PROCUREMENT BASICS

By the end of Unit 1, you should be able to:

1.  Explain the changing profile of Procurement function and its increasing
contribution to profitability and strategic importance.

2.  Identify the relationship between procurement and other functional areas.

3.  Explain how procurement can affect an organisation’s competitive position.

4.  Identify the generic competitive strategies and the sources of competitive
advantage.

5.  Describe how procurement decisions are determined by the organisation’s

competitive priorities, its resource capabilities and the environment.

TOPIC: INTRODUCTION TO PROCUREMENT MANAGEMENT

1.1 INTRODUCTION TO PROCUREMENT MANAGEMENT

OBJECTIVES

By the end of this section, you should be able to:

1.  Define the terms purchasing and procurement management.

2.  Explain the perspectives on procurement in business management.

3.  Describe the interdependencies of procurement with other functions in the

organisation.

4.  Describe the drivers of change and future trends of procurement management.
 INTRODUCTION

The new millennium began with the global marketplace in an economic and
political quandary. The business world today is considerably different and more
complex than it was before the turn of the century. In addition to the significant
events that have impacted the world’s business environment, organisations have
had to transform radically in response to burgeoning technologies and the changes
in social, cultural, demographic and environmental variables.

Let us consider a scenario. Your organisation wants an across-the-board 12%

reduction in spending. As the procurement manager, you have to make some tough
decisions. Do you negotiate lower prices with your current Malaysian suppliers?
Do you take the advantage of global sourcing and buy from any country with the
lowest price? Do you fulfil your corporate social responsibility of developing other
Malaysian small and medium enterprise (SMEs) suppliers, which offer you a lower
price?

In today’s fast-paced global marketplace, procurement professionals do much more

than order supplies and maintain inventory. Procurement has made many strides
towards shedding the stigma of being labelled just as a clerical functional area in
an organisation. Procurement has emerged as a viable professional career path and
is likely to contribute to profits more than any other function in the organisation.

In this section, the term procurement and other related terminologies are first
defined in the context of the unlimited potential of the evolving profession. This
section also discusses the perspectives on procurement, the functional
interdependencies and the developments to date. This section ends with a look at
the future trends of procurement management.

THE CLASSIC DEFINITIONS

THE CLASSIC DEFINITIONS

Since you have studied the course of supply chain management in your previous
semester, you would understand that procurement is a major subsystem of supply
chain. Procurement involves many upstream activities within an integrated supply
chain. Procurement has been well described as the glue that holds the expanded
supply chain together. The terms procurement, purchasing and supply
management, are often used interchangeably to refer to the integration of related
functions to provide effective and efficient materials and services to an
organisation. Some academics and practitioners limit these terms to the process of
buying and store administration:

1.  The recognition of need;

2.  The translation of that need into a commercially equivalent description;

3.  The search for potential suppliers;

4.  The selection of a suitable source;

5.  The agreement on order or contract details;

6.  The delivery of the products or services;

7.  The receiving and inspection;

8.  The safe and accurate storage of materials in stock; and

9.  The payment of suppliers.

This is not the perspective taken in this course. Procurement management is not
only concerned with the standard steps in the buying process. There are further
responsibilities for other components of the supply chain, such as managing
logistics and managing customers’ and suppliers’ relationships. Maintaining
‘generous inventory levels to meet long-term customer demand, in a generally
sheltered market environment in the past is also outdated. Inventory management
is an obvious candidate for cost reduction in the current competitive global
business environment.

With the idea that competition has made a quantum leap from the firm level to the
supply chain level as the next stage of competitive evolution, it is clear that no
definition can wholly incorporate the demands placed on these professionals’ set of
skills. Situational diversities, such as strategic importance, contribution to
profitability, supplier relationships and the recognition given to the position in a
particular organisation, mean that any definition is open to criticism.

For instance, purchasing has been defined by some as:

To buy materials of the right quality, in the right quantity from the right source
delivered to the right place at the right time at the right place.

However, what is ‘right’ is contingent on a particular organisation or situation.

Moreover, in practice, some of the ‘rights’ are irreconcilable and a particular
‘right’ can only be obtained by trading off another. Thus, it may be possible to
obtain the right quality but not at the right price.

Furthermore, the definition also implies that purchasing is:

1.  Reactive rather than proactive — that is, purchasing is a service activity,

buying what is instructed to buy rather than one that takes the initiative in helping
to determine purchasing policies.

2.  Transactional rather than relational — that is, purchasing is primarily

concerned with the mechanics of order placing on a one-off basis rather than the
establishment, where appropriate, of long-term, collaborative supply relationships.

3. Tactical rather than strategic — that is, purchasing is focused on short-term

buying rather than on contributing to the achievement of long-term corporate
goals.

The above definition is obviously outmoded in the business context today.

For the purpose of this course, the term ‘procurement’ will be used in place of the
term purchasing and supply management, which implies the acquisition of goods
and services in return for a monetary or equivalent payment. The term
‘procurement’, as it is used in the course, is the process of obtaining goods or
services in any way, including borrowing, leasing and even force or pillage (Lyson
and Farrington, 2006), in a wider context of supply management relevant to
today’s business practices
 PERSPECTIVES ON PROCUREMENT IN BUSINESS

TOPIC: PERSPECTIVES ON PROCUREMENT IN BUSINESS

What is the role of procurement in business management? Why is it important? To

answer these questions, Procurement function will be studied from several
perspectives.

1.  Procurement as a function

In management studies, a ‘function’ is often defined as a unit or department in

which people use specialised knowledge skills and resources to perform
specialised tasks. In many organisations, procurement is still a part of a segmented,
departmentalised structure in which the procurement of supplies is a discrete
activity in the sequence of activities from the acquisition of supplier to the delivery
of a finished product to the ultimate user. The challenge of global competition is,
however, increasingly leading many organisations to replace segmented structures
with integrated structures in which procurement is part of a larger grouping, such
as managing international logistics or supply chain management. Such structures
emphasise the importance of cross-functional decision-making. Procurement’s
many interfaces within an organisation and the concept of working as a team will
be discussed later in the unit.

2.  Procurement as a process

The ISO 9000:2000 quality management standard defines process as ‘a set of

interrelated or interacting activities, which transforms inputs into outputs”. Any
activities or set of activities that uses resources to transform inputs to outputs can
be considered as a process, as depicted in Figure 1.1.
Figure 1.1  The concept of process

The quality management principles advocate that a desired result is achieved more
efficiently when related resources and activities are managed as a process.

Procurement as a process can be viewed as a sequential chain of events from

recognition of needs leading to the acquisition of supplies to afterprocurement
activities such as supplier evaluation and development. It is through the
examination and identification of value-added and non-valueadded activities in this
chain of events that cost reduction strategies can be formulated.

Value to the customer is good quality, a fair price and a fast and accurate delivery.
Organisations should look for ways to create value internally in every one of their
organisational processes where the outputs of each process is greater than the
inputs plus resources consumed as illustrated in Figure 1.2.

Figure 1.2 The concept of value-added

 
3.  Procurement as a link in the supply or value chain

Procurement, along with activities such as production, warehousing and

transportation, is one of the links in the supply chain or sequences of processes by
which supplies are converted into finished products and delivered to the customers.
Supply chains and value chains are synonymous. A value chain is a linear map of
the way in which value is added by means of a process from raw materials to
finished, delivered product (including service after delivery). Porter’s value chain
model as shown in Figure 1.3 regards procurement as one of the four support
activities that contribute to the competitive advantage of a business.

Figure 1.3 M E Porter’s value chain model

4.  Procurement as a relationship

Procurement relationships may be both, internal and external, short or long-term.

Internal relationships are with other links in the supply chain, such as initiator(s) of
a procurement and the users of the goods/services procured. Increasingly, as
mentioned earlier, internal relationships are cross-functional and based on
teamwork.

Externally, relationships with suppliers, to be discussed later in the course, may

represent a continuum from arm’s length to supplier alliances. Many organisations
now rely on suppliers to design, develop and manufacturer items that they would
previously have produced themselves. As cited by Lysons, K and Farrington, B
(2006), Ford et al (2003) observe:
The main issue facing managers is no longer about ‘buying the right products at
the right time at the right place’ but of handling and developing relationships with
key suppliers over long period.

We have earlier on distinguished the term purchasing from procurement.

Procurement encompasses supplier management. Supplier management is that
aspect of procurement, which is concerned with rationalising the supplier base and
selecting, coordinating, appraising the performance of and developing the potential
of suppliers and, where appropriate, building long-term collaborative relationships.
Supplier management is more a strategic and cross-functional activity than
purchasing, which is transactional and commercially biased.

Figure 1.4 shows the relationship between procurement, purchasing and supplier

management. Over here, we see procurement as a wider term, which relates to both
purchasing and supplier management. In line with the developing trends in
procurement management and the characteristics of Procurement function in the
future, the design of this course provides more focus on the strategic activities of
supplier management. We shall return to study some of these activities in more
detail later in the other units of the course.
Figure 1.4  The relationship between procurement, supplier management and
purchasing

5.  Procurement as problem-solving

The following view of the IMP (Industrial Marketing and Purchasing Group) as
cited by Lyons, K and Farrington, B (2006), sums it all:

Customers are not looking for a product from a manufacturer. Instead they seek a
solution to a problem from a supplier. Business procurements are problem driven.
A problem may relate to the customer’s need to carry out its basic activities
efficiently and economically. Examples include the problems of wastage of
material, poor utilization of staff or an unacceptable failure rate in components.
We refer to these as problems of ‘rationalization’. A problem can also arise for
positive reasons such as when a company is trying to develop relationships with
new customers or enhance the performance of a product. We refer to these as
problems of ‘development’.

Procurement is no more relevant just as an arm’s length transactional functional

activity. The procurement professionals are expected to be part of an integrated
cross-functional problem-solving team that brings solutions to the discussion table
to satisfy customers’ needs

TOPIC: RELATIONS WITH OTHER FUNCTIONS

We have discussed in the earlier section that organisations have replaced the
segmented structure of the procurement function with integrated structures, and
procurement has moved on from being a discrete activity to being the hub of a
large part of the organisation’s business activity. By its very nature, procurement
has continuing relationships with many other functions in an organisation, in
addition to the relationships established with the organisation’s suppliers and
customers. The procurement operations cut across most departmental lines. Figure
1.5 provides a graphic illustration of procurement’s many interfaces within the
organisation.

Figure 1.5 The many internal interfaces of the Procurement function

 
The perspective of procurement as problem solving requires cross-functional
teamwork. However, procurement and other functions often view common
problems differently. This is a normal and healthy situation — provided the
functional opinions are held objectively. We shall now explore some of the
challenges that often surface in the team working between procurement and four
other key functions.

1.  Procurement and Design engineering

Procurement, Engineering and Production have many mutual problems. Design

engineering, like Production, greatly influences the amount of time Procurement
has to handle a procurement assignment. Engineering usually has the initial
responsibility for preparing the technical specifications for an organisation’s
products and the materials that go into them. To exercise this responsibility
effectively, Engineering must have the constant help of Procurement and
Production. A number of organisations have initiated early Procurement and early
supplier involvement programs to assist this effort. The prices paid for production
materials and the cost to fabricate them are inextricably related to their
specifications. Similarly, specifications can be written in a manner that reduces or
enlarges the number of organisations willing to supply specific items. If profit is to
be maximised, the materials specified by engineering must be both economical to
procure and economical to fabricate, and they should normally be available from
more than one efficient, low-cost producer.

Procurement and Engineering occasionally differ in their concepts of materials

problems. This is understandable. Engineers naturally tend to
design conservatively. Hence, their specifications provide amply for quality, safety
and performance. By training, the engineer may be inclined to seek the ‘ideal’
design, material or equipment without complete regard for cost or timing. The
buyer, on the other hand, often believes it is appropriate to reduce the designer’s
performance goals and safety margins, and to work closer to actual performance
requirements. Is an expensive design with a high safety factor necessary if a less
costly design with a lower safety factor will do the job? Why use costly chrome
plate if brushed aluminium is adequate? Clearly, such conflicting functional
interests cannot always be resolved easily. The answers to such problems are
seldom clear-cut. Mutual understanding and willingness to give and take are
required from both sides if mutually satisfactory solutions areto be reached.

 
2.  Procurement and Production

The Procurement-Production relationship begins when the Production function

transmits its manufacturing schedule or materials requisitions to the Procurement
function. Procurement subsequently translates these documents into a procurement
schedule. Procurement timing is often the most difficult problem faced when
making this translation. When Production does not allow Procurement sufficient
time to procure wisely, many needless expenses inevitably creep into the final
costs of an organisation’s products. When Procurement has inadequate time to
develop competition or to negotiate properly, premium prices are certain to be paid
for materials. Costly special production runs and premium transportation costs are
two additional factors that frequently result from inadequate procurement lead
time.

The most serious problem stemming from insufficient procurement lead time is a
production shutdown. In most process types of operation, for example, chemicals,
cement, paint and flour, equipment either runs at nearly full capacity or it does not
run at all. Consequently, material shortages in these industries can be catastrophic,
resulting in complete production stoppage. Losses resulting from material
shortages in non-process industries are not always so disastrous or apparent. A
production shutdown in a custom metal fabricating shop, for example, can be
piecemeal. The indirect costs of such shortages, consequently, are often hidden in
production costs. One or two machines from a large battery of perhaps fifty can be
shut down as routine occurrence. Conventional accounting records fail to reveal
the financial impact of this kind of slow profit-draining inefficiency of asset
utilisation.

Coordination between Procurement and Production pays off in many ways. For
example, a more expensive alternative material that will save
the organisation money can on occasion be selected. This may sound like a
paradox. “Pay more and save more” — how can this happen? Savings in
manufacturing and assembling costs often can exceed the increased procurement
costs. In the normal manufacturing operations of casting, forging, machining,
bending, grinding, punching, stamping, and so on, some materials are much more
economical to work with than others.

The potential consequences of a production stoppage cause many Production

managers to advocate an excessively large inventory of production materials.
Again, this is understandable. For Production managers to reach their main
manufacturing objective of low unit costs, they must minimise idle time and keep
the production line operating. However, Procurement has the related objective of
accomplishing the task with the minimum reasonable capital investment in
inventory, a major concern which production typically does not share with equal
intensity. The cost of carrying inventory is high. Reconciling these two conflicting
organisation objectives (one calling for a higher inventory than the other) requires
capable, informed and understanding functional heads. Although chief executives
themselves must occasionally resolve the issue, it should normally be resolved by
the functional heads within adopted policy guidelines.

The scenarios just described are but just a few of the numerous operating situations
that illustrate the continuing and coordinative nature of the Procurement and
Production relationship.

3. Procurement and Sales

All organisations recognise the direct relationship between the sales function and
profit. In their enthusiasm to increase sales, however, many organisations overlook
the leaks in profit that can occur when the sales activity is not properly meshed
with the Procurement and Production activities.

The Procurement-Production-Sales cycle has its genesis in a sales forecast. Most

sales forecasts include two important parts:

1.  An estimate of sales based on what has happened in the past to an

organisation’s products, territories and markets; and

2.  An adjustment of this estimate to include changes the organisation expects in its
future sales.

The changes reflect alterations in the marketing program and shifts in economic
and competitive conditions. The sales forecast is the basis for the production
schedule. The sales forecast also influences an organisation’s capital equipment
budget, as well as its advertising campaigns and other sales activities.

Prompt communication to Production and Procurement of changes in the sales

forecast permits these functions to modify their schedules as painlessly and
economically as possible. Changes in the production schedules should be
communicated immediately to sales. This action permits sales to alter its
distribution schedule in a manner that will not alienate customers. Procurement
must immediately transmit to Sales, as well as to other management groups,
information concerning increases in materials prices. This permits sales to evaluate
the effect of price rises in price estimates given for future sales quotations, on
current selling prices, and on plans for future product lines.

Procurement and Sales must wisely blend their interest in the delicate area of
reciprocity (buying from customers). If satisfactory legal reciprocal transactions
are to be developed, they must be pursued with an understanding of the true costs
of reciprocity. Buying from customers can be good business, but not when it is
done at the expense of product quality or organisation profit. In the zest for
increased sales, an organisation can lose sight of the fact that increased sales do not
always result in increased profit. Sometimes, increased sales result in decreased
profit if they simultaneously require a greater increase in procurement costs.

4.  Procurement and Finance

Procurement’s relationship with Finance is different from its relationships with

Production, Engineering and Sales. The difference stems from the fact that cost
determinations cannot be hidden in the Procurement-Finance relationship as they
often can in the other relationships. The importance of good financial planning is
highlighted by the fact that poor financial planning is one of the major causes of
business failure. Among the basic data needed by an organisation for proper
planning of its working capital and cash flow positions are accurate sales forecasts
and accurate procurement schedules. It is just as important for Procurement to
inform Finance of changes in its schedule, as it is to inform Production and Sales
of these changes.

There are many economic factors that periodically bring about favourable and
completely unexpected buying opportunities. For example, a supplier may
momentarily have excess capacity because of the cancellation of a large order.
During the period that this condition exists, the supplier may sell products at prices
designed to recover only out-of-pocket costs. This may be done because it is in the
long-term interest of the organisation not to reduce its labour force. The potential
income from such unexpected buying opportunities must be weighed against the
potential income from other alternative uses of the organisation’s capital.
Acquiring new equipment, adding to plant facilities, and increasing sales and
promotional efforts are some of the alternative uses of capital that an organisation
must consider. Usually, the alternative offering the greatest income in the long run
should be selected, since no organisation has enough capital to satisfy all
requirements.
Regardless of the price advantage obtainable, the right time to buy from the
standpoint of business conditions is not always the right time to buy from the
standpoint of the organisation’s treasury. If the Procurement function makes
commitments to take advantage of unusually low prices without consulting the
finance function, the organisation could find itself paying these procurements with
funds needed for other purposes. On the other hand, if the Finance function does
not strive diligently to make funds available for such favourable buying
opportunities, the organisation may have to pay higher prices later for the same
material.

Prompt payment to suppliers is a key contributor to good supplier relations. During

material shortage periods, an organisation with a preferred customer status has a
much better chance of avoiding shortage problems experienced by most others.
Hence, a cooperative relationship between Procurement and Finance clearly can
impact the development of good supplier relations.

TOPIC: THE FUTURE TRENDS OF PROCUREMENT MANAGEMENT

At least three drivers have been identified to have influenced and are influencing
changes in procurement philosophies, processes and procedures today.

1.  Globalisation

There are numerous definitions of globalisation and one such useful definition is:

The increasing interdependence across national and geographical boundaries of

people, trade and commerce driven in large part by information technology and
technology generally.

From the perspective of procurement management, an important aspect of

globalisation is global sourcing, which may be defined as:

A process of manufacturing and/or purchasing of components in various parts of

the world and then assembling them into a final product: an international division
of labour in which activities are performed in countries where they can be done
well at the lowest level.

Global sourcing is a wider term than ‘import purchasing’ or ‘international

procurement’ as it involves strategic product life cycle decisions relating to long-
term supplier relations based on such factors as purchase price and lead time
reliability, supplier flexibility and political stability. Global procurement will be
considered further in later units.

2.  Information technology

As stated in the definition earlier on, globalisation is driven in large part by

information technology. Information technology — comprised of computers,
telecommunications and the Internet — has already had a significant effect on
procurement processes and procedures. By sharing information and processing
electronic transactions over the Internet, suppliers are being converted into e-
suppliers.

E-business is a new source of sustainable competitive advantage. While e-

commerce is the buying and selling of products and services over the internet, e-
business is the strategic use of information and communication technology to
interact with customers, prospective customers and partners through customer-
centric multiple communication and distribution channels. When implemented
successfully, e-business system is a means to improve customer service level while
reducing costs through greater effectiveness and efficiency by aligning the
organisation’s people, processes and technology into an integrated system.

3. The changing role of Procurement

Intense global competition has brought about the search for strategies that will
yield sustainable competitive advantage. Many models and approaches have
surfaced in recent times and competitive advantage is sought via reduced
inventories, lower costs, Just-in-Time, Total Quality Management (TQM), supplier
collaboration, time-based competition, lean and agile production and supply chain
management. All these are a part of the procurement evolution.

As the level of attention paid to procurement management increases, the

procurement tends to become strategic in emphasis, concentrating more upon such
activities of long-term relationships, supplier development and total cost reduction
rather than ordering and stock replenishing routines. Table 1.1 sums up the
changing procurement roles: reactive and proactive procurement as adapted from
your textbook.
Table 1.1  Changing procurement roles: reactive and proactive
Source: Adapted from page 13 of your textbook Procurement Principles and
Management, 10th edn, England: Prentice-Hall, Pearson Education Limited by
Baily, P, Farmer, D, Crocker, B, Jessop, D and Jones, D (2008).

Besides the proactive procurement as stated above, the future trends of

procurement are listed as below:

1.  Procurement will be more customer focused and customer driven.

2.  Proactive application of leading-edge concepts such as TQM, JIT, lean

production and relationship management.
3.  Tactical purchasing activities of ordering and expediting will be automated and
selected low-value items, low-risk supply items, sub-materials and standard items
are likely to be outsourced to full-service providers.

4.  Upstream integration and partnership with suppliers will increase.

5.  Purchasing ethics, purchasing social responsibility or green purchasing will

become increasingly important.

6.  Procurement strategy of fewer but larger suppliers.

7.  Best practice benchmarking in order to stay competitive in the market.

The global impact of the procurement process for individual organisations is

revolutionary in the new millennium. To become a competitive strategic weapon,
procurement has to abandon the fragmented approaches of the past. Integrated
procurement management activities are critical for the organisation’s success.
Procurement actions must be in alignment with the business strategy and designed
to reinforce the organisation’s competitive priority. Section 1.2 looks into the
linkages between business strategy and procurement decisions, and how
procurement can play a significant role in making an organisation competitive.

TOPIC:  LINKING PROCUREMENT DECISIONS WITH BUSINESS

STRATEGY

OBJECTIVES

By the end of this section, you should be able to:

1.  Identify the steps of strategy formulation.

2.  Identify the key macro-level environmental factors for an organisation and the
core of the organisation’s environment.

3.  Explain the necessity for strategic positioning.

4.  Identify the different sources of competitive advantage.

5.  Explain the procurement and strategic interface and the important linkages
between the organisation’s competitive strategy and procurement decisions.
 INTRODUCTION

Visioning is big in corporate international. Everyone from big corporations to the

small firms has been encouraged to have mission statements, visions, philosophies
and core values. Most mission statements began in the 1990s, when organisations
incorporated total quality, teamwork and customer focus into their day-to-day
operations — and they have multiplied rapidly since.

Mission statements are the ‘constitution’ for an organisation, the corporate

directive. However, they are no good, unless they are supported by strategy and
converted into action. That is what this section is all about — converting missions
to strategy to results.

TOPIC: STRATEGY FORMULATION

Strategy is about winning. It is how the mission of an organisation is

accomplished. It is not a detailed plan or program of instructions; it is a unifying
theme that gives coherence and direction to the actions and decisions of an
organisation. Strategic formulation consists of five basic steps:

1.  Defining a primary task

The primary task represents the purpose of an organisation — what the

organisation is in the business of doing. It also determines the competitive arena.
As such, the primary task should not be defined too narrowly. For example, KTM
is in the business of transportation, not railroads. Golden Screen Cinema is in the
business of entertainment, leisure and communication, not just showing movies.
Berjaya Time Square is in the business of providing the most enjoyable shopping
experience together with theme park and restaurants, while Genting Highland’s
theme park and casino are providing people exciting experience! The primary task
is usually expressed in an organisation’s mission statement. The mission may be
accompanied by a vision statement that describes what the organisation sees itself
becoming.

2.  Auditing the industry environment

The business environment of an organisation consists of all the external influences

that affect its decisions and performance. Given the vast number and range of
external influences, we need some kind of system or framework for organising
information. For instance, environmental influences can be classified by source as
shown in Table 1.2.

EconomicBusiness
cycles, industry trend,
Political/Legal/EcologicalMon
economic/investment
opolies legislation,
/work migration
environmental protection law,
trends, interest rates,
taxation policy, foreign
inflation,
trade regulations,
unemployment,
employment law,
disposable income,
government stability, etc.
energy
availability/cost, etc.

TechnologicalGovern
ment spending on
Socio/DemographicPopulatio
research,
n demographics, income
government and
distribution, social mobility,
industry focus of
lifestyle
technological effort,
changes, attitudes to work
new discoveries/
and leisure,
development, speed
consumerism, level of
of technology
education, etc.
transfer, rates of
obsolescence, etc.

Table 1.2 PESTLE analysis of general environmental influences

Though continuous scanning of the whole range of external influences might seem
systematic and desirable, such extensive environmental analysis is unlikely to be
cost effective and creates information overload. The prerequisite for effective
environmental analysis is to distinguish the vital from the merely important. To do
this, let us return to first principles. For the organisation to make profit, it must
create value for customers. Hence, it must understand its customers. Second, in
creating value, the organisation acquires goods and services from suppliers. Hence,
it must understand its suppliers and manage relationships with them. Third, the
ability to generate profitability depends on the intensity of competition among
firms that compete for the same value-creating opportunities. Hence, the
organisation must understand competition. Thus, the core of the organisation’s
business environment is formed by its relationships with three sets of
players: customers, suppliers and competitors. This is its industry environment.

This is not to say that macro-level PESTLE factors as shown in Table 1.2 are
unimportant to strategy analysis. These factors may be critical determinants of the
threats and opportunities an organisation will face in the future. The key issue is
how these more general environmental factors affect the organisation’s industry
environment as illustrated in Figure 1.6.

Figure 1.6 From environmental analysis to industry analysis

Consider the threat of global warming. For most firms, this is not an important
strategic issue (at least, not for the next hundred years). However, for the producers
of automobiles such as Proton and Perodua, global warming is a vital issue. In
order to analyse the strategic implication of global warming, the automobile
manufacturers need to trace its implication for their industry environment. For
example, what will be the impact on demand — will consumers switch to more
fuel-efficient imported cars? Will they abandon their cars in favour of public
transportation such as LRT in KL or Rapid Penang? With regard to competition,
will there be new entry by manufacturers of electric vehicle into the car industry?
Will increased R & D costs cause the industry to consolidate?

3.  Assessing core competencies

Core competency is what an organisation does better than anyone else,

its distinctive competence. An organisation’s core competence can be exceptional
service, higher quality, faster delivery or lower cost. One organisation may strive
to be the first to the market with innovative designs, whereas another may look for
success arriving later but with better quality.

Based on experience, knowledge and know-how, core competencies

represent sustainable competitive advantages. For this reason, products and
technologies are seldom core competencies. The advantage they provide is short-
lived, and other organisations can readily procure, emulate or improve on them.
Core competencies are more likely to be processes, an organisation’s ability to do
certain things better than a competitor. Thus, while a particular product is not a
core competence, the process of developing new products is. Consider Chaparral
Steel for example. Chaparral management allows its competitors to tour its plants
at will because “they cannot take — what we do best — home with them.”
Although Chaparral is known for its low cost and high technology, its core
competency is not technology, but the ability to transform technology rapidly into
new products and processes. By the time, a competitor copies its current
technology, Chaparral will have moved on to something else.

Core competencies are not static. They should be nurtured, enhanced and
developed over time. Close contact with the customer is essential to ensure that a
competence does not become obsolete.

4.  Determining order winners and order qualifiers

An organisation is in trouble if the things it does best are not important to the
customer. That is why it is essential to look towards customers to determine what
influences their procurement decision.

Order qualifiers are the characteristics of a product or service that qualify it to be

considered for procurement by a customer. An order winner is the characteristic of
a product or service that wins orders in the marketplace — the final factor in the
procurement decision. For example, when buying a DVD player, customers may
determine a price range (order qualifier) and then choose the product with the most
features (order winner) within that price range. Alternatively, they may have a set
of features in mind (order qualifiers) and then select the least expensive DVD
player (order winner) that has all the required features.

Order winners and order qualifiers can evolve over time, just as competencies can
be gained and lost. Japanese automakers initially competed on price but had to
ensure certain levels of quality before the US consumer would consider their
product. Over time, the consumer was willing to pay a higher price (within reason)
for the assurance of a superior-quality Japanese car. Price became a qualifier, but
quality won the orders. Today, high quality, as a standard of the automotive
industry, has become an order qualifier, and innovative design wins the orders.

It is important for an organisation to meet the order qualifiers and excel on the
order winner. Ideally, an organisation’s distinctive competence should match the
market’s order winner. If it does not, perhaps a segment of the market could be
targeted that more closely matches the organisation’s expertise. On the other hand,
the organisation could begin developing additional competencies that are more in
tune with market needs.

5.  Positioning the organisation

No organisation can be all things to all people. Strategic positioning involves

making choices — choosing one or two important things on which to concentrate
and doing them extremely well. An organisation’s position strategy defines how it
will compete in the marketplace — what unique value it will deliver to the
customer. An effective positioning strategy considers the strengths and weaknesses
of the organisation, the needs of the marketplace and the positions of competitors.

TOPIC: COMPETITIVE STRATEGY

An organisation can compete in two broad alternate ways. It can either seek
competitive advantages on cost or choose to differentiate itself from its competitors
on some attributes of the products or services or in the way it markets its products
or services. The notion of two generic competitive advantages — cost and
differentiation — is important but too broad to be useful for a management faced
with day-to-day decision-making. The competitive strategy is articulated in terms
of competitive priorities.

COMPETITIVE PRIORITIES

The competitive priorities operationalise the organisation’s competitive strategy.

The two generic competitive advantages — cost and differentiation — are
operationalised in terms of cost, quality, flexibility and speed. By assigning
priorities to these dimensions, the organisation operationalises its strategy. The
priorities can then be used to generate supply objectives related to quality and
innovation, availability and lead-time, supplier service and responsiveness and
cost reduction that are consistent with the organisation’s competitive strategy.
Let us now look at organisations that have positioned themselves to compete on
cost, quality, flexibility and speed.
1.  Competing on cost

Organisations that compete on cost relentlessly pursue the elimination of all

waste. In the past, organisations in this category produced standardised products
for large markets. They improved yield by stabilising the production process,
tightening productivity standards and investing in automation. Today, the entire
cost structure is examined for reduction potential, not just direct labour costs.
High-volume production and automation may or may not provide the most cost-
effective alternative.

Take the example of Southwest Airlines’ strategy of low-cost, no-frills air

transportation that forever changed the public’s attitude towards flying. The
strategy is supported by carefully designed service, efficient operations and
committed personnel. Southwest uses only one type of airplane, the Boeing 737, to
facilitate crew changes and to streamline training, record-keeping, maintenance
and inventory costs. Turnaround time between flights is 15 minutes. Since its
flights are limited to short routes, all flights are direct. That means no baggage
transfers and no meals to be served. There are no assigned seats and no printed
boarding passes for flights. Boarding priority is
a function of arrival time at any Southwest check-in facility. Southwest saves tens
of millions annually in travel agent commissions by requiring customers to contact
the airline directly to book flights. The airline carefully selects employees and
reinforces its commitment with a model profit-sharing plan. The result is
Southwest flies more domestic passengers than any other airline in the US and
earns more money than all other US airlines combined. Its on-time performance,
baggage handling and customer satisfaction are always among the best in the
industry. The discount airline in Malaysia, AirAsia, is making similar choices on
competitive strategic positions, and has beaten the odds to find the ‘blue ocean’ in
a very competitive industry.

Organisations that compete successfully on cost realise that low cost cannot be
sustained as a competitive advantage if increases in productivity are obtained
solely by short-term cost reductions. A long-term productivity ‘portfolio’ is
required that trades off current expenditures for future reductions in operating cost.
The portfolio consists of investments in updated facilities and infrastructure;
equipment, programs, and systems to streamline operations; and training and
development that enhances the skills and capabilities of people.
2.  Competing on quality

Most organisations approach quality in a defensive or reactive mode. Quality is

confined to minimising defect rates or conforming to design specifications. To
compete on quality, organisations must view it as an opportunity to please the
customer, not just a way to avoid problems or reduce rework costs.

To please the customer, one must first understand customer attitudes towards and
expectations of quality. The Ritz-Carlton Hotel Company is a Malcolm Baldrige
National Quality Award winner and a recognised symbol of quality. A host
attempting to impress party guests is often said to be ‘putting on the Ritz’, whereas
someone trying to downplay a less-than-glamorous spread may offer the excuse,
“It is not the Ritz, but it is the best I could do.” In both cases, the comments are a
way of comparing current standards to those exemplified by one of the world’s
most respected and benchmarked organisations.

The entire service system in Ritz-Carlton is designed to understand the individual

expectations of more than half a million customers worldwide and to ‘move
heaven and earth’ to satisfy them. Every employee is empowered to take
immediate action to satisfy a guest’s wish or resolve a problem. Processes are
uniform and well defined. Teams of workers at all levels set objectives and devise
quality action plans. Each hotel has a quality leader who serves as a resource and
advocate of the development and implementation of those plans. Daily quality
reports submitted from close to a thousand work systems track such measures as
guest room preventive maintenance cycles, percentage of check-ins with no
waiting and the time spent to achieve industry-best clean room appearance. Guest
Incident Action Reports completed by every employee help identify patterns of
problems so that they can be resolved permanently. Guest Preference Reports are
recorded in a sophisticated customer database for service delivery throughout the
organisation. For example, if a guest in Atlanta likes fresh fruits and five different
newspapers each morning, that wish is stored in the database and automatically
fulfilled whether the guest’s next stay occurs at a Ritz in Naples or Hong Kong.
Ritz-Carlton provides exceptional service quality — one customer at a time.

3.  Competing on flexibility

We have discussed in the first part of this unit how marketing functions always
want more variety to offer to its customers. Production will generally resist this
trend because variety upsets the stability (and efficiency) of a production system
and increases costs.
The ability of Production to respond to variation has opened up a new level of
competition. Flexibility has become a competitive weapon. It includes the ability to
produce a wide variety of products, to introduce new products and modify existing
ones quickly, as well as to respond to customer needs. Examples of organisations
that compete on flexibility include Andersen Windows, Custom Foot Shoe Store
and National Bicycle.

Andersen Windows, like most manufacturers, used to produce a limited range of

standard products in large volumes. As customers demanded
uniqueness, Andersen introduced more and more options to their standard windows
— so many, in fact, that the number of products offered grew from 28,000 to
86,000. Thick catalogues allowed customers to combine thousands of options into
truly unique windows. However, pricing became quite complex, and the rate of
error in the finished product was high. Then, Andersen introduced an electronic
version of its catalogue that can be used to add, change or strip away features until
the customer is pleased with the design. Special computer-aided design (CAD)
programs are used by architects and builders to incorporate Andersen windows
directly into their design. The computer then checks the window specs for
structural soundness, generates a price quote and transmits the order to an
Andersen factory. At the factory, standard parts from inventory are used to
assemble custom products and the bar codes keep track of the customer order as it
moves through assembly. In five years, demand for Andersen windows has tripled,
the number of different products offered has topped 188,000 and the errors are
down to 1 per 200 truckloads.

Shoe stores carry lots of inventory and yet customers are still turned away because
a particular size or style of shoe is not in stock. Other styles are sold only with
deep discounts. Customer Foot Shoe Store has an alternative business model for
selling shoes. Handmade shoes begin with customsculpted models, called ‘lasts’
that can cost hundreds of dollars and take 10 to 20 hours to construct. The entire
shoemaking process takes about eight months and is very expensive. At Customer
Foot Shoe Store, a customer’s feet are scanned electronically to capture 12
different three-dimensional measurements. The measurements are sent to a factory
in Italy, where a library of over 3000 computerised lasts can be modified digitally
instead of manually and then milled by a machine out of plastic. Custom shoes are
mailed to the customer’s home in weeks, and since the shoe store carries no
inventory, the prices are comparable to off-the-shelf shoes.

National Bicycle Industrial Company fits bicycles to exact customer

measurements. Bicycle manufacturers typically offer customers a choice
among 20 or 30 different models. National offers over 11 million variations and
delivers within two weeks at a cost of only 10% above standard models.
Computerised design and computer-controlled machinery allow customised
products to be essentially mass-produced. The popular term for this phenomenon
is mass customisation, which takes advantage of both flexibility and speed at
comparable costs.

4.  Competing on speed

More than ever before, speed has become a source of competitive advantage. The
internet has conditioned customers to expect immediate response and rapid product
shipment. Service organisations such as McDonalds’ and Poslaju have always
competed on speed. Citicorp advertises a 15-minute mortgage approval and LL
Discount Store ships orders the day they are received. Now, manufacturers are also
discovering the advantages of time-based competition, with build-to-order
production and efficient supply chains.

In the fashion industry where trends are temporary, Gap’s nine-month time-to-
market can no longer compete with the two-month design-to-rack lead-time of
H&M, the Swedish retailer, or the two-week lead-time of Zara of Spain. The Gap
only introduces less than 50 new fashion lines a year compared to hundreds for
H&M and Zara.

Saks Fifth Avenue sends suit measurements via the Internet to France, where a
laser cuts the cloth and tailors begin their work. The suit is completed and shipped
back to New York within four days. That is about the same amount of time
required for alterations in most clothing stores. The standard for custom-made suits
is 10 weeks.

Competing on speed requires an organisation characterised by fast moves, fast

adaptations and tight linkages. Decision-making is pushed down the organisation
as levels of management are collapsed and work is performed in cross-functional
teams. Change is embraced and risk-taking encouraged. Close contact is
maintained with both suppliers and customers. Performance metrics reflect time,
speed and rate, in addition to cost and profit. Strategy is time-paced to create a
predictable rhythm for change. Intel’s time-paced strategy involves doubling the
capacity of computer chips every 18 months and adding a new fabrication facility
every nine months. Dell computer sets the pace for the entire industry.

Forming alliances is one of the most effective avenues for competing on speed.
The best example is the textile industry’s quick response (QR) initiative, designed
to improve the flow of information, standardise recording systems and reduce
turnaround time along the entire supply chain from fibre to textiles to apparel to
retailing. Automotive, electronics and equipment manufacturers encourage similar
alliances within their respective industries with an initiative called ‘agile
manufacturing’. E-marketplaces and companysponsored B2B sites are dramatically
speeding up the time required to locate suppliers, negotiate contracts and
communicate procurement needs.

PROCUREMENT’S ROLE IN BUSINESS STRATEGY

PROCUREMENT’S ROLE IN BUSINESS STRATEGY

Effective strategy can be achieved in two ways — by

performing different activities from those of competitors or by performing the
same activities better. Procurement plays an important role in either approach. It
can provide support for a differentiated strategy and it can serve as an
organisation’s distinctive competence in executing similar strategies better than
the competitors.

In today’s turbulent supply markets, procurement professionals are expected to

develop options that can help their organisations stay competitive. To begin with,
procured inputs constitute a large portion of the organisation’s resources and offer
a potential source for helping an organisation develop leverage against its
competitors. Procurement actions must be devised such that they are consistent
with each other and with the organisation’s competitive strategy. Furthermore,
procurement actions should also be designed to reinforce the organisation’s
competitive priorities. Figure 1.7 shows the components and linkages for
procurement strategy.
Figure 1.7  Components of procurement strategy
Source: Adapted from page 21 of the book by Benton, W C Jr. (2007). Purchasing
and Supply Management, McGraw-Hill/Irwin, New York, USA.

As mentioned earlier and again depicted in Figure 1.7, competitive priorities are
one means of articulating an organisation’s competitive strategy. For instance, an
organisation competing on cost should drive the overall costs down. On the other
hand, an organisation competing on differentiation must devise actions that
enhance its uniqueness on values perceived by customers, be it cost or quality or
flexibility or speed, or on any combination of the four.

The competitive priorities are also a key determinant of the importance given to
different criteria in procuring material. However, the buyer performance measures
or reward criteria are other factors that also influence the buying criteria. The
competitive priorities define the intended or desired buying criteria, and the
reward criteria determine how closely the objectives are met.

First, the criteria in procuring material must reflect the organisations’ competitive
priorities. Procurement decision-makers must consider the organisation’s
competitive priorities in choosing the criteria on which the material is procured. An
organisation competing on cost must give high priority to procurement costs. On
the other hand, an organisation competing on flexibility must give high priority to
lead time in buying material. With short lead times, the organisation can be more
flexible; it can develop the ability to respond to changing situations quickly. Lead
times are also important in achieving speed for superior customer service.
Suppliers with short lead times and those that are reliable in meeting their due
dates minimise the problem of material shortages for the manufacturer. As a result,
the organisation’s production can be more dependable in meeting the customer’s
due dates. An organisation emphasising speed for superior customer service will
need to carry more inventories to buffer against uncertainties if the supplier is
unreliable. Inventory is an expensive alternative.

Next, the criterion in which the buyer’s performance is evaluated can greatly
influence the effectiveness of procurement actions and in making the organisation
competitive. Cost variance seems to be the dominant criterion in evaluating
performance of procurement decision-makers. This emphasis on cost can drive
procurement decision-makers to take actions that keep material costs low, but other
criteria may be neglected, and the procurement actions may end up being
inconsistent with the competitive strategy. The reward criteria determine the
organisation’s actual priorities. The closer the reward criteria reflect the
performance on the competitive priorities, the narrower will be the gap between
intended and realised objectives. In short, if reward criteria emphasise cost,
procurement decision-makers will emphasise cost in making decisions, irrespective
of the competitive priority.

Strategic procurement is all about the linking of procurement decision-making and

actions to corporate business strategies. In practice, the extent to which
procurement is involved in the formation of organisational strategies is largely
dependent on the extent to which procurement is perceived by top management as
contributing to competitive advantage. Kraljic (1983) as cited by Lysons, K and
Farrington, B (2006) states that such will often depend on:

1.  The strategic importance of procurement in terms of the value added by the
product line and the percentage of materials in total costs.

2.  The complexity of the supply market, gauged by supply scarcity, pace of
technology and/or materials substitution, entry barriers, logistics cost or
complexity, and monopoly or oligopoly conditions.

Kraljic further claims that ‘by assessing the company’s situation in terms of these
two variables, top management and senior Procurement executives can determine
the type of supply strategy the company needs both to exploit its procurement
power vis-à-vis important suppliers and reduce its risk to an acceptable minimum.’

Figure 2.1 on page 36 in your textbook shows the involvement of procurement at

strategic, tactical and operational levels. We shall discuss the development of the
different types of supply strategies later in Unit 3.

SUMMARY

SUMMARY

Ultimately, procurement’s measure of its contribution needs to be seen in the

success of the organisation as a whole. Contributing operationally and
strategically, directly and indirectly, and in a positive mode, the Procurement
function is contributing to its full potential when the way the procurement relates
to its internal interfaces and the suppliers brings about performance better than the
competition and greater customer satisfaction.

ORGANIZATION STRUCTURES FOR PROCUREMENT

UNIT OBJECTIVES

UNIT OBJECTIVES

By the end of Unit 2, you should be able to:

1.  Explain the various procurement organisational designs, their advantages and
disadvantages.

2.  Describe the main activities of a typical Procurement function and steps in the
procurement cycle.

3.  Describe the intervention of technologies in the purchasing process and their
advantages and challenges.

4.  Describe online sourcing in the e-marketplace and issues with online auctions.
ORGANISATIONAL STRUCTURES FOR PROCUREMENT MANAGEMENT

OBJECTIVES

By the end of this section, you should be able to:

1.  Explain where the Procurement function is commonly fitted in an organisational

structure.

2.  Explain the basic approach to organising procurement activities in small and
large organisations.

3.  Describe the advantages and disadvantages of centralised and decentralised

procurement organisational designs.

INTRODUCTION

All organisations have to make provision for continuing activities directed towards
the achievement of given aims. Regularities in activities such as task allocation,
supervision and coordination are developed. Such regularities constitute the
organisation’s structure and the fact that these activities can be arranged in various
ways means that organisations can have differing structures, formal or informal.

When an organisation is very small, one or perhaps a few people will undertake all
of the necessary functions and processes, and there is no need for a formal
organisational structure. The head of the organisation will give instructions to
employees, and there will most likely be no clear division of responsibilities. In
Malaysia, we could find this example in small-sized, family-owned businesses. As
the organisation grows, though, it will become increasingly difficult for a single
person to control it. The need for a formal structure will then emerge.

Formal structure allows the responsibilities for different functions and processes to
be clearly allocated to different departments and employees. With this clarity of
responsibility comes the authority to control. The design of the structure should
aim to implement the organisation’s processes as efficiently and effectively as
possible, and to facilitate the working relationships amongst its various functions.
Ideally, it must balance the need for order as a command structure with the need
for flexibility and promoting creativity.

The size and activities of the Procurement function in a single business unit
organisation will depend on a number of factors, such as the size of the
organisation and the nature of its businesses. Obviously, in small and medium-
sized organisations where the supply staff consists of only one or two individuals,
the staff is expected to be flexible in terms of their capabilities and skills. In fact, in
small companies, it is not unusual to see procurement responsibilities shared by a
variety of individuals for whom procurement may even be a secondary
responsibility. As the size of the organisation grows, the idea of assigning a
professional the responsibility of procurement emerges and a separate function is
created. Specialisation will occur as the organisation gets larger and can afford to
hire additional procurement personnel. Figure 2.1 provides an example of a
Procurement organisation in a typical mediumsized single-business unit company
staffed by procurement professionals with clearly defined responsibilities in four
general areas of specialisation: sourcing, materials management, administration
and supply research.

Figure 2.1 Example of a typical Procurement organisation in a single location,

medium-sized company
 LOCATION OF THE PROCUREMENT DEPARTMENT

LOCATION OF THE PROCUREMENT DEPARTMENT

A firm’s organisational structure reflects the management’s basic attitudes toward

the major activities involved in its operation. Where should the Procurement
function fit into a firm’s organisational structure? A study funded by the National
Association of Purchasing Management (NAPM) among the Fortune 1000 firms
reveals the reporting relationships shown below:

Percent of Procurement function

firms reporting to

President or Executive Vice

34%
President

Vice-President or
25%
Manufacturing

Other Functional Vice-

29%
President

12% Other Units

Table 2.1  Reporting relationships survey

The two most commonly found alternatives are shown schematically in Figure
2.2 and Figure 2.3.
Figure 2.2  Skeleton organisation for a medium-sized firm, with Procurement
function as a top-level function

Figure 2.3  Skeleton organisation for a medium-sized firm, with Procurement

function as a second-level function
In a given firm, how does one tell whether Procurement function is a top-level
function that should report to a general management executive, as do Marketing
and Finance, or a sub-function that should report to one of the top functional
executives? This is just one of the several questions that must be answered when
organising a Procurement department. We will next explore the various key
influencing factors.

THE KEY INFLUENCING FACTORS ON THE ORGANISATION OF

PROCUREMENT DEPARTMENT

THE KEY INFLUENCING FACTORS ON THE ORGANISATION OF

PROCUREMENT DEPARTMENT

Organising a Procurement department involves determining not only what we have

discussed earlier:

1.  Where it should be located in the organisational structure (position); and

2.  How it should be organised internally (structure)

But, it also involves the considerations of:

1.  What it is responsible for doing (that is, its scope and involvement in the
corporate processes (scope))

2.  Which resources it will require to carry out its responsibilities effectively
(staffing)

Due to the varied nature of different firms’ products and operations, answers to the
preceding questions differ among firms. A number of factors with significant
impact on the above issues should be considered before final decisions are made on
the organisation of the department. We shall discuss three of the key factors below
and the fourth in the next sub-section.

1.  The importance of the Procurement function

In the competitive fast-paced business world today, the importance of Procurement

in any specific firm is detailed largely by four factors:
a.  Availability of materials: Are the major materials used by the firm readily
available in a competitive market? Or are some key materials bought in volatile
markets subject to periodic shortages and price instability? If the latter condition
prevails, creative performance by analytical procurement professionals is required;
this typically is a top-level group.

b.  Absolute dollar volume of procurements: If a firm spends a large amount of

money for materials, the sheer magnitude of the expenditure means that top-flight
procurement can usually produce significant profit. Small savings add up quickly
to big amount when thousands of units are procured.

c.  Percent of product cost represented by materials: When a firm’s materials

costs make up a high percentage of its product cost (or its total operating budget),
small reductions in material costs increase profit significantly. Top-level
procurement usually pays off in such firms.

d.  Types of materials procured: Perhaps even more important than the preceding
considerations is the amount of control procurement personnel actually have over
materials availability, costs and services. Most large firms use a wide range of
materials, many of whose price and service arrangements definitely can be
influenced by creative procurement performance. Some firms, on the other hand,
use a fairly small number of standard production and supply materials, from which
even a high calibre, top-flight Procurement function can produce little profit as a
result of creative management, pricing and supplier selection activities.

For progressive firms with a long-term view, there are also other important
considerations on whether Procurement function is critical to a firm’s success,
which will depend on whether the function contributes to:

a.  Improved product design and innovation through creative acquisition of state-
of-the-art technology and materials.

b.  Attaining the firm’s competitive strategic quality goals by ensuring that only
inputs with the required levels of quality are acquired.

c.  Flexibility of production and quick response to market changes by reducing

supply lead-time through excellent supply chain management.

If many of these efforts at the corporate level rely on the Procurement function, it
will be considered a strategically important function.
2.  Procurement function’s relations with other departments

In Unit 1, we have already discussed the continuing relationships of the function

with other departments in an organisation. The Procurement
department needs to interact with various other parts of the organisation in order to
effectively carry out the processes relevant to the function.

If the Procurement department is located at a high level within the organisation, it

is expected to deal with more strategic issues. Thus, its relations with other
departments will also be at a higher level, team working on matters that are critical
to the survival of the organisation. This will require having people with the right
calibre for this type of work.

If on the other hand, the Procurement function is located lower down in the
organisation, its level of attention will become more operational rather than
strategic, and the types of staff qualifications needed will be different.

In a nutshell, the criteria for Procurement function’s participation in an

organisation’s various processes should focus entirely on whether or not the
department is adding value to the process.

3.  Orientation of work and sub-cultures

These considerations concern how a Procurement department is organised

internally with the alignment of the nature of work with the people in the
department to achieve maximum benefits for the organisation as a whole.

a.  Specialists buyers

Here, each buyer has a portfolio of products and services that he or she is
responsible for procuring. The buyer will be responsible for making all
procurements within his/her portfolio regardless of what is being procured or
whom the procurement is for.
Figure 2.4  Specialist buyers procurement organisation

In this case, buyers can concentrate on a small range of procurement items and so
develop in-depth expertise of the relevant supply market. It will also mean that all
procurements of a particular type will be consolidated and channelled through a
single point. By combining procurements of similar items across different product-
lines and/or projects throughout the organisation, the buyers can make full use of
leverage opportunities with suppliers, and economies of scale.

On the other hand, this approach often does not allow buyers to have a full
understanding of each individual customer group’s needs. For
example, each production line in the firm has to deal with four buyers. There is no
single point of contact.

b.  Generalists buyers

Under this type of arrangement, a buyer focuses on serving a particular customer

group, either a product-line or a project, and buys all items for it regardless of the
item type. This allows buyers to become very familiar with the needs of a
particular product-line or project. Internal customers often prefer the single point
of contact that this approach provides.

The disadvantage is that buyers will not develop as much in-depth expertise on
supply markets as those who focus on particular portfolios of procurement
products or services all the time. Two buyers may be buying the same item
independently without realising it, and as a result leverage opportunities and
economies of scale may be missed. This approach is illustrated in Figure 2.5.

Figure 2.5  Generalist buyers procurement organisation

The choice between the two options will depend on the type of organisation and on
the nature of the work it carries out. Where independent product-lines and/or
projects with very different needs are the norm, the customer group orientation
would be preferred.

Where most procurements are for common use items, the item-based specialisation
is likely to be more appropriate. However, it is possible to go for a third option, a
mix of the two.

c.  The hybrid approach

In larger organisations, the two approaches can be combined in an attempt to

achieve the benefits of each option without its disadvantages. In such a case, a few
specialist buyers are each made responsible for developing and implementing
procurement strategies for a specific portfolio of important procurement items
required across a number of product-lines or projects. These items may be
important because they are either of high total procurement value or critical to the
operations of the firm.
We could call the people responsible for these procurements ‘procurement
portfolio managers’. They will work on reaching ‘framework agreements’ with
suppliers but will not usually become involved in operational procurement issues.

Under this approach, another separate set of buyers will be allocated to particular
customer groups, generally product-lines or projects. These buyers will carry out
operational procurements within the overall strategies and the framework
agreements developed by the product portfolio managers. They will also deal with
the special requirements of their customer groups and work to solve their day-to-
day supply problems. This dual approach is illustrated in Figure 2.6.

Figure 2.6  The hybrid procurement organisation

ADVANTAGES AND DISADVANTAGES OF MULTI-SITE

CENTRALISATION AND DECENTRALISATION

ADVANTAGES AND DISADVANTAGES OF MULTI-SITE

CENTRALISATION AND DECENTRALISATION

The other key influencing factor on the organisation of the Procurement

department is the issue of centralisation and decentralisation.
A multi-site firm faces one additional organisational question that does not concern
most single-site firms: To what extent should procurement activity be centralised at
the corporate level? In practice, virtually every firm answers this question
differently. Some firms centralise the activity almost completely, doing the
procurement for all sites at a central headquarters office. Others decentralise the
function entirely, giving each site full authority to conduct all of its procurement
activities. Still some firms — the majority of them — develop an organisation
somewhere between these two extremes. Each extreme approach offers significant
benefits.

1.  Advantages of multi-site centralisation

a.  Greater buying specialisation: Perhaps the greatest benefit of centralisation

stems from the fact that it permits greater technical specialisation among buyers.
This leads to the development of more knowledgeable and more highly skilled
buying personnel.

In most firms, the importance of specialised buying cannot be overvalued. The

complexity of industrial materials increases constantly. A buyer who does not fully
comprehend the significance of a material’s major technical and manufacturing
characteristics cannot perform effectively. If buyers fail to perform with technical
competence, the important buying decisions will ultimately be made in the using
departments, and buyers will be relegated to a glorified clerical status.

b.  Consolidation of requirements: Just as single-site centralisation facilitates the

consolidation of organisation requirements, multi-site centralisation facilitates the
consolidation of material requirements at the corporate level. In most situations,
such consolidation results in larger procurements from a smaller number of
suppliers, yielding more favourable prices and increased supplier service.
Increased procurement volumes also permit the negotiation of highly profitable
long-term contracts for many production materials.

c.  Easier procurement coordination and control: When all organisation

procurement activities are consolidated in one office, procedures for coordinating
and controlling individual segments of activity can be effected more quickly and
with less paperwork. Consolidation permits more direct administration and control
of such important policies as those affecting supplier selection procedures, supplier
relations, procurement ethics, budget compliance and the consistency of general
procurement practices among the various buyers. In general, under this type of
organisation, the chief procurement executive finds it easier to control the total
efficiency of the corporate procurement activity.

d.  Effective planning and research work: The existence of a centralised group to

handle corporate-wide procurement requirements provides the concentrated staff
know-how to improve procurement research work. Virtually, all procurement-
planning needs — from internal systems design to strategic materials planning —
can be conducted in more depth with greater efficiency for all procurement
operations throughout the corporation.

2.  Advantages of multi-site decentralisation

a.  Easier coordination with operating departments: From an operating

standpoint, the greatest advantage of decentralisation is that it facilitates the
coordination of procurement activities with the activities of using departments at
each site. When a complete Procurement unit is located at each operating site,
procurement personnel are close to the users’ operating problems and develop a
much better feel for unique site needs and their implications in the procurement
area. Buyers can personally discuss procurement matters with using supervisors
anytime they wish. A site Procurement department can develop a much closer
working relationship between suppliers’ technical representatives, buyers and site
engineers/users than is possible under a centralised organisation.

In brief, under a decentralised arrangement, Procurement personnel can participate

more fully as members of a specific Procurement-Production or Procurement-
Operation team.

b.  Speed of operation: A Procurement department located at the site clearly can

respond more quickly to users’ needs. The transmittal of
information from site to headquarters can considerably lengthen the procurement
procedure and cycle even when telephone, fax and computer links are used. If most
operating needs could be adequately planned, and plans always function according
to schedule, the time delay factor would be a minor problem. In a dynamic
business situation, however, unforeseen events could cause enough deviations from
schedule so that this rarely is the case.

c.  Effective use of local sources: If a firm’s sites are geographically dispersed, it

can be difficult for a centralised Procurement department to locate and develop
potentially good suppliers in the locale of each site. At times, this difficulty
deprives a site of various technical and procurement benefits resulting from close
working relationships between site personnel and suppliers. If sites are separated
by great distances, decentralised Procurement departments in many cases may also
be able to reduce material transportation costs by the wise use of local suppliers.
For example, a Penang manufacturing facility could purchase materials from
Penang suppliers situated in Bayan Lepas, Perai and Kulim High Tech. A Selangor
facility could purchase materials from Shah Alam or Nilai industrial areas.

d.  Site autonomy: A fundamental principle of management holds that the

delegation of responsibility must be accompanied by the delegation of adequate
authority to carry out that responsibility. A site manager who is given full
responsibility for the operation and profit performance of a site can properly
contend that he or she should have full authority over the expenditures for
materials and other procurement items. Decentralisation of Procurement gives a
site manager this authority.

3.  Factors affecting feasibility and desirability of centralisation

Generally, three factors determine how feasible or desirable centralisation of the

Procurement function may be in a given situation.

a.  Similarity of materials usage: If a firm’s sites use entirely different materials,

centralisation of Procurement offers only minimal benefits; the major benefits of
increased specialisation and requirement consolidation cannot be achieved. In such
cases, potential disadvantages of centralisation usually outweigh the advantages
gained from better coordination and control.

Most firms, however, generally have a greater similarity of materials usage among
sites than is at first apparent. To make specialisation profitable, the various sites do
not have to use exactly the same items. The important thing is the similarity of
types of materials (or markets). Specialisation of buyers is accomplished on the
basis of material (or market) classifications. Most firms find that their sites do use
a number of the same classifications of materials.

b.  Site department size: As a general rule, centralisation is more advantageous

when a firm’s individual site Procurement departments are not large. If site
procurement operations are large, a high degree of buyer specialisation may
already have been achieved. Similarly, the benefits to be gained from consolidating
requirements of large departments are less significant than those gained from
consolidating the requirements of small sites. This is not to say that consolidation
of large departments does not yield benefits. The benefits, however, are not as
significant as in the case of small departments, and they are frequently outweighed
by the offsetting disadvantages.
c.  Geographic dispersion of sites: The closer a firm’s sites are situated
geographically, the easier centralisation becomes. Conversely, if much centralised
buying is done, and the more widely the sites are dispersed, the more serious the
disadvantages of centralisation become as the problems of communication and
coordination will be more difficult to handle.

SUMMARY

SUMMARY

The fundamental purpose of organisation is to provide a structure that facilitates

the motivation of people and the coordination of their efforts towards the common
goals of the firm. A poorly designed structure can inhibit such accomplishments,
just as a well-designed structure can facilitate them.

This section has explored the various approaches to the Procurement structure
within a firm’s hierarchy. The challenge for Procurement executives is to
maximise the benefits of their organisational structure, whether it is centralised,
decentralised or hybrid.

TRADITIONAL PURCHASING PROCEDURES AND INEFFICIENCIES

TRADITIONAL PURCHASING PROCEDURES AND INEFFICIENCIES

Apart from pre-procurement activities, such as supply markets analysis, supply

planning, participation in the preparation of specifications and budgets, purchasing
has traditionally involved three main phases:

1.  The identification phase: Notification of the need to procurement by either a

requisition or a bill of materials.

2.  Ordering phase: Involving the steps of enquiries/requests for quotations, receipt
of quotations, preparation of purchase orders.

3.  Post-ordering phase: Including activities such as expediting orders, delivery

arrangements, quality inspections, storage, payment processing and documentation.
 

The above traditional procedures are administrative and merely provide a

documented logistical trail. The inefficiencies include:

1.  A sequence of non-value adding clerical activities.

2.  Tendency to result in excessive documentation.

3.  Excessive order processing time.

4.  Excessive administrative cost for pure transactional activities.

Many organisations that have implemented the ISO 9000 quality management
system with the principle of ‘you document what you do and do what you have
documented’ are experiencing similar inefficiencies in practice though the quality
management system is intended to allow an organisation to run more efficiently
with less wastages and rework.

To stay competitive and relevant in today’s business environment, progressive

organisations need to transform this administrative function into value-added
processes by reducing, eliminating or combining the traditional purchasing
procedural steps, and by embracing the strategic implications of IT and e-
procurement.

E-COMMERCE, E-BUSINESS AND E-PROCUREMENT

E-COMMERCE, E-BUSINESS AND E-PROCUREMENT

In Unit 1, we have already distinguished e-commerce as the buying and selling of

products and services over the internet while e-business is the strategic use of
information and communication technology to interact with customers, prospective
customers and partners through customer-centric multiple communication and
distribution channels. E-commerce relates primarily to transactions. E-business,
however, incorporates a wide range of production, customer and internal processes
that are only indirectly related to commercial transaction. E-business system is a
means to improve customer service while reducing costs through greater
effectiveness and efficiency by aligning the organisation’s people, processes and
technology into an integrated system.

E-procurement uses the internet to operate the transactional aspects of

requisitioning (against agreed contract), authorising ordering, receiving and
payment processes for the required services or products. The key enabler of all the
above is the ability of systems to communicate across organisational boundaries.
While the technology for e-commerce provides the basic means, the main benefits
are derived from the resultant changes in the traditional procedures, processes and
changes.

PURCHASING TECHNOLOGIES: EDI

PURCHASING TECHNOLOGIES: EDI

There are various types of e-procurement trading models in the market. In this
section, we will look at an electronic method of transmitting data that offer a whole
new way of communicating across the internet and beyond.

1.  What is electronic data interchange (EDI)?

EDI is the direct computer transmission of orders and other transaction

information. In purchasing, EDI is usually used for the electronic
transmission of orders, invoices and payment between buyer and seller. The main
elements of an EDI system are computer hardware, software, computer
compatibility between the sender and receiver, and subscription to a common
network.

There are many benefits of using EDI. For a small firm, EDI may help keep a
valued trading partner or customer or even gain new ones. For larger firms, the
main benefit is generally the cost savings, or to be known as a leading-edge
company.

A simple example of what EDI can do for a firm follows. A buyer takes a request
from someone within the organisation, creates a purchase order and mails it to the
supplier to fill and ship. This process is speeded up when the buyer enters the
purchase order on a computer screen as he or she is talking to the user and sends
the order electronically to the supplier’s system as soon as he or she hangs up the
phone. This, of course, would only be done if the person ordering had the
authorisation and if the order had to be sent that quickly. Traditionally, a firm
could collect the orders to a single vendor and send them all together at the end of
the day. EDI software technology enables the orders to be converted into a
standard format and translated either directly to the supplier’s system or to an
electronic mailbox on a third-part valued-added network (VAN) accessed by the
partners. On the supplier end, there must be a computer either to receive the
communication or to go to the VAN to get the messages. Once the data are
received, they must be converted back into readable information. If the format of
the data is not the same or corruption occurs, the data are useless. Industry trade
groups have developed standard formats that allow different systems to
communicate with each other.

2.  Advantages of EDI

There are some definite benefits of utilising EDI:

a.  Replacing the paper documents : Replacing purchase order s ,

acknowledgements, invoices and so on — used by buyers and sellers in
commercial transactions with standard electronic messages conveyed between
computers, often without the need for human intervention.

b.  Reduction in lead times: Buyers and suppliers work together in a real-time

environment. Time saved can be used for data analysis to improve process further.

c.  Reduction in the cost: The cost of labour, inventory and release of working
capital.

d.  Better customer service: EDI capabilities show potential customers a supplier’s

willingness to cooperate, which improves relations and leads to better long-term
relationships.

e.  Facilitation of global procurement using internal standards.

f.  Facilitation of invoice payments: Computer-to-computer transfer of money

eliminates the need for the preparation and posting of cheques.

g.  Integration of functions: Particularly marketing, procurement, production,

engineering and finance.

h.  Suppliers’ relationships: EDI tends to promote long-term buyer-supplier

relationships and increase mutual trust.
3.  Potential problems and challenges in EDI implementation

EDI is not for everybody.

EDI requires additional costs that must be considered including computer

hardware and software costs, as well as the maintenance fees for the mailbox
(VAN) usage. The largest and most important cost is the training of the users and
the suppliers. The system itself is a waste of money if it is not effectively used.
This means extensive training of buyers, administrators, management, suppliers
and auditors will be required. Implementing EDI will also demand new procedures
that will take time to learn and use effectively, as well as learning to control by
management and auditing.

As with any major change, like implementing EDI, at least some resistance and
many barriers are to be expected. Informing users of the change along with heavy
training and education will support the move to EDI. This is vital to users, who
must feel comfortable with their new jobs. EDI is a concept designed to support the
organisation operations, and without proper training, it will cost an organisation
quality and efficiency.

Data integrity and legal issues are barriers that management will also encounter.
Change agents will need to understand the emotions in change process and work
through the transition with the stakeholders. Top management support may also be
hard to obtain, but it is vital for a successful move to EDI operations, just like any
other change program.

There are also some risks when using EDI that should be considered. As discussed
above, EDI is expensive. The machine and training costs will add up to a large
amount and cutting corners in other areas to provide for the budget may cost an
organisation more than it can save. Security is also an issue. It is felt that
procedural safeguards have not kept up with the technology in this area. The
problem is exposure to outside users, which opens up a doorway to false messages.
These messages may come in the form of a person who is not a supplier sending
data or the data being interrupted and/or altered. Operational procedures need to
have safeguards in place in order to avoid such situations. Buyers and sellers must
interactively communicate, especially if a questionable transaction is received.

Then, after all the capital expenditures and efforts setting up EDI system in the
organisation, an obvious risk is that current trading partners may refuse to use EDI.
This is a situation that must be addressed by the organisation policy. A decision
must be made whether to trade singularly through EDI or use both EDI and
traditional methods.

4.  EDI limitations and future outlook with small and medium-sized firms

Most of the world’s economies are supported by small and medium-sized firms,
which form a significant majority of their nations’ enterprises. EDI has two
principal limitations with this category of potential users:

a.  Cost: EDI was and still is an expensive option. The heavy overheads associated
with EDI infrastructure were prohibitive for many small and medium-sized firms.
Moreover, the volume of transactions for individual firms is not likely to justify the
investment.

b.  Inflexibility: EDI is a cumbersome, static and inflexible method of transmitting

data, most suited to straightforward business transactions, such as the placement of
purchase orders for known requirements. It is not suitable for transactions
requiring tight coupling and coordination, such as the consideration of several
possible procurement alternatives or supply chain optimisation. Unlike human
beings, computers are poor at interpreting unstructured data and cannot derive
useful information from web documents that are not predefined and permanent.
Traditional EDI approaches do not provide the flexibility required in a dynamic
business environment. This is the other main obstacle with the system for small
and medium-sized enterprises, many of which have their competitive edge on
working with unstructured data.

While the new technology brings on excitement for the larger firms, the above
limitations also work against the business practices of many smaller
firms that are purposefully more fluid and unpredictable

E-SOURCING FUNDAMENTALS

OBJECTIVES

By the end of this section, you should be able to:

1.  Describe e-catalogues, e-auction and reverse auctions.

2.  Describe e-sourcing and the transformation of the procurement system.

 INTRODUCTION

All over the world, the way business is carried out is changing with the use of
information technology. Most businesses now have to compete in a global
environment. A properly thought through Information Technology (IT) strategy is
essential to facilitate this. Similarly, a properly implemented IT can fundamentally
change the nature of a business and the way it is managed.

One of the most critical ways IT affects business is in changing the relationship
between suppliers and customers, in particular the ways that customers buy from
firms and how suppliers interact with buyers. As we look into the future, the
traditional procurement approach will be transformed into e-sourcing

E-CATALOGUES, E-AUCTION AND REVERSE AUCTION

E-CATALOGUES, E-AUCTION AND REVERSE AUCTION

This section begins with a look at electronic online data storage, the infrastructure
for e-sourcing. Then, we proceed to explore internet auctions and issues
encountered with conducting reverse auction.
1.  Online or electronic catalogue (e-catalogue)

Printed catalogues or product lists provide specifications, prices and frequently,

illustration of the items that suppliers can provide. The disadvantages of hard copy
catalogues are that they may be obsolete even before they are published and are too
slow to provide information in a dynamic marketplace.

An online catalogue is a digitised version of a supplier’s catalogue. It benefits both

buyers and suppliers in that they:

a.  Facilitate real-time two way communication between buyers and sellers.

b.  Allow for the development of closer buyer-supplier relationships due to

improved vendor services and by informing buyers about products or services of
which they might otherwise be unaware.

c.  Enable suppliers to respond quickly to market conditions and requirements by

adjusting prices and repackaging.
d.  Virtually eliminate the time lag between the generation of a requisition by a
catalogue user and the issue of the purchase order as:

i.  Authorisation, where required, can be done online and notified and confirmed
by email.

ii.  Users are authorised to generate their own procurements (subject to value and
item constraints), the order can be automatically generated without the intervention
of the Procurement function.

There are three types of e-catalogue:

a.  Sell-side catalogues: These provide potential buyers with access to the online
catalogues of a particular supplier who provides an online procurement facility.
Sell-side catalogues provide many benefits to suppliers, including ease of keeping
the contents up to date, savings on advertising costs and the costs of processing a
sale. The benefits to potential buyers include 24/7 access to information and ease
of ordering.

However, they also have disadvantages. Buyers may not have sufficient time to
surf all the available supplier websites. Buyers tend to be overly dependent on
particular suppliers as training in the use of new software may be required if
suppliers are changed.

b.  Buy-side catalogues: These are catalogues created by the buying organisations.

Normally, such catalogues are confined to goods covered by pre-negotiated prices,
specifications and terms and run by a program that is integrated in the buying
organisation’s intranet.

The benefits to buyers of such catalogues include reduced communication costs,

increased security and many catalogues can be accessed via the same intranet
application. However, the compilation and updating of buy-side catalogues does
require a large investment in clerical resources that will be uneconomical for all
but the largest organisations. Suppliers wishing to be included in the catalogue will
also be required to furnish their content in a standard format. For suppliers dealing
with a large number of buyers, the workload in terms of providing information in
the form required by each online catalogue will be unsustainable.

Figure 2.7 shows an example of the operation of buy-side catalogues.

Figure 2.7  Buy-side catalogues

c.  Third-party catalogues: The disadvantages of sell- and buy-side catalogues can

be minimised by outsourcing the process to an electronic marketplace or buying
consortium. This can be done by linking the in-house e-procurement catalogue to a
master catalogue administered in the marketplace. Standard information for
inclusion in the ‘market site’ or ‘master catalogue’ is provided by the suppliers.
This information is then made available to the in-house catalogues of individual
buying organisations. The responsibility of managing and updating product and
other information rests with the suppliers. In this case, the suppliers have a good
incentive to provide the information in the specified standard format as the master
catalogue will be available to a large number of buying organisations.

Product information can be divided into two parts — public and encrypted. Public
information will include a basic product description
and specification, often accompanied by an illustration or diagram, while
encrypted information will provide details of prices, discounts and similar matters
applicable to specific buyers that cannot be accessed by unauthorised users. Figure
2.8 shows an example of the third-party catalogues.
Figure 2.8  Third-party catalogues

2.  Online auctions (e-auctions)

Auctions have been used for commercial transactions for centuries and there are
many different types of auction methods. Generally, auctions can be classified on
the basis of competition, between sellers or buyers; and forward or descending
prices. For example, the online property and used cars auctions in Malaysia is a
price auction with multiple buyers. Other examples are Lelong Malaysia Auction
and Malaysia Free Auctions, which include multiple items. These various auction
models have been married with internet technology to provide buyers with new
techniques for determining price, quality, volume allocations and delivery
schedules with suppliers.

The actual internet auction events can be conducted in a number of ways, including
open offer auctions, private offer negotiations, posted prices and reverse auctions.

a.  In open offer auctions, suppliers can select the items they want to place offers
on, see the most competitive offers from other suppliers for each item, and enter as
many offers as they want up until a specified closing time.

b.  In private offer auctions, the buying organisation offers a target price and
quantity. Suppliers select the item(s) they wish to bid on and enter an offer by a
specific time. The buyer evaluates each supplier’s offer and enters a ‘status’ for
each item. The levels of status are accepted: the supplier is awarded the contract,
contingent on final qualification; closed: the supplier may no longer submit offers
for the item in question; BAFO: the supplier who receives electronically the best
and final offer status may submit one more offer for the item; or open: the
supplier may submit another offer. Bidding may be continued for as many rounds
as necessary to accept or close all items.

c.  In posted price auctions, the buyer indicates the price that is acceptable and the
first supplier that meets this price gets the award.

3.  Reverse auctions

A reverse auction is an online, real-time, declining-price auction between one

buying organisation and a group of pre-qualified suppliers. The bidding process is
dynamic, where the suppliers compete for business by bidding against each other
online using specialised software. Suppliers are given information concerning the
status of their bids in real time and the supplier with the lowest bid or lowest total
cost bid is usually awarded the business. An example of this auction could be a
Penang multinational company selecting several local suppliers to participate in the
e-auctions or e-bidding of its packaging items. The company, which offers with
lowest price, would be invited to submit its sample product for quality approval.
The contract will be awarded later subject to this sample approval. However, this
e-auctions is still not popular among the smaller companies as the system
implementation is quite costly.

There are various issues to consider when using reverse auctions for sourcing
goods and services:

a.  When to use reverse auctions? Most reverse auctions are used for spot buying
and to eliminate the time-consuming offline process of selecting suppliers,
requesting quotations and comparing quotes received. Reverse auctions are
particularly useful in the following circumstances:

i.  When there are clearly defined specifications for the goods or services,
including technological, logistical and commercial requirements.

ii.  Existence of a competitive market and a sufficient number of qualified

suppliers willing to participate in the auction.

iii.  When there is an understanding of the market conditions in order to set

appropriate expectations for a reserve price.

iv.  When buyer and seller are familiar and competent in using the auction
technology.
v.  When there are clear rules concerning how the auction will be conducted, such
as conditions for extending the length of the auction and award criteria.

vi.  When the buyer believes that the current price is sufficiently high so that the
savings justify the use of a reverse auction.

In general, reverse auctions were not considered appropriate for complicated

products or projects requiring collaboration or considerable negotiation.

b.  Advantages of reverse auctions: Reverse auctions provide benefits to both

buyers and sellers. The benefits to buyers include:

i.  Savings over and above those obtained from normal negotiations as a result of
competition.

ii.  Reductions in acquisition lead times.

iii.  Access to a wider range of suppliers.

iv.  A global supply base can be achieved relatively quickly.

v.  Sources of market information are enhanced.

vi. More efficient administration of requests for quotations (RFQ) and proposals.

vii. Auctions conducted on the internet generally provide total anonymity so time
is not wasted on seeing suppliers’ representatives.

The benefits for suppliers include:

i.  An opportunity to enter previously closed markets, which is particularly

important for smaller firms.

ii. Reduced negotiation timescales.

iii. Provision of a good source of market pricing information.

iv. Clear indications of what must be done to win the business.

c.  Disadvantages of reverse auctions: Some objections to reverse auction are that

they:
i.  Are based on a win-lose approach — the seller is trying to get the most money
while the buyer is after the best deal and the goal is to screw your opponent to win
either a good deal or a profitable deal at the other person’s expense, so that logical
progression is always towards cheating and, therefore, such a system cannot be
sustained without burdensome watchdogs and regulators.

ii.  Can cause an adverse shift in buyer-seller relationships as the supplier may feel
exploited and become less trustful of buyers.

iii.  Can have long-term adverse effects on the economic performance of both
suppliers and buyers. First, some suppliers may not be able to sustain sharp price
reductions in the long term. Second, buyers will eventually have reduced supplier
base as suppliers that cannot
compete at the lower price levels may be removed from the buyer’s approved
supplier list. Moreover, in order to ensure that the exact goods and services
required are obtained, considerable time may be needed to complete details
specification sheets, when time can be ill-afforded in a fast-paced world.

d.  Ethical issues with reverse auctions: There are a number of ethical issues that
buyers and sellers need to be concerned with when participating in reverse
auctions.

Potential ethical transgressions on behalf of buyers are:

i.  Buyer knowingly accepts bids from suppliers with unreasonably low prices.

ii. Buying firm submits phantom bids during the event to increase the competition
artificially.

iii. Buyer includes unqualified suppliers to increase price competitions.

Some potential ethical issues involving suppliers are:

i.  Suppliers act in collusion.

ii.  Suppliers bid unrealistically low prices and attempt to renegotiate afterwards.

iii. Suppliers participate in the event but do not bid. This behaviour is referred to as
‘bird watching’ and is a strategy designed to collect market intelligence. Some
reverse auction events have participation rules where suppliers must enter bids
before gaining access to the results.
Buyers should always behave in an ethical manner and avoid the appearance of
ethical conflicts in order to protect the reputation and integrity of their firm and
individuals involved. Communicating clearly defined rules of the reverse auction
upfront helps avoid ethical misconceptions

E-SOURCING AND TRENDS

E-SOURCING AND TRENDS

Although there are problems and challenges with sourcing from the e-
marketplaces, e-sourcing offers so many advantages that they are here to stay. It is
redefining the way firms manage their supply chain. Buyers and sellers located in
different countries can now meet electronically any time any place. As depicted
in Figure 2.9, it will be the tool that drives supply management into the future,
creating values by:

1.  Reducing the total cost of ownership.

2.  Streamlining the purchasing process.

3.  Procurement innovation.

Figure 2.9  Benefits of e-sourcing
However, as we have discussed earlier on purchasing technologies, the degree of
applicability of e-sourcing is not universal for all procurement items. The
procurement item’s position in the value chain determines the degree of
applicability. The lower the risk impact and the more generic the goods or service
is, the more ideal it is for e-sourcing. Figure 2.10 shows the e-sourcing commodity
continuum. The generic products and services are easily specified commodities.
The complexity increases as we move from left to right on the continuum. We shall
look into the procurement item characteristics in more detail in Unit 3.
Figure 2.10  E-sourcing commodity continuum
Source: Adapted from Leenders, M R, Johnson, P F, Flynn, A E and Fearon, H E
(2006). Purchasing and Supply Management: With 50 Supply Chain Cases,
13th edn, McGraw-Hill/Irwin, USA, page 137

SPECIFICATIONS, STRATEGIES AND SUPPLIER EVALUATION

1. 44. Unit Overview
2. 45. Unit Objectives
3. 46. 3.1 Developing Requirement Specifications
4. 47. Methods of description
5. 48. Service specifications
6. 49. Specification writing

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CONTENTS
BLC 304/05 PROCUREMENT MANAGEMENT
463.1 DEVELOPING REQUIREMENT SPECIFICATIONS
OBJECTIVES

By the end of this section, you should be able to:

1.  Describe the importance of specification requirements from a procurement

perspective.

2.  Identify the different methods of descriptions and the general presentation for a
specification to capture the organisation’s expectations.

3.  Identify the key differences between product and service specifications.

4.  Identify the elements of a procurement specification and principles of

specification writing.

INTRODUCTION

A specification has been defined as a statement of the attributes of a product or

service or a statement of needs to be satisfied by the suppliers, e.g., 4 feet by 8 feet
2 mm thick mild steel plate (acceptance tolerance of +0.05 mm). It must be
distinguished from standards. A standard is a specification intended for recurrent
use, e.g., enclosure for electrical equipment reference standard IEC529:1989-11
(2nd edn). Standards differ from specifications in that, while every standard is a
specification, not every specification is a standard. The guiding principle of
standardisation is the elimination of unnecessary variety.

Both specifications and standards aim to:

1.  Indicate fitness for purpose or use, linking quality to product satisfaction and
dissatisfaction.

2. Communicate the requirements of a user or buyer to the supplier.

3. Compare what is actually supplied with the requirements in terms of purpose,
quality and performance stated in the specification.

4. Provide evidence, in the event of a dispute, of what the buyers required and what
the supplier agreed to provide.

The primary purpose of procurement is to contribute to the profitability of the

organisation by obtaining the best-quality products or services in terms of fitness
for use at the least possible total cost. From the procurement perspective, the
purpose of specifying requirements is to provide the information that the supplier
requires in order to reliably meet the organisation’s expectations. It is important,
therefore, that all expectations are captured in the specification. If they are not, the
supplier may meet the specification but not at all satisfy the organisation’s actual
needs.

Specifying requirements correctly is fundamental as it is a major determining

factor of cost and effectiveness, and hence of profitability. Unclear or incorrect
specifications can result in:

1.  Disruption and delays in supply of the product or service, e.g., caused by time
spent providing additional information and clarification or correcting errors with
the supplier.

2.  Additional costs arising from the product or service not performing as needed,
e.g., the cost of rectifying its performance.

Within the procurement requisitioning process, it is hence important to include a

detailed description of what is to be sourced. The using, requesting or specifying
department must be capable of reasonably describing what is required to be sure of
getting exactly what is needed.

Although the prime responsibility for determining what is needed usually rests
with the using or specifying department, the Procurement function, as the
intermediary between the user and the supplier, has the direct responsibility of
checking for the completeness of description given. Buyers should, of course, not
be allowed to alter arbitrarily the description or the quality. They should, however,
have the authority to insist that the description be accurate and detailed enough to
be perfectly clear to every potential supplier. In addition, the Procurement function
also has other
important roles to play by:
1.  Bringing supply market knowledge and commercial awareness to the process.
For example, the buyers should call the attention of the requisition party to the
availability of other options that might represent better value. They should also be
able to advice on whether or not any of the requirements stated in the specification
are liable to cause commercial, environmental or legal problems.

2.  Contributing to the design or specification stage in the application of value

analysis and the provision of innovative suggestions, aimed at achieving cost
reduction without detriment to the required performance, reliability, quality and
maintainability.

3.  Facilitating supplier involvement where appropriate.

It is therefore important for a buyer or a Procurement manager to be fully familiar
with how requirements are determined, in order to carry out his/her job
competently.

METHODS OF DESCRIPTION

METHODS OF DESCRIPTION

The description of an item may take any one of a variety of methods or, indeed,
may be a combination of several different methods. For our discussion, description
will mean the various methods by which a buyer conveys to a seller a clear,
accurate picture of the required item. The term specification will be used in the
narrower sense referring to one particular method of description.

The methods of description will be discussed in order:

1.  By brand

2.  “Or Equal”

3.  By specification

a.  Physical or chemical characteristics

b.  Material and method of manufacture

c.  Performance or function

4.  By engineering drawing

5.  By miscellaneous methods

a.  Market grades

b.  Sample

Let us understand each method in detail.

1.   Descriptions by brand

This method is used when a product or service is proprietary, or when there is a

perceived advantage in using a particular supplier’s products or services.

Descriptions by brand may be not only desirable but necessary under the following
circumstances:

a.  The manufacturing process is secret or covered by a patent.

b.  The supplier’s manufacturing process calls for a high degree of ‘workmanship’
or ‘skill’ that cannot be defined exactly in a specification.

c.  Only small quantities are bought so that the preparation of specifications by the
buyer is impracticable.

d.  Testing by the buyer is impracticable.

e.  The item is a component so effectively advertised as to create a preference or

even a demand for its incorporation into the finished products on the part of the
ultimate customer.

f.  There is a strong preference for the branded item on the part of the design staff,
a bias the buyer may find almost impossible to overcome.

The main disadvantages of specifying branded item are as follows:

a.  The cost of a branded item may be higher than that of an unbranded substitute.

b.  The naming of a brand effectively results in a ‘closed specification’ which

restricts the number of potential suppliers and deprives the buyer of the possible
advantage of a lower price or even of improvements brought out by competitors.
2.  “Or Equal”

It is not unusual to see requests for quotations or bids that will specify a brand or a
manufacturer’s model number followed by the words “or equal”. In these
circumstances, the buyer tries to shift the responsibility for establishing equality or
superiority to the bidder without having to go to the expense of having to develop
detailed specifications.

3.  Descriptions by specification

In some cases, an organisation may need to provide very detailed descriptions of

the characteristics of an item or service. Specification constitutes one of the best
known of all methods employed. A lot of time and effort has been expended in
making it possible to buy on a specification basis. Closely related to these
endeavours is the effort towards standardisation of product specifications and
reduction in the number of types, sizes, and so on, of products accepted as
standard. It is becoming common practice to specify the test procedure and results
necessary to meet quality standards as part of the specification as well as
instructions for handling, labelling, transportation and disposal to meet
environmental regulations.

a.  Specification by physical or chemical characteristics

This specification provides definitions of the properties of the materials the buyer
desires. They represent an effort to state in measurable terms those properties
deemed necessary for satisfactory use at the least cost consistent with quality.

b.  Specification by material and method of manufacture

The second type of specification prescribes both the material and method of
manufacture. This method is used when special requirements exist and when the
buyer is willing to assume the responsibility for results.

c.  Specification by performance or function

The heart of performance specification is the understanding of the required

functions. Performance or function specification in combination with a request for
proposal is employed to a considerable extent, partly because it throws the
responsibility for a satisfactory product back to the seller. Performance
specification is result-and user oriented, leaving the supplier with the decisions on
how to make the most suitable product. The assumption is that the supplier will
know the best way to meet the buyer’s needs. This enables the supplier to take
advantage of the latest technological developments and to substitute anything that
exceeds the minimum performance required. The detailed specification is in the
hands of the supplier.

Where applicable, performance specifications are to be preferred in that they allow

a wider competition and enable suppliers to suggest new improved ways of
meeting the requirement. The satisfactory use of a performance specification, of
course, is absolutely dependent on securing the right kind of supplier. It should be
noted that it may be difficult to compare quotations and the supplier may include a
risk allowance in the price.

In general, traditional advantages of buying with specifications include:

i.  Evidence exists that thought and careful study have been given to the need and
the ways in which it may be satisfied.

ii. A standard is established for measuring and checking materials as supplied,

preventing delay and waste that would occur with improper materials.

iii. An opportunity exists to procure identical requirements from a number of

different sources of supply.

iv. The potential exists for equitable competition. This is why public agencies
place such a premium on specification writing. In securing
bids from various suppliers, a buyer must be sure that the suppliers are quoting for
exactly the same material or service.

v.  The seller will be responsible for performance when the buyer specifies
performance.

However, there are also several limitations in using specifications:

i.  There are requirements for which it is practically impossible to draw adequate
specifications.

ii. The use of specifications adds to the immediate cost.

iii. The specification may not be better than a standard product that is, readily
available.
iv. The cost is increased by testing to ensure that the specifications have been met.

v.  Unduly elaborate specifications sometimes discourage potential suppliers from

placing bids in response to inquiries.

vi. Unless the specifications are of the performance type, the responsibility for the
adaptability of the item to the use intended rests wholly with the buyer.

vii. The minimum specifications set up by the buyer are likely to be the maximum
furnished by the supplier.

SERVICE SPECIFICATIONS

SERVICE SPECIFICATIONS

There are many and diverse types of services that an organisation can procure,
including such things as:

1.  Transport

2.  Advertising

3.  Payroll administration

4.  Security services

5.  Banking services

6.  Catering

7.  Training

8.  Design services

9.  Management consultancy

Services are different from products in a number of ways. Specifications such as

samples and by characteristics are either irrelevant or rarely associated with
services. However, the choice of a prescriptive, e.g., detailed technical
specification or non-prescriptive, e.g., a performance-based specification remains
valid for service specifications.
The difficulty in specifying services

Services are typically more difficult to specify than products. The requirements of
many products can be precisely stated, for example, in terms of dimensions,
weight, type of materials or energy consumption.

Services, being intangible, are less easy to define. For instance: how clean is a
clean building? What is the definition of a good, well-cooked meal? Additionally,
there is the difficulty in assessing whether the service has been correctly
performed. For example, is an architect at fault if the client does not like the
architect’s design?

Nevertheless, service specifications should still be as precise as possible. They

should generally be stated in terms of outputs, that is, what is to be achieved
through the service. These outputs should be measurable, and formulated in a clear
and precise manner. Closely associated with this, is the need to indicate the time
frame in which the outputs are to be achieved. The specifications should also state
what will occur in the event that these outputs are not achieved in the expected
time frame, e.g., cancellation of payment, deductions for reduced performance,
penalties, etc.
Variability — the human factor

In the case of products, unless there is a particular defect in materials or

workmanship, identical products will perform uniformly. For example, two
identical computers will do the same things in the same way.

Services, however, are performed by human beings, and as we all know, everyone
is different. The quality of services can therefore be dependent on the particular
individual(s) providing them.

Where the capability of the individual(s) providing the service is important, the
specification might state which qualifications will be required of the person who
will perform the service, e.g., academic background, professional and work
experience, etc.). This might be the case with a management consultancy service,
for example, to the extent of specifying as a requirement the specific consultant to
provide the service
 SPECIFICATION WRITING

SPECIFICATION WRITING

The contents of a specification will vary according to whether the specification is

written from the standpoint of the user, designer, manufacturer or seller. The
specification will also vary according to the material or item concerned. For a
simple item, the specification may be a brief description, while in the case of a
complicated assembly it may be a comprehensive document that perhaps runs to
many pages. The following order of presentation for a specification relating to a
product, process or service is adapted from BS7373 (now BS7373 2:2001):

1.  Identification title, designation, number, authority.

2.  Issue number publication history and state of issue, earlier related

specifications.

3.  Contents list guide to layout.

4.  Foreword the reasons for writing the specification.

5.  Introduction description of the content in general and technical aspects of

objectives.

6.  Scope range of objectives/content.

7.  Definitions terms used with meanings special to the text.

8.  Requirements/guidance/methods/elements the main body of the specification.

9.  Index cross-references.

10. References to national or international standards or other internal company

specifications.

The ‘procurement specification’ is made up of different elements as illustrated

in Figure 3.1.
Figure 3.1  The procurement specification

The following principles should be observed by all specification writers:

1.  If something is not specified it is unlikely to be provided — The consequence

is that all requirements should be stated in the specification before awarding the
order. Suppliers will normally charge requirements subsequently added as ‘extras’.

2.  Every requirement increases the price — All specifications should therefore be

submitted to rigorous value analysis.

3.  The shorter the specification, the less costly it takes to prepare it — The
expenditure in staff time devoted to the preparation of a specification can be high.
This can be significantly lower when the length of a specification is short and the
time taken in its preparation is reduced.

4. The specification is equally binding on both the buying organisation and the
supplier — Omissions, incorrect information or imprecision in a specification can
be cited by the supplier in any dispute with the buyer. A rule of evidence is that
words are construed against the party who wrote them. Where there is uncertainty
about the meaning of a specification, the court will generally interpret it in the
supplier’s favour.

5.  Specifications should as far as possible, be presented in performance terms

rather than as a detailed design — This is particularly applicable to items about
which the buyer has little expert knowledge.
 6.  Specifications, should wherever possible be ‘open’, not closed — Closed
specifications can take the form of naming a particular brand and the manufacturer
or supplier, hence not permitting the use of alternatives. Open specifications are
written so that the stated requirements can be met by more than one supplier. By
making the requirements sufficiently flexible to be met by several suppliers,
competition is encouraged and prices reduced.

7.  Specifications must not conflict with national or international standards or

health, safety or environmental laws and regulations — National and
international specifications should be incorporated into individual specifications
and identified by their numbers and titles.

STORAGE & PRESERVATION

Storage and Preservation are an important part of the storekeeping function. When materials
remain idle in the store these materials should be taken care of and looked after properly.
Otherwise these materials may get perished due to natural chemical reaction like rusting by
moisture, melting by heat etc and also may get affected by insets, rats etc.

In order to protect the materials from various adverse effects the following actions should be
taken: -

1. Materials should be stocked free from ground. No material should be stocked on the
floor as it may be affected by dampness, white ants etc.
2. Materials should be stocked in the appropriate place according to the nature of the
materials.
Eg :
a. Stationery, Electrical, Civil Engineering, Cleaning and Similar items may be
stocked in the steel racks.
b. Medicine items may be stocked in the fridge.
c. Perishable items may be stored in the cold rooms.
d. Explosive, film, fuse items may be stored in the AC room.
e. Attractive items may be stored in shelves under lock and keys.
3. Daily and periodical cleaning should be carried out.
4. Daily and periodical verification of stock should be carried out to ensue correctness of
 stock.
5. Proper method of handling should be followed to avoid damages to the materials.
6. Preservation materials should be applied to protect the items.
7. Hazardous materials should be segregated and stocked in a separate store house away
from other store houses.
8. Safety precautions should be taken and safety appliances should be provided.

Receiving Materials
After, all the pre-purchase actions are completed, like selecting supplier, placing purchase
order, follow-up etc., the materials are supplied by the supplier. Which receiving materials, a
systematic record of the consignment received, carrier details and descriptions of materials
so that inspection can be arranged prior to acceptance. Many organizations have a separate
central receiving section for this purpose. As mentioned earlier a copy of the purchase order
is sent to the central receiving section for reconciling purposes.

INVOICE CHECKING:
The supplier normally sends the invoice for the materials supplied for payment. It is
essential that the invoice is matched against the receipt details, quantity accepted and
rejected so that payments can be made within the discount period or provisions be made
whic1h will keep in funds planning. Normally invoices are sent to the buyers finance
department. A close coordination between the finance and materials management
departments is necessary.

OPENING AND CHECKING OF CONSIGNMENT:

The bulk consignment should be opened at the central receiving section in the presence of a
properly constituted board of officers comprising a presiding officer and some members
from the concerned departments. Number of packages mentioned in the packing notes, If
available should be opened and the materials checked against the invoice. The materials
should be checked for quantity, quality, specification, condition etc. If the quantity is found
less in comparison with the invoice, a discrepancy/shortage report will be raised and sent to
the supplier to make good of the quantity found less. If any materials is found of
substandard, and found not in confirmation with specification or found in a damaged
condition, such materials will be rejected and the supplier should be informed o this matter.
The supplier shall collect the rejected materials at his cost and shall provide suitable
replacement as per the terms and condition laid down in the purchase order. The materials
will be accepted and taken into stores stock and the bill be passed for payment.

RECEIVING MATERIALS SUPPLED AS DOOR DELIVERY:

The materials supplied by the supplier as door delivery, will be checked in comparison with
the invoice in the presence of the supplier. If everything is OK the materials will be accepted
and one copy of the invoice or the delivery will be signed and returned to the supplier. If any
complaint is found, action as mentioned above will be taken.

Store Management
Stores play a vital role in the operations of an organization. It is in direct touch with the user
department in its day-to-day activities. The most important purpose served by stores is to
provide an uninterrupted service to the various user departments. In the case of a Hospital
we can say the Operation Theatre, wards, specialty clinics, units, refraction departments,
Registration, Admission departments etc., are the user departments. Further stores often
equated directly with money, as materials have money value.

The stores function can be details as under:

1. To receive ordered materials such as, components, tools, equipments, and other items
and account for them.
2. To provide adequate and proper storage for preservation of various items.
3. The meet the demands of the consuming department by proper issues and account for
the issues.
4. To minimize the stock holding through proper codification and handling to avoid the
materials becoming surplus, obsolete and scrap.
5. To highlight stock accumulation, discrepancies and abnormal
6. Consumptions and effect suitable control measures.
7. To ensure good house keeping so that material handling, preservation, receipt and
issue can be done smoothly.
8. To assist in verification and provide supported information for effective purchase
activity.

To carryout the above function the following arrangements are essential:

a. Accommodation
b. Lay of stores
c. Central receiving and dispatching location
d. Cold storage etc
e. Comfortable working condition

1.Lighting
2. Safety

1. Safety consciousness
 2. Safety Appliances

Store
Location : Easily accessible to transport.
Near to the user department.
SPACE: Sufficient space for accommodating all kind of Materials.

BUILDING : Pucca building to withstand natural calamities.

SEPARATE AREAS : For receipt of Materials, Issue of Materials, Office of storekeepers.
Ramps for handling of Materials.
Convenient for the movement of the men and Materials.
Infrastructure : Cold Rooms, Fridge, Dunnaga, Racks, Shelves, Fireproof of storage etc.
Proper Ventilation.
Fire fighting equipments.
Sufficient light and pleasant working atmosphere.
Separate store for Drugs, Rubber goods, Plastic goods and Inflammable Items.
Trollies / hand cart for handling the materials

Vendor Selection
INTRODUCTION: In order to procure materials at the most competitive rates and ensure a
fair selection amongst suppliers, tender system is normally adopted. A major disadvantage
of procurement through the tender system is the prolonged lead time. When the
requirements are urgent, procurement is invariably done through the limited tender system.
In such cases enquiries are sought from genuine bidders and the lead time is also reduced.
Registration of firms should be done after scrutiny, analysis of its financial reliability
credentials.

Criteria for registration:

The following criteria should be fulfilled for registering a firm as supplier of pharmaceutical
products and equipment.

1. The firm should have been in business for a period of at least two years in the country
in relation to the type of equipment for which the registration in sought.
2. The latest balance sheet should be obtained to know the financial health of firm.
Turnover for last two years should be obtained.
3. Income tax clearance certificate should be obtained of previous year.
4. Sales tax registration certificate, wherever applicable.
5. Financial standing of the firm should be enquired from the bankers.
6. A record of last one to two years performance of the firm is to be obtained from other
 similar organizations where the firm was registered for supply of hospitals
equipment / pharmaceutical products.
7. A proof of ownership, partnership etc. should be obtained along with verification of
address, telephone numbers and Fax numbers.
8. It should also be ensured that the firm has remitted the prescribed fee for registration.
9. The suitability of the firm should be verification from the referee to be appointed by
the firm.
10.The firm must furnish an undertaking on a non-judicial stamped paper that the firm
has not been black listed in the past and there is no CBI / vigilance case pending
against it.
11.Authority letter from manufacturer / principals, if applicable, should be obtained.

If the firm is not fulfilling the terms and conditions it should be removed / black listed or
banned.

Removal of firms from registration list

Black listing of firms
Vendor selection and rating
Conclusion

ROLE OF PURCHASE MANAGER

1.The role of the Purchase Manager in any company, Public or Private or state sector, Small
scale industry, partnership concern or any is becoming more andmore difficult and complex
due to the factor, he has to satisfy various departments internally and statutory authorities,
suppliers, transport agencies, insurance companies, banking sectors and the like. The role is
more complex as each department looks upon its needs only and is not able to appreciate the
problems faced by the purchase executive. Scarcity of the goods in the market, uncertainty
in the supply of raw materials, frequent changes in the taxes and duties, acts of God, acts of
Governments, power failure transport problems, industrial relationship, low productivity etc,
have been conquered with and goods procured. There are many opposing forces. Above all,
queries/audit objections have to be answered.

ISSUE, VERIFICATION AND ACCOUNTING

The main role of the Stores of a hospital is to ensure an uninterrupted supply of materials to
the various departments so that smooth and efficient functioning of the hospital is not
affected.

In order to ensure a smooth issue of materials, a systematic procedure should be followed.

Good stores systems can greatly help the stores manager in smooth issue, accurate stock
status reports, timely detection of discrepancies, prompt clearance of goods inward notes to
expedite bill payment, reduction in losses etc. For this purpose a stores manual incorporating
all the features has been prepared in many organization.

On receipt of this indent in store, the store keeper scrutinises it for correctness in all
respects. If any shortcoming or mistake is found the same will be intimated to the indenter
for rectification action. If the indent is found Ok in all respects, the materials will be issued
and the signature of the person receiving the materials will be obtained in the appropriate
column. Then the original copy will be detached from the indent book and kept by store for
feeding in the computer for writing off the quantity of materials issued from the inventory
stock. The counterfoil will remain in the indent book itself for the reference of the
department. After all the issue action through out the day and feeding to the inventory ledger
the stock position will be checked and ensured that the stock is correct. The issue in our
hospital is followed on FIFO method.

MANAGEMENT TRAINING & SYSTEM DEVELOPMENT FOR HOSPITAL

ADMINISTRATORS
MATERIALS MANAGEMENT SYSTEM IN A HOSPITAL

INTRODUCTION: -
Material management department is an essential part of any organisation. Especially in a
hospital, Materials Management Department plays a vital role in the smooth and efficient
function of it.

IMPORTANCE OF MATERIALS: -
A hospital is known as labour oriented. Because human physical labour has much
importance in health care. Labour in this context means the skilled labour of the medical,
nursing, paramedical and other personal. The hospital depends upon the technological skill
and knowledge of the hospital personnel. These personnel, in turn, depend on various
materials, with out which their skills cannot be converted in to diagnostic and therapeutic
services. Eg: - a surgeon with out sutures and surgical blades, a nurse with out syringes and
needles, a Radiologist with out x-ray film and so on. Thus it is obvious that materials play a
vital role in hospital. Proper knowledge and experience in acquisition, storage, distribution,
replemishment and allied functions is therefore a must in a hospital. Therefore the science of
material management comes in very handly and to the rescue of the hospital administrators.

IMPORTANCE OF THE MATERIAL MANAGEMENT SYSTEM IN A HOSPITAL:

-
In the present fast developing Eye Care system the Material Management Department has to
face a tremendous challenges and responsibilities in its job. The task is really Herculean as
lacs/crores worth of materials are involved in The process of purchase and issue. The task is
so tough as the money tied up in Inventory aggregates to a major portion of the budget of the
organisation. In many organisation materials forms the largest single expenditure item that
accounts nearly 60 percent of the total expenditure. Thus the importance of Materials
Management lies in the fact that any significant contribution made by the Materials Manage
in reducing the materials cost will go a long way in improving profitability and in achieving
economy.

ROLL OF MATERIAL MANAGEMENT SYSTEM: -

The role of the Material Management System is to provide various kinds of materials
uninterruptedly to the different user departments of a hospital to ensure a smooth and
efficient function of the hospital. Interruption in the availability of materials in an industry
may result in loss of productivity. In a hospital, it may even mean death or suffering of
human beings, both of which can not be valued in terms of money.

TYPES OFMATERIALS MANAGEMENT SYSTEM: -

There are two types of Material Management System.

a. Integrated type of MMS

b. Decentralised type of MMS.

INTEGRATED TYPE OF MMS: -

This is the system in which the entire functions of the Materials Management System are
done under a single department under one Manager.

DECENTRALISED TYPE OF MMS: -

Under this system the entire functions of MMS have been divided in to two parts, viz
Purchase Department and Stores department.

ADVANDGES AND DISADVANDGES: -

Both these systems are having their own pros and cons.

SCOPE OF MMS: -
The scope of the Materials Management is vast. We can broadly identify the following
functions: -

Materials Planning and Control

Purchasing
Inventory control
Receiving and storage
Issuing
Documentation
Disposal of scrape
Feed Back

AIM OF MMS:-

a. To optimize the usage of resources to meet the needs in an efficient manners.

b. To purchase right materials, at right time, at right quantity at the right rate and of
course through right sources.
c. To keep stock at all items
d. Avoid over stock
e. Avoid under stock/stock out
f. Proper storage to avoid loss, obsolescence, difference.
g. Proper and prompt issue to departments.
h. Cut cost and achieve profitability and economy.

Internal Planning for Effective Operations in Warehousing Projects

Globally outsourcing 3PL Market is growing fast. In the US, the industry is
expected to reach over $150 billion as compared to a global estimate standing at
$450 billion as per industry experts estimates.
Companies aiming for aggressive growth in global scenario recognize the need to
partner with 3PL logistics providers to be able to establish supply chain networks
across countries. Outsourcing is the only vehicle with which they can operate and
cannot afford to manage functions in-house.
Warehousing activities whether in Finished Goods logistics or Plant logistics, are
very critical to the entire supply chain. Take the example of an automobile
manufacturer who depends upon a 3PL to manage complete inbound activities
including vehicle unloading, inventory management, and JIT supplies to the plant.
The manufacturing facility completely is dependent upon the 3PL service provider.
Both the buyer and 3PL co-exist together at the same location, over a period the
systems and operations get enmeshed and integrated into the process of
localization and finding practical solutions. In such cases, any non-performance on
the part of 3PL due to any reason will affect the plant output. It is not possible to
make a sudden switch to another 3PL overnight. Hence, the marriage has to be
lived through and managed.
Therefore choosing a 3PL partner for your warehouse operations needs thoughtful
considerations and evaluation. Of course, any project of this nature is dependent
upon the relationship between the buyer and 3PL. Collaborative and partnership
approaches have yielded very good results than a buyer and seller relationship.
Where ever buyers have invested time and interest in engaging directly with 3PL
operations, with helping in training and periodic assessments coupled with
motivational exercises, have helped 3PL operations remain focused on the
deliverables and maintain efficiencies.
Before you start looking for a 3PL partner, internal alignment with management,
clarity of the project and criteria for selecting 3PL Partner is to be worked out in
detail.
Following factors are to be considered internally to plan the exercise:

1. Internal Decisions
a. Outsourcing project should be clearly defined as to Scope of Activity,
Business Risks Identified. Decision to outsource with definite
timelines in-line with business function should be approved by
Management.
b. Budgetary approvals should be in place for the project implementation
as well as the monthly logistical service outflow from concerned
business functions and Management.

Without clarity, many times RFP & RFQs are floated and discarded
resulting in wastage of time and effort of all parties concerned.

2. Defining Project Scope and Responsibilities

Plant Supply Warehouses, Regional Distribution Centers, VMI, etc. projects

are often very huge in size of operations as compared to a flow through
finished goods warehouse in a supply chain network.
Such big projects are characterized by huge capital outlay, multiple process
designs, and infrastructure-intensive and involve complex IT system design
and interfaces.
 RFP / RFQ would need to define each element very clearly and describe the
scope of activity and responsibility on the part of the buyer as well as the
3PL.
The document should define clearly the capabilities and competencies
required for the project, the timelines, and deliverables.
Detailed understanding of the project scope will ensure that only the 3PL
who has the required capability and strength will bid for the project.

3. An outsourcing project should have clear internal guidelines about the

ownership of the project, individual program owners, business unit who will
own the project after implementation coupled with operation management
and escalation process.

This information can be shared with the 3PL in the RFQ, and one should
expect similar structure from the 3PL in its response document.

4. Defining Length of the Contract with possible scope for extension and

period of extension is essential to help 3PL work out financials. It helps to
define the methodology of costing template along with the RFQ to ensure
common platform.
5. Finally determining process for evaluation of vendor is very essential.
What are the capabilities that you look for in a 3PL, what is the selection
criteria, who are the internal team members to be involved in selection
process and decision making should be clearly enumerated.

A well thought out internal proposal and RFQ document will help you find the best
fit and smooth project implementation.
Warehouse Design Concepts
Supply chain efficiencies depend upon the efficiency of logistics including
transportation and warehousing operations. Warehouse efficiencies depend upon a
combination of warehouse design, layout, infrastructure, systems, process and
people.
In cases where one can design a warehouse and implement the complete project
from ground zero, gives the SCM Project Manager a good scope to create a tailor
made solution design matching the exact requirement, thereby increase efficiency
as well as reduce transactional cost. However, this may not be the case all the time.
In an ongoing situation, often SCM managers are forced to take up available
facilities and work around the available design and try to get the best results.
Warehouse Design element aims to maximize the utility of space, equipment,
and efficiency of operations. We will briefly cover the various elements of a
warehouse design and understand their importance.
In basic functional aspects, a warehouse function consists of - Material receipts
including unloading, unpacking and inspection, put away and Storage of materials
in various categories of storage locations, systems updating, pull materials for
dispatch and delivery of materials after processing.
Warehouse Location, Layout and Building

The location of a warehouse should ideally be situated on a flat ground. The

location should be easily approachable and in a area suited for this nature of
business. Locations closer to markets or to national highways would be ideal.
Public transportation and communication infrastructure should also be available.
The layout of the building should be designed to accommodate fleet parking, and
enable containers to drive in and drive out easily. Any time two containers should
be able to pass through on the path without any interruption. There should be
enough free space for vehicles to maneuver. The layout should also provide for
other utility, safety and security operations.
Building is normally constructed using galvanized metallic sheets mounted on C
Section girdles. The flooring should be RCC concrete with weight bearing capacity
as per requirement of the load to be calculated in each case. The ground should be
flat, even and smooth surface to facilitate MHE movements and dust free.
The roof height would be a major consideration to be able to install multi-vertical
storage racking installation. The walls and roof should be designed with suitable
lighting panels and ventilators for air exchange fitted with bird cages.
The number of loading and unloading docs and placement of these docs play an
important role in the design of operations and efficiency of operation. All weather
docks and the facility should enable 24 hours operations. Dock Levels. The docks
should be equipped with dock levelers and all these have to be installed during
construction phase itself. Ramps have to be provided to facilitate movement of
forklift etc.
Lighting design will depend upon the layout and the racking design.
Internal Layout

Internal layout design will be built taking into account the operational process,
nature of goods, volumes of transactions both inbound and outbound, storage
types, in-house operations involving put away and pull sequences and process
requirements including packing, kitting etc and the availability of floor space
coupled with building layout design of inbound and outbound docks.
The design aims to maximize space utilization, minimize MHE movement and
Manpower movement.
Types of Storage

Types of storage are determined by the nature of cargo. Depending upon the cargo
whether finished goods, raw material parts, etc., the types of storage can vary from
bulk stock, block stock, racking, pallet racking, shelf racking, binning, unit pick or
loose pick face, carton pick, etc. The storage types vary with nature of materials
with different types of storage designs for drums, pallets, tires, cartons, tube, and
rods, etc.
Racking Designs & Material Handling Equipment

Racking Design takes into account the storage type, storage unit, volume, and
weight coupled with the available floor space and roof height to design system that
maximizes the storage capacity. Put away and picking process and transactional
volumes are also taken into consideration. The profile inventory study would
include detailing of number of SKUs in each category of fast moving, slow moving
or other criteria as per the nature of business and the storage type would be
designed as per the inventory profile and the process.
Racking designs are very many and varies with the type of industries and nature of
inventory. Normal racking designs include pallet racking on multiple levels. You
can have shelving, binning or a combination of bulk stock and forward pick face
racking designs. Block stack racking and other types of high-density racking can
be found in FG warehouses. Mezzanine store binning and shelving rack designs are
normally designed for spare parts and small parts.
Highly automated racking designs can have automatic retrieval systems and
conveyors in the warehouse.
Material Handling Equipment are specified based on rack design coupled with
pallet design, nature of the cargo, weight, and the warehouse layout, etc. Forklifts,
reach trucks, hand pallet jacks, trolleys are normal Material handling equipment in
normal warehousing operations.
Warehouse Operational Efficiency Contributing Factors
Managing Warehouse Operations is akin to playing a symphony with people,
systems, and processes. As long as these elements are balanced and in harmony the
operations go on smoothly and efficiently.
People

People are very important assets of warehouse operations. Human resources can be
the strongest and the weakest link to warehouse performance.
Even in a highly automated and system controlled design, warehouse operations
are heavily dependant upon people to run and manage operations.
Typically in warehouse operations, besides management structure, the operations
resource categories are MHE Operators, Operations staff who manage shipments,
put away, material picking tasks and other operations including labeling, packing,
kitting, inventory counting, documentation and systems operators. These resources
are mainly categorized as team leaders and operators.
Normally in warehouse operations, the manpower resources structure is employed
in a mix of, on the company role jobs, on contract and temporary or daily wages
and outsourced contract labor. The categorization is based on the nature and skill
set requirement of each job coupled with criticality of the position and the local
supply and availability of resources.
Workforce - Qty, Job Structure

Many times in 3rd party managed warehouses, workforce strength is often an issue
that affects the operational efficiency. It has been noticed several times that few
local managements try to cut corners by understaffing at various levels and
extending the working hours or job responsibilities and trying to save costs. There
can be several instances of shortage of manpower from the strength that has been
planned and budgeted for.
Any warehouse operations needs to have an optimum workforce budgeted based
on clear-cut tasks and volumes of transactions. As all operations are time bound
activities having inter-related tasks and dependencies, estimation of work and work
division clarity is essential to avoid overstaffing or understaffing. Overstaffing can
result in slackness in individual performance levels besides increasing the costs.
Warehouse activities very often are found to be seasonal and cyclical. The business
type and seasons resulting in peak seasons and low seasons place similar demands
on the warehouse to step up operational throughputs or cut down on operations.
Besides internal requirement also creates temporary demand for workforce. Extra
teams are called for during year-end operations, annual wall to wall stock takes or
any internal inventory exercises, etc.
Warehouses source temporary labor and resources from local nearby areas to
mange this sudden surge in demands. Any change in internal process or business
process or improvement in systems and processes can lead to redundancies. Many
times, they are having to face over staffing problems and need to look at ways to
reduce numbers or re deploy resources into other activities. Therefore, warehouse
operations are never in a stable state or status quo for a long time. Managing
people dynamics holds key to managing operations effectively.
Right skill sets

In warehousing operations, process and system compliance demands keen focus

and discipline at all levels. The skill sets and attitude requirements are different for
different jobs. The skill set requirement is more linked to attitude and functional
capability of the persons and less dependant upon knowledge or educational
qualification.
Any person who works on Forklift would need to have a good sense of control,
direction, and patience. Similarly, a picker would need to be able to identify and
have a feel of locations, Inventory SKU types and be able to identify the part
numbers, description.
At operating level, people are required to understand what is expected of them, be
able to follow the process and comply with the process and instructions. The
operations require manual dexterity and ability to be on feet for long durations
besides being able to bend down and reach up constantly to pick up items. Ability
to lift small weights and walking distances in the warehouse are a Must Have
strengths. These practical points have to be kept in mind and evaluated while
hiring people.
Attitude and Outlook

It has been seen in warehouse operations that the workforce attitude towards the
company, job and customer plays an important role in the operations. Studies done
in various cases have shown a direct link between people’s attitude and
commitment to day to day operations. Wrong shipments, short shipments and
defective deliveries coupled with warehouse equipment damage, misuse and
accidents are few of the results of the problems that show up and need correction
of attitudes at individual levels. Inventory management functions are highly
vulnerable to individual performance and attention to detail.
A good warehousing operations management team who is sensitive to the above
factors and is equipped to manage a team and the dynamics would be successful in
ensuring efficient operations.
Issue of Materials: Basic Requirement and Methods | Materials Management

.   
Issue of Materials # Basic Requirement:
Since large sums of money remain blocked in materials, it is essential for the
custodian of materials to ensure that the issue of materials are made only under
proper authorisation.

In fact, authorisation of stores is very vital.

Moreover, for efficient operation, the following points to be considered:

(a) Authorisation of issues

(b) Identification of requirements

(c) Timing of issues.

(a) Authorization of Issues:

 Since materials represents money, for the issue of materials there must be
some authorization by responsible officers nominated by the management.
Such authorization should be given clearly in the form of a directive circular.
 The object is to avoid misunderstanding and unpleasantness that may arise
due to the refusal by the storekeeper to issue materials. In many industries,
 the designation of the person authorized to draw materials along with their
specimen signature are sent to the stores for verification.
 The request for issue of materials is invariably made in written form or
documents for proper authorisation. It is the primary responsibility of the
storekeeper to verify all such documents for proper authorisation before the
materials are issued.
 Even though certain persons are authorised to draw goods from the stores,
management normally imposes a few restrictions for drawal of the goods
beyond a certain level of consumption. In all such cases, a clear directive
must be given to the stores department.

(b) Identification of Requirement:

Largely due to ignorance, in several cases the correct description of the items is not
given by the user department. Often the code number given may not tally with the
description of the goods, and vice versa. Hence an experienced store-keeper should
use his intelligence to identify the mistake and suggest to the indenter the correct
item.

Details about materials requirements such as part number, code number, etc.
ensure that it is supplied without delay and unnecessary correspondence.

(c) Timing of Issue:

The stores manager should ensure that the indenting departments are fully aware of
the timing of issues. However, there may be sudden rush during the peak hours.
This may put undue pressure on the stores department and may lead to sudden
stoppage of production, in case of undue delay.
So our intelligent store-keeper should study carefully the requirements of various
departments and stagger (spread) the timings in such a way that each department
can draw their requirements without loss of time.

Issue of Materials # Methods:

Issues from stores must be efficiently organised so that the requirements of the
production/operations department can be met.

1. Issue on request:
This is the most orthodox way of issue wherein the indenting department normally
sends a man and collects the materials from stores.

2. Issue per schedule:

In a batch production unit sometime, the requisition for issue of stores is sent well
ahead indicating when, i.e., the time and date it is required. The stores department
will collect all the materials and keep them ready.

Then it will intimate the indenting department about this. Depending on the
prevailing practice of the industry either they are collected from stores or delivered
at the shop floor. This is desirable in order to prevent any loss of man-hour caused
by sudden absenteeism of a worker in the production department.

3. Imprest issues:
In this system a list of certain items especially for tools and components and in
specified quantities is approved. The list is then held in a sub-store or tool kit near
the shop floor.

4. Replacement issue:
 In most engineering industries a large number of workshop machines are used. So
there will be considerable requirements of tools and gauges. When a fresh issue
has to be made the machine shop operator may be asked to return the old ones to
the stores and obtain new one for replacement. This is done without issue notes and
the storekeeper has to maintain proper records of such replacement.

5. Loan issues:
The issue of stores on loan should, as far as possible, be discouraged. Situations
often arise where some amount of spares; electrical fitting, etc. are required on
emergency basis due to some breakdowns. In such cases the materials are to be
issued on a loan basis. However, the storekeeper is to maintain a separate record
and ensure that they are returned before year-ending when annual stock-taking
begins.

6. Stock records:
In a store-house where thousands of transactions take place some amount of
records are to maintained. This makes it possible for the storekeeper to make an
entry of all transactions.

Documents for issuing inventory

1. Materials requisition note

Materials can only be issued to production departments against a materials
requisition. 

This document must record not only the quantity of goods issued, but also the cost
centre or the job number for which the requisition is being made. 

The materials requisition note may also have a column, to be filled in by the cost
department, for recording the cost or value of the materials issued to the cost centre
or job.
2. Materials returned note
This is used to record any unused materials which are returned to stores.
3. Materials transfer note
This document is used to transfer materials from one production department to
another.

Order Picking – Definition, Types & Process

GUIDES | 4 min read |

  2   comments
Have you ever placed an order for a certain product, but ended up receiving the

wrong one? If you have, then you know how unpleasant it can be. Every time a

customer receives the wrong order, it adds extra work for the store to exchange the

products, deal with refund amounts, and update stock levels. It also causes a drop

in customer satisfaction levels, which is why it is every business owner’s

responsibility to make sure that their customers never have to deal with this type of

situation. This is where a solid order picking process will help.

Order picking is when the products listed in an order are retrieved from their

respective warehouses. It is the first stage in fulfilling a customer’s order, and it’s

essential that the process is flawless so that the remaining fulfilment processes—

order packing, shipping, and post-sales activity—can also run smoothly. An

efficient order picking process should be able to make sure that the right product is

picked for every order. To understand better, think about shopping at a store like

Costco or IKEA. In this scenario, you are the warehouse picker. You notice that

you have items on your list that won’t be shelved in the same area, so you walk

around to different parts of the store until you have all the products that you need.

This is exactly what a picker does in a warehouse.

Although order picking may seem like a basic process, it actually costs a lot of

money. Several studies show that out of all the warehouse processes, order picking
accounts for the highest portion of operating costs, and according to a report from

Georgia Tech, this portion can be as high as 63% of a warehouse’s total spending.

This makes it one of the most important processes taking place in a warehouse.

Types of picking
There are three types of picking systems: piece picking, case picking, and pallet

picking. Under these types are 5 different processes: single order picking, batch

picking, multi-batch picking, zone picking, and wave picking. Let’s start by taking

a look at each picking system:

Piece picking
Piece picking is when items are picked one at a time from a warehouse. This type

of picking is commonly seen in orders that have many different SKUs but a

smaller quantity of items per pick.

Pallet picking
A pallet is a wooden platform that holds an arrangement of products in a

warehouse. Depending on the size of a pallet, it can hold one large item, or several

smaller ones. So pallet picking is when one entire pallet of items is picked and sent

to the packing area.

Case picking
Case picking is similar to pallet picking except here, only a part of the pallet is

picked and sent to the packing area. This form of picking is used when there is a

large number of SKUs with fewer items per SKU.

Now let’s take a look at the different picking processes:

Single order picking

Single order picking is when the picker picks one order at a time before taking it to

the packing station. This is usually only used in smaller warehouses with low

traffic. This technique can be used with piece picking, case picking, and pallet

picking.

Batch picking
Batch picking allows pickers to work with multiple orders at the same time. The

picker is given multiple orders to pick in one go and take to the packing station.

This method is ideal for warehouses that deal with a large number of orders with a

small number of products each. Batch picking is usually used with piece picking,

rarely with case picking, and cannot be used with pallet picking.

Zone picking
Zone picking is used when a warehouse is split into different zones. Pickers are

assigned to individual zones to handle all the orders that come from their section of
the warehouse. Zone picking is best for warehouses that receive many high-volume

order, meaning orders with a large number of items, and it can be used for all 3

types of picking processes.

Pick-and-pass
Pick-and-pass is like an extension of the zone picking technique. Here, an order is

passed down each zone, until all the items or SKUs contained in the order have

been picked. The pick-and-pass technique can be used with all 3 types of picking

processes.

Wave picking
Wave picking is when pickers from different zones of a warehouse select the items

for an order at the same time, and send them to consolidation. After all the items in

the order have reached consolidation, they are sent to the packing station. This

form of picking is also called order consolidation, and it is typically used by

warehouses that need a quick process to ship multiple high-volume orders. Wave

picking can be used with all 3 picking processes.

Automated Picking Systems

Traditionally, pickers used a paper picklist, which is a list of products required to

fulfill a particular order. These days, pickers use automated picking systems, which
can act as a picklist, display the best possible route to a product’s location, check if

the item picked is the right one, and more. Take a look at these commonly used

automated picking systems:

Pick-to-light
Pick-to-light order fulfillment technology requires a barcode scanner and pick-to-

light LEDs set up throughout the warehouse’s racks and shelves. A picker starts by

scanning a barcode that is attached to a shipping carton, which is a container that

temporarily holds the items from a single order. Scanning a shipping carton causes

the respective pick to light LEDs for the products of the order to glow. So the

picker can basically just follow the light until they’ve got all the products for their

order. Pick-to-light technology helps reduces picking time as well as labor costs.

Voice picking
With voice picking technology, pickers wear a headset that is connected to an

order management system, and they receive instructions on where to go to collect

the items for an order. This method increases productivity as well as accuracy.

Mobile scanner picking

With mobile scanner picking, all the products in your warehouse need to be

labelled with unique barcodes. Pickers use a mobile scanner that displays the

picklist for an order along with the location of each item. If the picker scans the
barcode of item that is not a part of the picklist, the scanner notifies them of the

error so that they can remove it. This error-checking gives mobile scanner picking

a high accuracy rate.

Regardless of the method you choose, order picking is simply the process of

pulling out the right products from a warehouse for an order. It’s the first step in an

order fulfillment process, so if a warehouse gets the order picking process right,

then they’re one step closer to reaching customer satisfaction. Depending on the

volume of orders and the infrastructure of the warehouse, there are several

different ways an order can be picked, and there is no one-size-fits-all method.

Choose the right method for your business so that you can have a top-notch order

picking process

INVENTORY CONTROL DOCUMENTS

Documents

Inventory Control includes the following documents:

Document Description

Reserves quantities of stock items from an on-hand supply for

Stock Requisition later delivery. This reduces the available quantity. If items are
(SR) not immediately available, they may be backordered and later
filled by having the Backorder Servicing program run.
 Schedules previously reserved items to be picked up for
delivery and releases them from a reserved status. This function
is performed by creating a Pick Ticket Report (IN80). From this
Pick and Issue
report, the warehouse can determine the stock item, the
(PI)
quantity, and the bin number of the items that are to be picked
up. It also creates the corresponding Issue Confirmation (CI)
document.

Confirms to the system that previously reserved and released

Stock Issue items have been issued from the warehouse to the buyer. The
Confirmation (CI) on-hand quantity of the warehouse for this item is reduced by
the amount issued.

Issues requested items directly from the on-hand quantity. As

the items are issued immediately upon request, in effect, "over-
the-counter," backordering is not allowed. Once an "Over the
Counter" transaction is successfully completed, an Over the
Over the Counter
Counter Issued Report will be produced, identifying the
(OC)
requestor and the stock items issued. Any request for items
unavailable for immediate issuance must be reserved through a
Stock Requisition (SR). On-hand quantity is reduced by the
amount issued.

Allows the original buyer to return previously issued items. At

Stock Return
the option of the issuing warehouse, a return charge may be
(SN)
imposed.

Allows warehouse management to adjust quantities or unit

Inventory values of on-hand items due to a change in on-hand quantities or
Adjustment (IA) unit costs. These adjustments alter inventory and cost of goods
expense balances.

Physical Allows warehouse management to adjust quantities of on-hand

Inventory items due to a change in on-hand quantities at a specified unit
Purchase Input costs. These adjustments alter inventory and cost of goods
(IP)
 expense balances.

Stock Transfer
Initiates the transfer of items from one warehouse to another.
Issue (TI)

Recognizes the receipt of transfer items by the receiving

Stock Transfer
warehouse. On-hand quantities of receiving/issuing warehouses
Receipt (TR)
are adjusted.

Contract Logistics Cost Model

Warehousing Costing methods vary with the business models. While some
warehouses using common shared facilities may be worked up based on
transaction costs, dedicated and stand alone facilities would be on a different
costing model.
In this section, we shall go through the cost elements of a warehouse project
briefly.
Warehouse Cost elements are primarily divided into Fixed Costs, Variable Costs
and Overheads.
1. Cost of Land & Building

This cost element is included if the land and building are provided by the
3PL and not the buyer.
Incase the land and building is acquired by the 3PL, the cost of land and
building may be amortized over the life of the building or as per industry
standards (average 10-12 years) and proportionate monthly costs can be
added. One needs to ensure that the costs are realistic and nearer to market
rates for rentals.
Incase the land and building is rented by the 3PL, the cost of monthly rental
along with the cost of funds for security deposit may be added to the costs.
All costs would be worked out for the term of contract period with annual
escalations considered annually.
2. Infrastructure Cost
 Cost of acquisition of all infrastructure including racks, MHE, Charging
equipment, dock levelers and any other equipment including office
equipment are itemized and amortized over the contract period or over the
shelf life of the equipment as the case may be, to arrive at monthly cost of
infrastructure.
3. IT Infrastructure

IT infrastructure consists of the cost of Hardware & Cost of Software.

Hardware covers all servers, desktops, printers, laptops, RF Equipment and
any other IT related hardware.
Software application costs include cost of WMS based on one-time fee or
individual number of user license, cost of other soft wares including mailing
system and any operations related soft wares.
IT Costs are amortized over two or three years depending upon statutory
audit guidelines.
4. Manpower

Detailed manpower costing will include the cost of Management Staff,

Operating staff, in-house operatives and outsourced operatives like labor,
MHE Drivers, etc. Outsourced security staff costs are also added under this
item heading.
In case of in-house staff, detailed calculations based on cost to the company
is worked out including staff benefit, insurance, bonus, training costs,
uniform, etc. along with proposed incremental cost over the number of years
as per contract period.
Outsourced staff costs are also tabulated for the contract period including
annual escalations.
5. Utilities & Consumables

Utilities are not fixed costs. They are monthly variable costs. The items in
this category are the costs towards office and communication expenses
including telephones, the internet, etc., stationary and consumables both for
office and shop floor items like tapes, packing materials, etc., cost of
electricity, water, fuel, etc.
6. Administrative expenses
 Costs of office support, cost of insurance and third party liabilities and travel
costs, etc. including any other statutory costs, deposits are covered here.
7. Overheads

Cost of management time is estimated and included here. Alternatively, a

percentage of corporate or regional office cost overhead is loaded.
Cost of money or interest cost on working capital for three months can be
included.
8. Profit / Management Fee

Management fee can be added as a percentage of total cost or a fixed amount

ontract Logistics Pricing Methods
Warehousing and Contract Logistics forms an important part of Supply Chain
Networks. Contract Logistics projects are of two kinds. The first being a flow
through the warehouse that can be a Finished Goods warehouse for the purpose of
consolidation and merging or documentation purposes or in the case of supplier
shipments, inventories being consolidated to enable FCL shipments. Often supply
chain logistics calls for shipments and cargo to be warehoused at the point of
origin or destination. In all such cases, warehousing facilities are normally public
warehouses or shared, and common facilities offered by 3PL are used.
The second kind of Contract Logistics projects involves larger projects that are
client specific and dedicated. Such warehousing projects may be called for in
Supplier inventory management and supplies to the Plant or manufacturing lines
called in plant logistics or models like JIT, VMI warehouses. In case of Finished
Goods too, the distribution centers, FG warehouse and hubs at regional or country
level entail dedicated facility.
Warehousing Projects are normally managed through an RFQ process where the
qualified 3PL vendors bid for the business with the response document containing
solution design, followed by presentations and negotiations with final selected 3PL
supplier. Many companies prefer to suggest a pricing mechanism or model in the
RFQ to enable them to compare the various bids as well as have clarity on costs
involved therein.
Types of Pricing Models in Contract Logistics:

1. Fee-based on the percentage of Sales Turnover or volume.

 2. Cost Plus model
3. Price per Sq. Ft
4. Transaction and Fixed Price combination
5. Cost per transaction or unit pricing

Fee-based on percentage of Sales Turnover or volume.

Traditionally warehousing service providers who are called carrying and
forwarding agencies involved mainly in Finished Goods logistics have practiced
the pricing mechanism of charging Warehousing Fee as a percentage of sales billed
per month. The fee can vary anywhere from 0.5 to 2% of the monthly gross sales
turnover. This practice has been in vogue in a multi-tier supply chain network
involving distributors at state levels and further regional distributors and so on.
This pricing mechanism includes a basic minimum guarantee pricing called as
floor price. Floor price or minimum price covers the fixed cost expenses of the
warehouse. The revenue earned by the 3PL varies with the sales revenue. 3PL
stands to gain during peak months and loose during slack months. The variable
cost that has a major impact on the costing is labor. 3PL service providers manage
this costing by employing minimum number of human resources and add on
temporary labor only when required.
While 3PL is aware of the market conditions and sales estimation for the buyer’s
products he stands to make a gain when the sales shoot up. Buyer, on the other
hand, would find it easier to account the cost as a standard percentage of the sales
turnover without having to get into other operational details.
Cost Plus model

Large size projects that are dedicated and setup as per a buyer’s requirement are
normally run based on Cost Plus model. As the name suggests, the pricing
mechanism involves estimating the total cost of running operations and profit as a
Management Fee which is fixed as a percentage of the total cost.
This costing method works well when the project size is huge and operations
include multiple transactions and value-added activities within the warehouse. A
large size warehousing project calls for huge investments to create the building and
infrastructure. The build may have to be built or may be hired by paying a security
deposit. Infrastructure investments would include racking or shelving systems,
material handling equipment including Forklifts, Reach Trucks, Dock levelers,
etc., conveyer or any other equipment needed. IT infrastructure can include cost of
hardware including servers, desktops, laptops, printers, RF equipment, etc.
Given the size of the project and the investments involved, the contract or project
is awarded for three years with two extensions of one year each. This helps the
3PL to amortize the investments over the contract period.