Purchasing Management

MS 491
Chapter 2 - Lecture 5

Umar Farooq
Department of Management Sciences
GIK Institute
 Background
• Historically, the management of materials has
been the most neglected element in the production
process.
• In the past, businesses emphasized minimizing the
cost of capital and labor.
• The focus on labor was logical
because the industrial
revolution had generated many
labor-intensive manufacturers.
 Background
• Within a firm, purchasing and supply management
grappled with the stigma of being labeled a
clerical function.

• However, in the past 30 years, purchasing has

made many strides toward shedding this label and
has emerged as a viable professional career path.
 Background
• All organizations need inputs of goods and services from
external suppliers.

• But
• It should be in such a way that;
oTo reduce cost and increase profit

• How can you reduce cost and what cost should be

reduced first?
 Background

• Businesses have had to change radically in

response to changing technologies

• The reality is that technology is rapidly displacing

labor.

• During the next decade, the supply management

function is likely to contribute to profits more
than any other function in the company.
 Purchasing

• The Annual Survey of

Manufactures,
conducted by the U.S.
Census Bureau, shows
that manufacturers
spent more than 50
percent of each sales
dollar on raw materials.
 Purchasing vs. Fabrication-Past

Triangle = Inventory Storage

CP = Component Parts
RM = Raw Material
FG = Finished Goods
 Purchasing vs. Fabrication-Present

Triangle = Inventory Storage

CP = Component Parts
RM = Raw Material
FG = Finished Goods
OPR = Operations
 PURCHASING
 Purchasing/Procurement/Sourcing
Obtaining goods (merchandise, capital equipment; raw materials,
services, or MRO supplies) to satisfy internal needs in exchange for
money or its equivalent.
• Purchasers can be classified into two categories;

 Merchant Buyers-
wholesalers and retailers who purchase for resale.
e.g. Retailer, wholesaler
 Industrial Buyers-
– Purchasing raw materials for conversion, services, capital
equipment and MRO supplies.
e.g. Manufacturer

• Acquisition of services is widely called supply management.

• Term “Supply Management/Procurement” is used instead of
purchasing.
 The Role of Purchasing in an
Organization
Key purchasing Variable
 The Role of Purchasing in an
Organization
The primary goals of purchasing are:
1. Ensure uninterrupted flows of raw
materials at the lowest total cost.
2. Improve quality of the finished goods
produced, and
3. Optimize customer satisfaction.

Purchasing contributes to these

objectives by:
 Actively seeking better materials and
reliable suppliers,
 Work closely with strategic suppliers to
improve quality of materials, and
 Involving suppliers and purchasing
personnel in new product design and
development efforts.
 Purchasing vs Procurement
• One is a strategic process and other is a transactional
function.
• Procurement concentrates on the strategic process
of product sourcing, for example
o Researching (Identifying needs and requirement,
identify and evaluate supplier)
o Negotiation (Negotiate terms, conditions and
contracts)
o Planning (Profit margin analysis, build and
manage supplier relationships)
• Purchasing process focuses on how products and services are
acquired and ordered, such as
o Raising purchase orders (Receive purchase requisitions, Evaluate
quotes from suppliers, process purchase orders)
o Arranging payment (Process and organise payment with supplier)
 The Role of Purchasing in an
Organization
• Purchasing Cycle
• Obtaining a purchase requisition
• Obtaining proposals and quotations
• Evaluating quotations and supplier selection
• Dispatching official purchase orders
• Receiving products and services
• Checking the quality of delivered items
• Payment to vendors
The Role of Purchasing in an Organization
• A purchase requisition is a initial document/request
form that is used when an employee needs to purchase
or order something on behalf of their organization.
• The purchase order (PO) is where the buying happens.
Once the purchasing department has approved the
purchase requisition, it issues a purchase order to the
vendor.
• A Supplier Quotation is document by a potential
supplier specifying the cost of goods or services they'll
provide within a specified period.
 The Role of Purchasing in an Organization
Procurement is an umbrella term
• Spotting internal needs (Need Identification)
• Surveying/Research the market
• Spotting potential suppliers
• Creating an approved list of vendors
• Creating a purchase order
• Requesting proposals and evaluating quotations
• Selecting the right supplier and negotiating effectively
• Receiving goods and performing quality checks
• Developing and managing contracts
• Obtaining invoice approvals and fulfilling payment terms
• Establishing a good supplier relationship
Purchasing vs Procurement
 Purchasers: Target
• Determine the best value,

• Choose the appropriate suppliers

• Get best quality of supplies

• Negotiate the best price, and

• Award contracts that ensure that the correct amount of

the product or service is received at the appropriate
time.
 Purchasers/Buyers
• Purchasing managers, buyers, and agents must
become experts on the services, materials, and
products they purchase.

• Purchasing managers, buyers, and purchasing

agents evaluate suppliers on the basis of price,
quality, service support, availability, reliability,
and selection.

• Once all of the necessary information on suppliers

is gathered, orders are placed and contracts are
awarded to those suppliers who meet the
purchaser’s needs.
 Purchasing a key strategic business
process
• Global competition intensified in the 1980s
executives realized the impact of large quantities of
purchased material and WIP inventories on;
 Manufacturing cost,
 Quality requirements,
 New product development
 Delivery lead time
 Pull and Push Strategy
• What instigates the movement of the work in the system?

• In Push systems, work release is based on downstream demand

forecasts
• Keeps inventory to meet actual demand
• Acts proactively
• e.g. Making generic job application resumes today
• In Pull systems, work release is based on actual demand or the actual
status of the downstream customers
• May cause long delivery lead times
• Acts reactively
• e.g. Making a specific resume for a company after talking to the
recruiter
 Purchasing Dollar Responsibility
• The cost of acquiring, storing, and moving materials is an
increasingly large portion of the cost of goods sold.

• Example: Consider the dollar responsibility of one General

Motors’ materials management groups:
1.Parts and (materials) = 10 times of direct labor dollars
2.Supply management expenditures = $100 billion
3.Transportation bill = $3 billion
4.Purchasing buys 97 percent of all component parts.
The Financial Significance of Supply Management
Profit-Leverage Effect
• Measures the impact of a change in purchase spend on a firm’s profit
before taxes.
• Purchase spend is the money a firm spends on goods and services.
• The measure is commonly used to demonstrate that a dollar decrease
in purchase spend directly increases profits before taxes by the same
amount.
• But, a decrease in purchase spend must be achieved through better
purchasing strategy that acquire materials of similar or better quality.
• The profit leverage effect dictates that reducing operating expenses is
more efficient than increasing sales.
• Three options to increase bottom line (profit)
 Increase sales,
 Reduce COG (Cost of Goods)
 Cut Operating cost
 The Financial Significance of Supply
Management cont….
• Example: Income Statement
• Gross sales/revenue = $100 $100
• Cost of Goods(COG) = $50 $40
• Gross Profit = $50 $60
• Fixed cost (20%) = $20 $20
• Total Profit before tax = $30 $40

Cost of Goods(Material + Manufacturing Cost)

The Financial Significance of Supply Management
Profit-Leverage Effect
o Options for increasing profit
 Increase sales,
 Reduce COG (Cost of Goods)
 Cut Operating cost
• Every dollar saved in purchasing goes straight to the bottom line
(profit)
• Company statistics: Your material purchasing cost is 80% of COG
• 42428 x 80% = $33942 (Purchasing cost)
Sales $84167 100% How much 8% reduction in
Cost of Goods Sold(COGS) $42428 50.4% purchasing cost will impact our
profit?
Gross Profit $41739 49.6%
Operating Expenses $26950 32%
$33942 x 8% = $2715
Income/Profit $14789 17.6%
The Financial Significance of Supply Management
Profit-Leverage Effect
o Options for increasing profit
• Every dollar saved in purchasing goes straight to the bottom line
(profit)
• Company statistics: Your material purchasing cost is 80% of COG
• How much are you spending on purchasing?
• 42428 x 80% = $33942 (Purchasing cost)
• 8% reduction in purchasing cost = $33942 x 8% = $2715

Sales $84167 100% Sales $84167 100%

Cost of Goods Sold(COGS) $42428 50.4% Cost of Goods Sold $39713 47.2%
Gross Profit $41739 49.6% Gross Profit $44454 52.8%
Operating Expenses $26950 32% Operating Expenses $26950 32%
Income/Profit $14789 17.6% Income/Profit $17504 20.8%
 The Financial Significance of Supply
Management
Profit-Leverage Effect
• Every dollar saved in purchasing goes straight to the bottom line
(profit)

Sales $84167 100%

Cost of Goods Sold(COGS) $39713 47.2%
Gross Profit $44454 52.8%
Operating Expenses $26950 32%
Income/Profit $17504 20.8%

8% 18.4%
The Financial Significance of Supply Management
Profit-Leverage Effect
Increase sales
How much does marketing needs to sell to get same $2715 increase in
profit?
+15454

Operating Profit Margin of the company is 17.6% Which is more easier?

How much does marketing needs to sell

to get same $2715 increase in profit? 8% 18.4%

$2715/0.176 = $15454 Purchasing Sales

The Financial Significance of Supply Management
• Return on Assets Effect (ROA)
• Return on assets (ROA) is an indicator of how profitable a
company is relative to its total assets.
• (ROI) financial ratio of a firm’s net income in relation to its
total assets
• Total assets consist of current and fixed assets.
• Current assets include cash, accounts receivable and
inventory
• Fixed assets include equipment, buildings and real estate
• ROA indicates how efficiently management is using its total
assets to generate profits.
 Return on Assets Effect (ROA)
• Example:
Gross sales/revenue = $100
Cost of Goods(COG) = $50
Gross Profit = $50
Fixed cost or expenses= $20
Total Profit before tax = $30

Total assets = $1000

ROA = Net Profit/Income ÷ Total assets
= 30 ÷ 1000
= 3%
 Return on Assets Effect (ROA)
• Imagine two companies, one with a net income of
$50 million and assets of $500 million, the other
with a net income of $10 million and assets of $15
million.

• Which company would you rather own?

• = 0.1 x 100 = 1 millions

• = 0.66 x 100 = 67millions

The Financial Significance of Supply Management
• Inventory Turnover Effect
• Shows how many times a firm’s inventory is utilized and
replaced over an accounting period, such as a year.
• A low turnover implies weak sales and possibly excess
inventory.
• ITF = Cost of Goods (COG)/ Average Stock
Gross sales/revenue = $100
Cost of Goods(COG) = $50
Gross Profit = $50
Fixed cost or expenses = $20
Total Profit before tax = $30

Inventory turnover ratio = Sales / Average inventory

Average Stock Cost = $10
ITF = 50 ÷ 10 = 5 Times
 Inventory Turnover Effect
• Company ABC has $1 million in sales and
$250,000 in COGS. The average inventory is
$25,000.

$
• = 40
$

• = 9.1
 The Purchasing Process
• Manual Purchasing - slow system,
prone to duplication of effort and
errors.

o Step 1-Material Requisition/Purchase

Requisition- stating product, quantity,
and delivery due date are clearly.
Step 2- The Request for Quotation
(RFQ) - Buyer identifies suppliers &
issues a request for quotation (RFQ).
o Step 3- Request for Proposal - allows
suppliers to propose new material and
technology, thus enabling the firm to
exploit the technology and expertise of
suppliers
o Step 4- The Purchase Order (PO)- The
purchase order is the buyer’s offer &
becomes a binding contract when
accepted by supplier.
Purchase
Requisition
Purchase
Order
The Purchasing Process
 The Purchasing Process –
e-Procurement
• The rapid advent of Internet technology in the 1990s
spurred the growth of more flexible Internet-based e-
procurement systems
• Step 1- Material user inputs a materials requisition - Relevant
information such as quantity and date needed.

• Step 2- Materials requisition submitted to buyer - At purchasing

department (hardcopy or electronically).

• Step 3- Buyer assigns qualified suppliers to bid - Product

description, closing date, & conditions are given.

• Step 4- Buyer reviews closed bids & selects a supplier

The Purchasing Process
 The Purchasing Process
• Advantages of the e-Procurement System
o Time savings
o Cost savings
o Accuracy
o Real time- The system enables buyers to initiate bids
in real time on a 24/7 basis.
o Mobility- The buyer can submit, process and check
the status of bids regardless of the buyer’s
geographical location
o Trackability
o Benefits to the suppliers- lower barriers to entry and
transaction costs, access to more buyers and the
ability to instantly adjust to market conditions,
 Small Value Purchase Orders
• The administrative costs to process a single order can be quite
substantial.
• The cost of placing an order using the manual purchasing system
could be as high as $175.
(Ohmae, K., “The Global Logic of Strategic Alliances,” Harvard Business Review, March-April 1989: 143–152. )

• The purchase order value must not be less than small dollar value.
• Small dollar value a relative term depending on the size of the
firm, $500 to $1,000 can be considered a reasonable cutoff point.
• Purchasing managers have various alternatives to deal with small
value purchases.
 Small Value Purchase Orders
• Procurement Credit Card/Corporate
Purchasing Card (P-Cards) are credit
cards with a predetermined credit limit,
issued to authorized personnel of the
buying organization.
• e.g. American Express, Diners Club,
MasterCard and Visa cards
• The card allows the material user to
purchase the material directly from the
authorized suppliers, without going through
purchasing.
• At the end of the month, an itemized
statement is sent to purchasing, or directly
to the accounting department.
 Small Value Purchase Orders
• Blank Check Purchase Orders: a special purchase order with a
signed blank check attached, usually at the bottom of the purchase
order.
• Due to the potential for misuse, it is usually printed on the check
that it is not valid for over a certain amount, usually $500 or
$1,000.
• The supplier enters the amount due on the check and cashes it after
the material is shipped.
• Phasing out blank check purchase orders with the use of
procurement credit cards.
 Small Value Purchase Orders
• Stockless Buying or System Contracting
• The supplier is required to maintain a minimum
inventory level to ensure that the required items
are readily available for the buyer.
• Stockless purchase system can be defined as
arrangement in which a supplier holds the items
ordered by the customer in its own warehouse, and
releases them as and when required by the
customer. It is also known as just-in-time.
• It is stockless buying from the buyer’s perspective
because the burden of keeping the inventory is on
the supplier
 Small Value Purchase Orders
• Petty Cash
• Petty cash is a small cash reserve maintained by a
mid-level manager or clerk.
• Petty cash is a small amount of cash on hand that is
used for paying small amounts owed, rather than
writing a check.
 paying the postal carrier the 17 cents.
 paying $14 for bakery goods delivered for a company's
early morning meeting.
• Material users buy the needed materials and then
claim the purchase against the petty cash by
submitting the receipt to the petty cashier.
 Small Value Purchase Orders
• Standardization and Simplification of Materials and
Components
• These concepts can be effectively used in industry to minimize
unnecessary activity, reduce inventory costs, simplify controls and
improve product quality.
• Purchasing department should work with design and engineering
departments to standardize materials and components to increase the
usage of standardized items.
• Simplification refers to reduction of the number of components,
supplies or standard materials used in the product or process.
• e.g. Intel’s Systems Group reduced 20,000 active part numbers to
500 part types! Of 2,000 resistors, capacitors, and diodes, they
reduced 2,000 to 35 types.
 Small Value Purchase Orders
• Accumulating Small Orders to Create a Large
Order
• Numerous small orders can be accumulated and mixed into a large
order, especially if the material request is not urgent.
• Purchasing can simply increase the order quantity if the ordering
cost exceeds the inventory holding cost.
• Larger orders also reduce the purchase price and unit transportation
cost.
 Small Value Purchase Orders
• Using a Fixed Order Interval
• To group materials and supplies into categories
and then set fixed order intervals for each
category.
• Order intervals can be set to biweekly or monthly
depending on usage.
• This increases the dollar value and decreases the
number of small orders.
Boeing 787
 Sourcing Decisions: The Make-or-Buy
• The Make or Buy decision is a strategic decision.
e.g. Honda Motors make their engines but outsource the brake
drums from the outsource suppliers (high quality, less price)
• Example: Traders from all over Europe hired warehouses for
their goods in Venice since 14th century.
• Factors to be analyzed;
Evaluate whether outsourcing is right for your company;
Determine exactly what functions to outsource and the
performance expectations;
Use a well-defined professional selection process to evaluate and
select which provider(s) are right for the job.
 Sourcing Decisions: The Make-or-Buy
• Outsourcing -buying materials and components from
suppliers instead of making them in-house.
• The trend has moved toward outsourcing.
• Outsourcing is a practice used by different companies to reduce
costs by transferring portions of work to outside suppliers rather
than completing it internally.
• Generally, firms outsource noncore activities while focusing on
core competencies.
• Traditionally firms preferred the make option by means of
backward or forward vertical integration
 Backward integration refers to acquiring sources of supply
 Forward integration refers to acquiring customer’s operations.
 Sourcing Decisions: The Make-or-
Buy Decision…Cont.
Reasons for Buying or Outsourcing

• Cost advantage: Especially for components that are non-vital

to the organization’s operations.

• Insufficient capacity: A firm may be at or near capacity.

• Lack of expertise: Firm may not have the necessary

technology and expertise.

• Quality: Suppliers have better technology, process, skilled

labor, and the advantage of economy of scale.
 Sourcing Decisions: The Make-or-
Buy Decision…Cont
Reasons for Making

• Protect proprietary technology

• No competent supplier
• Better quality control
• Use existing idle capacity
• Control of logistics- Leadtime transportation, and
warehousing cost
• Lower cost
 Sourcing Decisions: The Make-or-Buy Decision
• Make-or-Buy Break-Even Analysis
 The make-or-buy decision is the action of deciding between
manufacturing an item internally (or in-house) or buying it from
an external supplier (also known as outsourcing).
 Break-even analysis is a tool for computing the cost-effectiveness
of sourcing decisions.
• Several assumptions must be consider for the analysis:
1. All costs involved can be classified as fixed or variable cost.
2. Fixed cost remains same.
3. Variable cost has linear relationship with quantity.
4. Fixed cost of the make option is higher because of initial capital
investment in equipment.
5. Variable cost of the buy option is higher because of supplier
profits margin.
 Sourcing Decisions: The Make-or-Buy
Decision
• Example:
• Consider a firm has the option to make or buy a part.
Its annual requirement is 15,000 units.
• A supplier is able to supply the part at $7 per unit.
• The firm estimates that it costs $500 to prepare the
contract with the supplier.
• To make the part, the firm must invest $25,000 in
equipment and the firm estimates that it costs $5 per
unit to make the part.
 Sourcing Decisions: The Make-or-
Buy Decision…Cont
• Example:
• Requirement of parts = 15000 units
• Buy Option: Supplier is able to supply the part at $7 per unit. The
firm estimates that it costs $500 to prepare the contract with the
supplier.
• Make Option: To make the part, the firm must invest $25,000 in
equipment and the firm estimates that it costs $5 per unit to make
the part
Sourcing Decisions: The Make-or-Buy
Decision…Cont
 Sourcing Decisions: The Make-or-Buy Decision
• For the annual requirement of 15,000 units
Total Cost = Fixed Cost + Variable Cost

 The analysis shows that the break-even point is 12,250 units.

Total cost at the breakeven point is $86,250.
 If the requirement is less than 12,250 units, it is cheaper to buy.
If the firm needs more than 12,250 units it is cheaper to make parts
 Class Exercise
• You are given the following information:

• Find the break-even quantity and the total cost at

the break-even point.
• If the requirement is 150,000 units, is it more cost-
effective for the firm to buy or make the
components?
• What is the cost savings for choosing the cheaper
option?
 Procurement Terms
• Arbitration – Third party dispute resolution, is a way to resolve disputes
outside the courts. An arbitration award is legally binding on both sides and
enforceable in the courts.
• Breach/Default – When a contract provision is not met.
• Force Majeure (superior force) – Riots, wars, weather, or other
“Acts of God”. Unforeseeable circumstances that prevent someone
from fulfilling a contract.
• Liquidated Damages – Estimated damages for specific types of
defaults as defined in the contract.
• These are the damages whose amount the parties designate during the
formation of a contract for the injured party to collect as compensation
upon a specific breach (late performance).
• Material Breach – A violation of the contract of sufficient
magnitude that the contract cannot be completed.
• Termination – Stopping the work before it is completed
• Waiver – Statements in the contract that indicate that rights cannot be
ignored or modified without written agreement between the two
parties
 Roles of Supply Base
Supply Base- list of suppliers that a firm uses to
acquire its materials, services, supplies, and
equipment.
• Firms emphasize long-term strategic supplier
alliances consolidating volume into one or fewer
suppliers, resulting in a smaller supply base.
 Early involvement of preferred suppliers provide:
Information on the latest trends in materials, processes, or
designs
Information on the supply market
Capacity for meeting unexpected demand
Cost efficiency due to economies of scale
 Importance of Supplier Selection
• Today the average U.S. manufacturer
Reliability
spends roughly half of its revenue to
purchase goods and services.
Service Distance
• This makes a company's success
dependent on its interactions with
suppliers.
• The process of selecting competent
suppliers for important materials, is a
complex one and should be based on
multiple criteria.
• A recent cross-industry survey of
companies placed companies’ average
total spend per procurement at $115
million.
 Importance of Supplier Selection
• Supplier non-performance on even the most basic level
can have dire consequences for the buyer.

• Many product safety issues have been traced back to

suppliers failing to meet a buyer’s requirements.

• Production delays due to parts shortages and recalls of

faulty products have cost buyer firms millions of dollars
through recalls, warranty costs.

• Can severely damage their reputations and future sales

potential
 Supplier Selection
• 2014, General Motors (GM)
recalled about 800,000 of its
small cars due to faulty ignition
switches, which could shut off
the engine while the vehicle
was in motion

• Before it was removed from

the market in 2004, Vioxx
may have hurt hundreds of
thousands of patients, killing a
third of them
 Supplier Selection
There were two battery issues;
1. The first one related to battery
size: batteries made by
Samsung's SDI group were too
small in one corner, causing
negative electrodes to be bent
and increase the likelihood of
short circuiting.
2. The second issue was with
batteries from a third party
provider, Amperex Technology
Ltd, which were found to be
incorrectly wielded.
 Supplier Selection

Components for the Organic Light Emitting Diode (OLED) screens,

which are in short supply in Asia

Boeing’s 787
Dreamliner production
schedule was
significantly affected by
shortages of fasteners,
essentially bolts that
secure sections of the
fuselage together.
 Supplier Selection

• Product and process • Order System and

technologies cycle time
• Willingness to share • Capacity
technologies and • Communication
information capability
• Quality • Location
• Cost • Service
• Reliability
 How Many Suppliers to use
• Single-sourcing- a risky proposition.
• Poor supplier performance will result in plant
shutdowns or poor quality finished products.
Sole sourcing and Single sourcing
• Sole sourcing typically refers to the situation
when the supplier is the only available source of
the required material.
• Single sourcing refers to the practice of
concentrating purchases of an item with one
source from a pool of many potential suppliers.
 How Many Suppliers to use
 Reasons Favoring a Single Supplier
• To establish a good relationship
• Less quality variability
oVariability in the quality levels is less than if the parts are purchased
from multiple suppliers
• Lower cost
• Transportation economies
oSingle sourcing concentrates volume, the firm can take advantage
of truckload (TL) shipments.
• Proprietary product or process
oIf the supplier holds the patents to the product or process
• Volume too small to split
oIf the requirement is too small, it is not worthwhile to split the order
among many suppliers.
 How Many Suppliers to use
Reasons Favoring More than One Supplier
• Need capacity
o When demand exceeds the capacity of a single supplier
• Spread risk of supply interruption
o Due to a strike, quality problem, political instability
• Create competition
o Encourages competition to get best price and quality.
• Information
o Multiple suppliers usually have more information about market
conditions, new product developments and new process
technologies
• Dealing with special kinds of business
o The firms may need to give portions of their purchases to small,
local or women or minority-owned businesses, either
voluntarily or as required by law.
 Purchasing: Centralized vs. Decentralized
• Purchasing Organization
depends on many factors, such
as market conditions & types of
materials required.
Centralized Purchasing-
purchasing department located at
the firm’s corporate office makes
all the purchasing decisions.

Decentralized Purchasing-
individual, local purchasing
departments, such as plant level,
make their own purchasing
decisions.
Purchasing: Centralized vs.
Decentralized
 Purchasing: Centralized vs. Decentralized
Advantages- Centralization
• Concentrated volume
• The purchase volume to create quantity discounts,
less-costly volume shipments
• Suppliers are willing to give better terms and share
technology due to the higher volume.
• Avoid duplication
• Eliminates the duplication of job functions.
• Specialization
• Allow purchasing professionals to specialize in one
area
• Lower transportation costs
• Allows larger shipments to be made to take
advantage of truckload shipments
 Purchasing: Centralized vs. Decentralized
Advantages- Centralization

• No competition within units

• when different units Purchase the same material,
a situation may be created in which units are
competing among themselves.
• Common supply base
• A common supply base is used, thus making
it easier to manage and to negotiate
contracts.
Purchasing: Centralized vs. Decentralized
• Advantages of Decentralization
 Closer knowledge of requirements
• A buyer at the individual unit is more likely to know its
exact needs better than a central buyer at the home
office
 Local sourcing
• A local buyer will know more about local suppliers
 Less bureaucracy
• Allows quicker response, due to less bureaucracy and
closer contact between the user and the buyer
• Hybrid purchasing organization- both decentralized at the
corporate level and centralized at the business unit level may be
warranted.
 International Purchasing/Global
Sourcing
Global sourcing-
• Opportunity to improve quality, cost, and delivery
performance.
• Requires additional skills and knowledge to deal with
international suppliers, logistics, communication,
political environment, and other issues.
Global Sourcing-Examples
International Purchasing/Global Sourcing
• Various methods are employed for global sourcing.
• Import broker or sales agent- performs service/
transactions for a fee.
• Import merchant- buys and takes title to the goods, and
then resell them to the buyer.
• Trading company- imports & carries wide variety of goods.
• Tariff -is an official list or schedule showing the duties,
taxes or customs imposed by the host country on imports or
exports.
• Non-tariffs-are import quotas, licensing agreements,
embargoes, laws and other regulations imposed on imports
and exports.
 Reasons for Global Purchasing
• Firms expand their supply base to include foreign suppliers for
many reasons.
• Lower Price of Material: Many factors can contribute to
cheaper materials from overseas suppliers.
 Cheaper labor costs and raw materials,
 Favorable exchange rates,
 More efficient processes
 Intentional dumping of products by foreign suppliers
• Quality of Product: The quality of overseas products may be
better due to newer and better product and process
technologies.
• Efficient Logistic System: deliver goods faster than domestic
suppliers due to a more efficient transportation and logistical
system
 Challenges of Global Sourcing
• Language barriers-Suppliers may not be
fluent in your language, and they may not be
comfortable asking for explanations multiple
times.
• It's not just a question of communication -
make sure any labeling or other printed
materials are error-free.
• Quality expectations-If you rely solely on
overseas suppliers to determine that quality
standards have been met, you won't know
about any problems until after orders arrive.
• One way to prevent that is to conduct quality
inspections
• Duty you pay- Tax rate or duties for import
and export can be very high
 Major international trade
organizations
• The World Trade Organization (WTO)1995
• It is the largest international trade organization dealing with the
global rules of trade between nations.
• Its primary goal is to ensure that international trade flows
smoothly, predictably and freely among member countries.
• The North American Free Trade Agreement (NAFTA)
• Its goal is to remove trade and investment barriers among the U.S,
Canada and Mexico for agricultural goods.
• The European Union (EU)1950
• The primary goals of the EU is to create a single market without
internal borders for goods and service
 Countertrade
• Goods of domestic firms are exchanged for
goods of equal value from foreign firms.
• In countertrade transactions cash does not
change hands
• It is used if there is a shortage of hard
currency or as a means to acquire
technologies.
• The various forms of countertrade include
barter
o No currency convertibility
o Weak reserves prohibit access to hard
currency
o Structures an international sale when means of
payment are difficult, costly, or non-existent
 Types of Countertrade

• Counter purchase-is an arrangement whereby the

exporter agrees to sell goods or services to a foreign
importer and simultaneously agrees to buy specific goods
or services from the foreign importer.
• Barter- Barter is the complete exchange of goods or
services of equal value without the exchange of currency.
• Offset- is an exchange agreement for industrial goods or
services as a condition of military related export.
 Types of Countertrade
• Switch Trading : It involves at least three parties.
• This means a country may barter goods from another
country which may be of no use to itself so it sells the
goods to third country for hard cash.
o Brazil exported corn to East Germany (before Unification)
and received products in return. Germany did not use corn
so it sold the corn to other countries for hard cash
• Buyback:
• It occurs when a firm builds a plant in a country - or
supplies technology, equipment, training, or other
services to the country and agrees to take a certain
percentage of the plant's output as partial payment for
the contract.
o BOT contracts (Build, Operate and Transfer)
Types of Countertrade
 Countertrade-Example
• Indo-Iraq Barter Deal :
• In 2000, India and Iraq agreed on an "oil for
wheat and rice" barter deal, subject to UN
approval under Article 50 of the UN Gulf War
sanctions, that would facilitate 300,000 barrels
of oil delivered daily to India at a price of $6.85
a barrel while Iraq oil sales into Asia were
valued at about $22 a barrel. In 2001, India
agreed to swap 1.5 million tones of Iraqi crude
under the oil-for-food program.
Countertrade-Example
 Public Procurement
• Public procurement that is completed within
the context of not-for-profit organizations
(NFP’s).
• The procurement that occurs in this context is
typically government affiliated, which can be
central, state, or local.
• Private procurement that is completed within
the context of for-profit organizations (FP’s).
Private procurement happens within privately
owned companies.
 Public Procurement
• Private procurement is typically in FP (for-profit)
organizations, while public procurement functions to
support NFP’s (not-for-profit)
• Invitation to Tender (ITT): An invitation to third
parties to submit offers
• Tendering is the beginning of the contracting process
and serves as an ITT
• Bid/proposal submission
• Requests for Proposals (RFP)
• Request for Quotations (RFQ)
• Bid/proposal evaluation
• Contract award recommendation
• Contract negotiations
• Contract Award (signing)
 Green Procurement
• Green procurement is the purchase of
environmentally friendly products and services, the
selection of contractors and the setting of
environmental requirements in a contract.
• Organizations with a positive public image, brand
and goodwill fare better in the marketplace than
those without.
o Ozone-Depleting Substances
o Office Paper and Equipment
 Green purchasing
Basic Principles of Green Purchasing
1. Consider whether a product is needed before purchasing it
or not.
2. Purchase a product considering the various environmental
impacts over its life cycle – from extraction of raw materials
to disposal.
3. Select suppliers who make a conscious efforts to care for
the environment.
4. Collect environnemental information on products and
suppliers.
5. Support Greening of your supply chain
 Green Purchasing
• Recycled content products
• Energy- and water-efficient
products
• Alternative vehicles
/alternative fuels
• Bio-based products
• Non-ozone depleting
substances

Prohibits the sale and

purchase of printing and
writing paper not containing
a minimum of 30%
postconsumer fiber
Green Purchasing
 Case Studies of Green Procurement
• Fujitsu Japan has a green
procurement policy that selects
materials; parts; products; and
production equipment based on
price; environmental impact;
quality; and delivery.
• Ikea, a furniture and household
goods retailer, has implemented
a code of conduct for its 2,000
suppliers. The code of conduct
focuses on environmental
impact and working conditions.