should become more effective negotiators through

participating in training workshops that built up critical negotiation skills.
• The five phases of negotiation are identifying or anticipating a purchase

requirement, determining if negotiation is required, planning for the
negotiation, conducting the negotiation and executing the agreement.
• Purchasing contracts are based on several forms of pricing methods and can
be categorised into two basic types, which are fixed-price contracts and cost-
based contracts.
• Although it is impossible to cover all potential situations when a specific

contract could apply, rules and conditions made can at least provide a pathway
to resolution.
Arbitration Objective
Cost-based contracts Position
Fixed-price contracts Power
Issues Strategy
Needs Wants
Negotiation
McGraw-Hill Irwin.
Monczka, R. M., Handfield, R. B., Giunipero, L. C., & Patterson, J. L. (2009). Purchasing
and supply chain anagement (4th ed.). Mason, OH: South-Western.
Topic  Global Sourcing
10 and Supply
Management
LEARNING OUTCOMES
1. Explain what is global sourcing;
2. Explain the stages to global supply management;
3. Identify the progression from domestic to global sourcing; and
4. Discuss the future of global supply management.
 INTRODUCTION
Nowadays, companies are able to expand their markets worldwide due to
emerging technologies and fierce competition. This has led to non-core
organisational activities to be partially outsourced to external companies equipped
with the appropriate expertise. Companies now have global supply chains and
consider global sourcing as an important procurement strategy.
10.1 IMPORTANCE OF GLOBAL SOURCING

Bozarth et al. (1998) and Van Weele (2005) defined global purchasing as the process
of searching and obtaining goods, services and other resources on a possible
worldwide scale to fulfil the needs of the company and with the aims of continuing
and improving the current competitive position of the company. This definition
leads to three ideas. Firstly, global purchasing is seen as more than just physical
sourcing. The operational task of buying is not the only aspect involved but also
the more strategic responsibility such as supplier development and the creation of

116  TOPIC 10 GLOBAL SOURCING AND SUPPLY MANAGEMENT
global purchasing synergy. Global purchasing leads to a reactive, opportunistic

decision to minimise the one time purchasing cost. However, it can also be a
strategic and coordinated effort to proactively improve the competitive position of
the company. It includes all stages of the purchasing process, from prior
determination of the specification list to supplier selection and buying to the
follow-up and evaluation phase (Van Weele, 2005).
Secondly, the definition acknowledges that not all global search activities should
lead to global purchase. For example, if after evaluating possible suppliers (both
local and foreign) and the company reaches the conclusion that the local supplier
is the best choice, then this decision is congruent with the definition of a global
purchasing strategy. This definition not only focuses on the results of global
purchasing but also on the process. As a result, the ratio of cross border to total
purchases is not a complete and accurate image of the level of global purchasing.
Thirdly, the definition refers to the aims of the company.
Global purchasing is believed to derive from the competitive benefits that it can
generate for a company. The components of global purchasing research are not
only the strategy formulation but also organisation coordination and execution
processes. The distinction between international and global purchases is not
always clear. For example, Trent and Monczka (2007) argued that international
purchases are a more reactive approach to foreign opportunities, where
coordination are among lesser allies.
Global targets, on the other hand, are seen as a more strategic way for international
trade in which MNC allies search for common goods, suppliers and technologies
(Trent and Monczka, 2002, 2003a b; Arnold, 1989). The process of global
purchasing like other internationalisation effort is not followed through discrete
steps (Johanson & Vahlne, 1990).Thus, the label „international‰ only refers to the
artificial cut-off point in the initial phase of the process towards a more advanced
global purchase.
One of the most revealing difference between international purchase and the
global sourcing segment is their perception of the benefits they accrue from their
dealings around the world. Table 10.1 presents the global sourcing benefits for
each area. Although the exhibition offers only 10 areas of benefits, firms involved
in global resources show that they are aware of 16 benefits at a higher level than
firms involved in international purchases. In fact, the average rating across all
areas of interest is 30 per cent higher for global resource firms compared to the
overall average for international purchasing firms.

TOPIC 10 GLOBAL SOURCING AND SUPPLY MANAGEMENT  117
Table 10.1: Global Sourcing Benefits
Area of Benefit Rate

Lower purchase price/cost 5.98
Greater access to product technology 4.69
Improved supplier relationship 4.61
Greater access to process technology 4.54
Greater supplier responsiveness 4.47
Greater appreciation of purchasing 4.25
Better management of supply chain inventory 4.25
Greater standardisation of the sourcing process 4.25
Higher materials, component or service quality 4.16
Improved sharing of information with suppliers 4.10
1 = not realised, 4 = moderately realised, 7 = extremely realised
Average across 16 benefits = 4.23/7
N = 52
A benefit of both high segment rates is the capability to achieve lower prices or
purchase costs via sources around the world. The initial benefits of international
purchases are often priced and come from basic international buying activities.
However, firms are savvy to the benefits of non-prices when they take steps to
grow to a higher source. In particular, this includes more robust access to product
and process technologies, a critical outcome given the increasingly dynamic
technological transformations faced by global resource firms. More efficient and
strategic management of supply chain inventory also benefits the global resource
firm. This is critical due to the fact that many firms place cost management and
inventory investments across the supply chain.
Other main benefits that are easily available from global sources include higher
supplier response, better source process consistency, better supplier relationships
and better information exchange with suppliers. The benefits these two groups
achieve explain why many firms pursuing international purchasing want to switch
to global resources.
Developing a thorough and transparent operation is vital to the success of global

resources. Some companies have taken regional assets or strategy processes and
adapted those to global resources. When this occurs, global processes may consider

specific factors in a different light (for example, greater emphasis on risk factors and
total cost of land) compared to regional commodity development processes.
Clear processes help to overcome various differences present in global resources.

The cultural and social laws, skills and abilities of the staff, and business culture
are three areas where the difference is greatest across different geographical units.
The global sourcing process helps coordinate different participants and practices
around the world.
The global sourcing process includes the following steps:

Step 1: Identify global sourcing opportunities
Step 2: Establish global sourcing development team
Step 3: Propose global strategy
Step 4: Develop request for proposal (RFP) specifications
Step 5: Release RFP to suppliers
Step 6: Evaluate bids or proposals
Step 7: Negotiate with suppliers
Step 8: Award contract
Step 9: Implement contract and manage supplier
10.2 REASONS FOR GLOBAL SOURCING

Let us now look at the reasons for global sourcing. The reasons are as follows:
(a) Cost/Price Benefits

International purchasing can have great savings of between 20 to 30 per cent.
Many factors should be considered other than price differentials during sourcing
but often this is a lead criterion. The differences in process are due to:
(i) Lower labour rates;
(ii) Acceptance of lower profit margins;
(iii) Difference in exchange rates;
(iv) Lower material cost;
(v) Government subsidies; and
(vi) Different productivity level.

(b) Access to Product and Process Technology

Many technological advances are spread out around the world. It is rare for
a country to possess all the leading edge technology under their divisions.
Thus, to ensure the best product, companies have to pursue global sourcing
to stay competitive.
(c) Demand for Better Quality Products

Some countries such as Japan and Germany place higher importance on
quality. Domestic suppliers often do not produce quality in the same level as
those countries. The result is lesser quality products. Many companies source
globally to obtain the best quality products to meet the needs of their
customers and to attract more customers.
(d) Access to Only Available Source

Sometimes, factors such as the lack of resource or the collapse of a particular
economy results in the only source of the supply available from international
sources. Often, the international sources have higher capability to supply
rather than a domestic supplier that is non-existent, making it the only viable
alternative.
(e) Introduce Competition to Domestic Suppliers

Companies sometimes source from global sources as a way to introduce
competition to domestic suppliers. By sourcing globally, they are shifting the
power from the sellers to the buyers, forcing the sellers to be innovative in
order to gain higher market share.
(f) React to Buying Patterns of Competitors

Sometimes, companies react to competitorsÊ move so as to remain relevant.
Missing a step while a competitor takes two steps ahead compels companies
to follow trends or new sources. Not following the trend would seem like a
disadvantage. This is especially true today with many companies believing
that they must source from China or risk being at a cost disadvantage.
(g) Establish Presence in a Foreign Market

One of the ways to develop goodwill in a country in order to gain product or
service acceptance is through business relationships that will help support
and expand its market presence. Thus, these companies can have a better
reach in the region to market their products and establish their presence
there.

10.3 BARRIERS TO GLOBAL SOURCING

Companies that have little to no international experience usually face obstacles or
barriers when starting to source from around the world. These barriers include:
(a) Deficiency in knowledge and skills with regard to global resources;
(b) Resilience to change;
(c) Longer lead times;
(d) Different business customs, languages and cultures; and
(e) Currency fluctuations.
Lack of knowledge and skills related to global resource complexity hinders

companies from considering or advancing their intentions for global resources.
These deficiencies include an absence of basic knowledge of possible supply
sources or the lack of knowledge about the necessary documentation for
international purchases. International documentation requirements include:
(a) Letters of credit;
(b) Multiple bills of lading;
(c) Dock receipts;
(d) Import licenses;
(e) Certificates of origin;
(f) Inspection certificates;
(g) Certificates of insurance coverage;
(h) Packing lists; and
(i) Commercial invoices.
Changing from routine established procedures or the transition from old suppliers
is also a huge obstacle. It is human nature to resist changes that signify radical
separation from the current method of conducting business. Domestic market
nationalism can also prove itself to be a barrier. Buyers are sometimes hesitant to
convert businesses from domestic sources to new foreign sources.
Other obstacles include longer lead times and additional material pipelines. Due
to increasing lead times, accurate material prediction over longer periods of time
becomes upmost importance. Companies have to manage more stringent delivery
dates due to possible delays in transit or at the custom. International sources also
introduce new risks with regard to logistics, politics and finance.

Other barriers relate to the lack of knowledge of foreign business practices,

languages and cultures. Negotiations with foreign suppliers can prove to be more
difficult and simple engineering or requests for shipment changes can turn into a
frustrating experience. Meetings and negotiations with international suppliers
almost always require custom and cultural knowledge of the specific country. Lack
of understanding of customs can lead to huge problems in negotiations and in
establishing good relationships with suppliers.
Currency changes can have a huge impact on the price paid for the item. The major
currencies fluctuate on a daily basis. Thus, it is important for parties to
comprehend the options to minimise this financial risk.
The most common method to overcome these barriers involves education and
training, which can generate support for the process as well as help overcome the
anxiety associated with change. Published success stories can also help to
showcase performance benefits provided by global purchasing. A whole network
of globally linked computer-aided design systems, electronic mail and barcode
systems that help to track items across international borders can reduce the
communication barrier often faced in global sourcing.
A system of measurements and rewards often encourage sourcing from the best
suppliers around the world. Buyers will be evaluated and rewarded by companies
on their ability to achieve performance benefits from their selected international
sources. At the start of global purchasing, third parties or external agents can assist
in overcoming barriers often seen in the sector. Brokers can also be an effective
way to start trading from around the world.
Whatever techniques used to overcome resource barriers worldwide, these efforts

will fail unless top management expresses support for global sourcing.
Management must support and send the message that this is the way to stay
competitive, that is, by using competitive suppliers worldwide. It is not the
intention of the company to drive domestic suppliers out of business.
10.4 GLOBAL SOURCING PROCESS

When selecting suppliers through a tender or sourcing process, the buyer works
in collaboration with internal customers or budget holders. Internal customers are
buyerÊs colleagues working in other departments such as finance or
manufacturing. They are the ones who originally raised the need for the purchase
and who will be transacting with the selected supplier. Internal customer
involvement is usually highest at the specification stage and then drops in

subsequent stages. Usually, these processes are not well operated, resulting in loss
of huge savings opportunities, delivery of poor quality products or other less
favourable terms.
To counter the problem, firstly, there must be a specification assessment so that

the total costs can be reduced, competitive edge maintained and customer needs
fulfilled. Once you have a clear picture of the business requirements, your next
step is to formally invite suppliers to quote for your business. This can manifest as
a request for invitation (RFI) or a request for quotation (RFQ). Following that is to
negotiate for the best deal and to discuss the contract to limit your companyÊs
exposure.
ACTIVITY 10.1
How does the global sourcing process differ from the domestic sourcing
process? Discuss with your coursemates in the myINSPIRE forum.
10.5 ORGANISING FOR GLOBAL SOURCING

The need to coordinate and share information across organisations and functional
groups has morphed into the development of higher-level positions designed to
oversee various supply chain activities.
A structure that manages the diverse activities within a supply chain is different
from one where separate supply chain groups or activities report to different
executive managers. The latter model results in each function or activity pursuing
conflicting organisational goals and objectives. Organising as an integrated supply
chain structure requires traditionally separate activities to report to an executive
responsible for coordinating the flow of goods, services and information from
supplier to customer.
Organisations that develop a coordinated approach to materials and supply chain

management show a greater interest in the control of material cost. This only
increases the importance of purchasing within the organisational hierarchy
because of purchasing influence on cost and quality.
Advances in software and systems have enabled visibility across the supply chain
that allows multiple participants to coordinate and schedule more efficient
material information and processes. Ideally, there is increased access to demand
forecasts, production requirements and inventory levels at any point within the

supply chain. Each side could now plan its own production and distribution
requirements with greater accuracy. The result of this integration is lower
inventory, shorter cycle times, an improved ability to plan and lower costs.
10.6 ASSESSING THE NEED FOR GLOBAL

SOURCING
From a long-term strategic perspective, global sourcing can result in a dramatically
more competitive position and visible financial alternatives. However, there are
many important factors that we have to consider and assess before companies can
implement the global sourcing strategy. After all, a piecemeal approach without a
corporate business plan would be confusing and will eventually result in failure.
Hence, some basic rules need to be comprehensively considered before applying
global sourcing.
Cost savings from global sourcing is one of the most important benefits for
companies. Since, companies can obtain the goods at a lower unit price, they may
consider global sourcing as a logical extension of their domestic make-or-buy
tactical decision. In most cases, global sourcing of products can reduce costs by 50
per cent of the given cost. This is why many are choosing global sources rather
than the domestic one.
On the surface, the basic purchasing strategy bears a rough similarity to domestic
purchasing but other factors like administration and communication differ
enormously, resulting in higher implied costs. Besides the assessment of unit cost,
the implied costs from international administration and communication should
also be considered and calculated carefully as well.
Transportation cost and duty rate also cannot be ignored by companies implementing
global sourcing. Depending on the materials and the conditions, there can be wildly
different costs associated with transportation fee and duty rate.
10.7 STAGES OF GLOBAL SUPPLY

MANAGEMENT
It starts with investigation and tendering. At this stage, the business identifies core
and non-core operational activities, analyses customer and market requirements
and identifies competitors. The idea is to develop the companyÊs business
objectives, prospective markets and brand positioning. Then comes the market and
supplier evaluation. The business develops a detailed list of supplier selection
benchmarks, which are used to select the most appropriate supplier that fits the

requirements. Based on the findings of the process, the sourcing strategy may be
tweaked further and a final costing model is released. The operational and
economic benefits of the project will then be estimated. This leads to the selection
of the supplier.
A final list of suppliers is selected and negotiations for the product is carried out,
culminating in a supply agreement. The technical assessment of final supply
candidates is conducted to derive at each savings estimate. Finally, an
implementation schedule outlining the timelines of various suppliers is
developed. The implementation team should be initiated by the procurement
agent and the schedule and strategy should be published. Agreements related to
shared supply, resources and logistical arrangements are developed. Periodic
measurements and reporting of actual performance should be carried out for
performance monitoring.
10.8 GLOBAL PERSPECTIVE OF SUPPLY

MANAGEMENT
Supply chain management encompasses the planning and management of all
activities involved in sourcing, procurement, conversion and logistics
management (Fan, 2007). Importantly, it also includes coordination and
collaboration with channel partners, which can be suppliers, intermediaries, third-
party service providers and customers. In essence, supply chain management
integrates supply and demand management within and across companies in order
to manufacture and sell with the best optimal cost.
Global economic integration facilitates the rational allocation of worldwide

resources and is also the direct driving force for global sourcing and supply chain
integration. Because of the accelerated development of global economic
integration, the economic strategy of each country is shifting from reliance on
domestic knowledge, human resources, basic infrastructure, domestic commodity
markets and consumer preferences to reliance on the approach of comparative
resource advantage, which enables the allocation of resources beyond the
country's geographical borders (Fan, 2007). Through the reallocation of global
resources, companies can achieve the best optimal and rational efficiency of
reallocation.

10.9 FROM DOMESTIC TO GLOBAL SOURCING:

THE FIVE-PHASE PROCESS
Somewhere along their business journey, many companies figured that moving
beyond basic international purchases could result in new and untapped benefits.
Figure 10.1 presents international purchases and global resources as a series of
changing levels or steps along the continuum. Internationalisation of sourcing
processes happens as companies grow or advance from domestic to international
purchases, and this leads to global coordination and integration of goods,
processes, designs, technologies and suppliers across the globe.
Figure 10.1: International purchasing and global sourcing levels
Level I, as shown in Figure 10.1, has companies buying local products exclusively.
Domestic sourcing can result in purchases from international suppliers with
facilities in the US. Level II shows the basic international purchase that is often
reactive and unbound to the purchase of a location or unit. In the third level,
companies are starting to realise that outsourcing strategies implemented
worldwide could result in significant improvements. However, strategies at this
level are not well coordinated across global buying locations, operating centres,
functional groups or business units.

Level IV, which represents the integration and coordination of sourcing strategies
across locations around the world, is an advanced stage of strategy development.
Operating at this level requires:
(a) Information systems around the world;
(b) Personnel with advanced knowledge and skills;
(c) Coordination and extensive communication mechanisms;
(d) Organisational structure that promotes the coordination of global activity
centres; and
(e) Leadership that supports global approaches to resources.
Although global integration occurs at Level IV (which does not occur at Level III),
it is primarily cross-locational rather than cross-functional. Organisations
operating at Level V have achieved cross-site integration, which companies
operating at the Level IV have achieved.
The main distinction of Level V concerns participants who have integrated and
coordinated common items, processes, designs, technologies and suppliers across
global purchasing centres and with other functional groups, particularly
engineering. These integrations happen during the development of new products
and also during the supply of goods or services to fulfil ongoing or post-market
demands. Only companies with design, development, production, logistics and
procurement capabilities worldwide have the ability to reach this level. While
many companies dream of reaching Level V, the truth is that many do not possess
the comprehension nor preparedness to reach this level of sophistication.
ACTIVITY 10.2
In the myINSPIRE forum, discuss the following:
(a) The reasons why a company would use a third-party external

agent for worldwide sourcing.
(b) The differences between international purchasing and global

sourcing. Do you think the differences are meaningful? Why?

10.10 FACTORS ENHANCING GLOBAL

SOURCING
What factors are associated with successful global sourcing? The following are
eight factors that relates to achieving desirable global sourcing outcomes
(Monczka, Trent & Petersen, 2008):
(a) Global sourcing initiatives need a defined process. This process needs to be
overseen by an executive leader or steering committee. Continuous review
and improvement of the global sourcing process is one of the best practices.
(b) Site-based or decentralised control of operational activities is more likely to
lower total cost of ownership, result in better inventory management across
the supply chain and improve overall performance to external customers.
(c) Real-time communication tools simplify a complex process, particularly
when the participants are geographically dispersed.
(d) Successful global sourcing requires not only access to information but also a
willingness to share information.
(e) Availability of critical resources, which include budget for travel and living
expenses, requires information and data, qualified personnel and time for
those personnel to develop global strategies. Lack of qualified people is one
of the most serious problems when organisations pursue global
opportunities.
(f) Sourcing and contracting systems offer a better way to access data, which will lead
to internal systems supporting the sourcing organisation's specific needs.
(g) An international purchasing office (IPO) acts as a full-service procurement
centre offering support within a geographic region.
10.11 GLOBAL SUPPLY CHANNEL

Countless organisations face component procurement challenges. There are
several rules of thumb that organisations working with distribution channels
should adhere to such as the following:
(a) Channel distributors need to be selected by the organisation. Do not let the
distributors select you instead. In this way, you have all the criteria that are
right for your organisation.
(b) Scrutinise distributors that are able to develop the market with you, rather
than those with few good customer contacts.
(c) Organisation selected treat local distributors as long-term partners. This in

turn will develop trust and a long-term relationship for both parties. The
distributor is not used as a market-entry instrument.
(d) Organisation supports fully all market entry strategy that the distributor has
planned. The organisation will commit energy, financial and non-financial
resources to strategies shared by both parties.
(e) Organisation needs to ensure that distributors share and provide details of
the overall marketing strategy.
(f) Organisation to make sure that distributors will be able to link with local or
national distributors at the earliest opportunity.
10.12 INFORMATION SOURCES FOR LOCATING

AND EVALUATING INTERNATIONAL
SUPPLIERS
Foreign suppliers have to be subjected to the same or, in some cases, more stringent
performance evaluations and standards than their domestic counterparts. Do not
ever assume that a foreign company can automatically meet the requirements or
expectations of the buyer. The following are various aspects to inquire when
evaluating foreign sources:
(a) Are there significant differences in total cost between domestic and foreign
sources even after calculating the cost of additional elements?
(b) Will foreign suppliers maintain the price difference over time?
(c) What are the effects of a longer material pipeline and an increase in average
inventory level?
(d) What are the technical capabilities and quality of the supplier?
(e) Can the supplier help with the new design?
(f) How about the supplier's quality performance? What sort of quality system
do they implement?
(g) Can the supplier consistently fulfil the delivery schedule?
(h) How much time does the supplier need?
(i) Can we develop long-term relationship with the supplier?
(j) Is patent and proprietary technology safe with this provider? Is the supplier
reliable? What legal system does the supplier expect?

(k) What does the provider demand in payments?

(l) How does the supplier handle currency exchange issues?
Sometimes buyers use trial orders to evaluate foreign sources. Initially buyers are
unable to rely on foreign sources for the entire purchase. A buyer can use a smaller
order or trial order and start a record of supplier performance.
10.13 CURRENCY AND PAYMENT ISSUES

In global sourcing, the payment has to be moved between domestic countries and
foreign partners. Stability of currency ease international trade while instability
makes it more complex and introduces risk. If the trade amounts to tens of millions
of dollars, a mere 0.5 per cent deviation of exchange rate could affect the
effectiveness of global sourcing strategy and profitability of the whole supply
chain.
Large multinational companies usually have specific personnel in the finance

department to take charge of collecting and managing the information on currency
valuations. On the other hand, small companies that are planning to carry out
global sourcing normally do not have a specific financial expert. However, they
must still set up an internal management system or outsource the work in order to
predict and hedge against currency fluctuations.
From another perspective, if companies can make good use of the risk from
currency fluctuation, such experienced companies can put themselves in a
beneficial position by managing currency well. Hence, the opposite of risk from
currency fluctuation is also present when discussing currency problems.
10.14 THE FUTURE OF GLOBAL SUPPLY

MANAGEMENT
One of the strategic issues includes choosing the right supplier for a particular
component. The purchasing company must know where to look for it. Those who
specialise in the industry for raw materials or certain parts of the component are
themselves their own buyers. There are resources for buyers to consider when
looking for potential providers. One of the most valuable sources of information
that could harm potential suppliers is the trade journals. Today, all of these
resources are accessible through the Internet.

Globalisation is a continuous journey of development and improvement. In this

journey in particular is the need to develop or acquire a set of supply management
skills that can encourage the valuation of supply chain from a worldwide
perspective. Other developments include the need to be on the same page
regarding global performance measures and establishing an integrated system
between units worldwide and with suppliers.
Global supply management requires continuous development and refinement of

integrated and coordinated global sourcing strategies across the entire
organisation. Robust and deep integration between marketing, engineering and
resource groups should occur as companies proceed to the upper levels of
globalisation. These companies must expect and be prepared for trends in the
business involving suppliers with global capabilities. Furthermore, the focus of
global resources will shift from the components part of resources to subsystems,
systems and services.
Low cost pressures can result in continued supply of new low-cost supply markets
such as China and Eastern Europe. Though attractive in price, there are hidden
costs in the market that have to be identified. Leading companies can distinguish
themselves from normal companies by navigating through these perilous changes.
Companies that produce and sell globally do not need to look at global sources as
new sourcing approaches emerge. Seeking competitive advantage requires the
development of global processes and strategies that are an inseparable part of a
company's bidding management efforts. Understanding the important differences
between international purchasing and integrated global sourcing is of utmost
importance before key players can comprehend the advantages of this complicated
approach to potential bidding.
ACTIVITY 10.3
In the myINSPIRE forum, discuss the future of global supply
management with your coursemates.
• Demand for raw materials, components, finished goods and services

internationally is increasing.
• Supply management staff at all levels must be familiar with the nuances of
sourcing from around the world. While most organisations prefer to buy from
suppliers that are geographically close, this is not always possible.

• Companies operating in a competitive industry must buy from the best sources
available worldwide.
• Developing resources requires constant monitoring of both the supply market

and national trends. Currently, the hot spots for sourcing are China and India.
• Globalisation will continue to be a key force that needs to be evaluated on a

company-by-company basis. Once the valuation is done, the management of
the bidding should act based on an effective global strategy.
Culture Purchasing
Global sourcing Values
Globalisation Worldwide sourcing
International purchasing
Alguire, M. S., Frear, C. R., and Metcalf, L. E. (1994). An Examination of the

Determinants of Global Sourcing. Journal of Business and Industrial
Marketing, 9(2), 62–74.
McGraw-Hill Irwin.
Fagan, M. (1991). A Guide to Global Sourcing. Journal of Business Strategy,

12(2), 21–5.
Johanson, V. (1990). The Mechanism of Internationalisation. International

Marketing Review, 7(4).
Kaufmann, L., and Carter, C. R. (2006). International Supply Relationships and

Non-Financial Performance: A Comparison of U.S. and German Practices.
Journal of Operations Management, 24, 653–675.

Monczka, R. M., Handfield, R. B., Giunipero, L. C. & Patterson, J. L. (2009).

Purchasing and supply chain management (4th ed.). Mason, OH: South-
Western.
Petersen, K. J., Frayer, D. J., and Scannel, T. V. (2006). An Empirical Investigation

of Global Sourcing Strategy Effectiveness. Journal of Supply Chain
Management, 36(2), 29–38.
Trent, R. J., and Monczka, R. M. (2007). Achieving Excellence in Global Sourcing.

Sloan Management Review, Fall, 24–32.
Van Weele, A. J. (2005). Purchasing and supply chain management (4th ed.).
London, United Kingdom: Thomson.

MODULE FEEDBACK
MAKLUM BALAS MODUL
If you have any comment or feedback, you are welcome to:
1. E-mail your comment or feedback to modulefeedback@oum.edu.my
OR
2. Fill in the Print Module online evaluation form available on myINSPIRE.
Thank you.
Centre for Instructional Design and Technology

(Pusat Reka Bentuk Pengajaran dan Teknologi )
Tel No.: 03-78012140
Fax No.: 03-78875911 / 03-78875966


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Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

Module Writer: Prof Dr Abdul Razak Ibrahim

Moderator: Nor Azian Abdul Rahman

Developed by: Centre for Instructional Design and Technology

First Edition, April 2020

Copyright © Open University Malaysia (OUM)

Topic 1 Introduction to Purchasing and Supply Management 1

Topic 2 The Purchasing Process 14

Topic 3 Purchasing Policy and Procedures 27

Copyright © Open University Malaysia (OUM)

Topic 4 Purchasing Policy and Procedures 39

Topic 5 Pricing and Cost Analysis 49

Topic 6 Technology and E-procurement 61

Copyright © Open University Malaysia (OUM)

6.2 Efficiency Improvements Through Technology 64

Topic 7 Sourcing and Supplier Selection 76

Topic 8 Supplier Quality Management 88

Copyright © Open University Malaysia (OUM)

Topic 9 Negotiation and Contract Management 101

Topic 10 Global Sourcing and Supply Management 115

Copyright © Open University Malaysia (OUM)

COURSE GUIDE DESCRIPTION

This course focuses on fundamental principles of purchasing, international

As an open and distance learner, you should be acquainted with learning

Copyright © Open University Malaysia (OUM)

Table1: Estimation of Time Accumulation of Study Hours

COURSE LEARNING OUTCOMES

Topic 1 provides an introduction to international purchasing and supply

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Topic 3 explores the purchasing policy. Information technology (IT) drives

Topic 4 discusses the position of the purchasing function within the

Topic 8 explores supplier quality management. The role of buyers in managing

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TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

Activity: Like Self-Check, the Activity component is also placed at various

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References: The References section is where a list of relevant and useful

Lysons, K., & Farrington, B. (2012). Purchasing and supply management

Monczka, R. M., & Handfield, R. B. (2011). Purchasing and Supply Chain

TAN SRI DR ABDULLAH SANUSI (TSDAS)

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To have an impact on the global market, emphasis needs to be given to an effective

1.1 WHAT IS PURCHASING?

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1.2 SUPPLY CHAIN AND THE ROLES OF

(a) Deciding on the Purchasing Identification: Quality, Quantity and Delivery

(b) Choosing Suppliers

(c) Determining Terms and Conditions of Purchase

(d) Providing and Managing Purchase Orders (PO)

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1.2.1 Reasons for Making

1.2.2 Reasons for Buying

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2. Describe the roles of the purchasing function in the supply chain.

3. What are the reasons for making and buying?

1.3 EVOLUTION AND DEVELOPMENT OF THE

The evolution of purchasing function can be categorised into seven periods,

(a) Period 1: The Early Years (1850ă1900)