UNIT 1: PURCHASING MANAGEMENT

1.1 INTRODUCTION

Any commercial transaction, however simple always involves a buyer and a seller. Thus
purchasing is one of the basic functions of any business. The buyer requires certain goods
and materials to satisfy this wants. He seeks a seller who can and is willing to supply him
with what he needs. Together they negotiate a mutually satisfactory price and the deal is
completed.

Individual purchases can range from simple to highly complex. More complex purchases
require buying experts. It is in the relatively simple purchases, however, that justification
for a specialized department can be found.

1.2 PURCHASING THE RELATED CONCEPTS

1.2.1 Purchasing Defined

Purchasing is a managerial activity that goes beyond the simple act of buying, and it
includes the planning and policy activities covering a wide range of related and
complementary activities. Included in such activities are the research and development
required for the proper selection of materials and sources; the follow-up to ensure proper
delivery; the inspection of incoming shipments to ensure both quantity and quality
compliance with order; the development of proper procedures, methods, and forms to
enable the purchasing department to carry out established polices; the co-ordination of
the activities of the purchasing department with such other external divisions of the
concern such as traffic, receiving, storekeeping, and accounting, so as to facilitate smooth
operations; and the development of a technique of effective communication with top
management of the company so that a true picture of the performance of the purchasing
function is presented.

A number of specific activities are performed by a typical purchasing department. The

primary responsibilities of a purchasing department involves buying, value analysis and
purchasing research. Many purchasing departments, however, also include activities such

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as inventory control, stores, receiving, subcontracting, and traffic. Consequently, when
one encounters the term “Purchasing department” the name alone does not reveal
precisely what operations are involved.

1.2.2 Procurement
“Procurement” is a term whose genesis can be traced to early government parlance.
Today it is widely used by the armed forces to define one of several supply functions
involved in logistics activities. In the broadest sense, the government defines
procurement to include the entire process by which all classes of resources (People,
materials, facilities, and services) for a particular project are obtained.

Although the term “Procurement” originated in governmental organizations, for many

years it has also been used by industries. The meaning of procurement in industry
parallels its meaning in government. In both cases, the procurement concept encompasses
a wider range of supply activities than does the purchasing concept.

1.2.3 Materials Management

Materials management, as practiced in business today, can be defined as a confederacy of

traditional materials activities bound by a common idea- the idea of an integrated
management approach to planning, acquisition, conversion, flow, and distribution of
production materials from the raw-material state to the finished – product state.

The materials management concept advocates the assignment of all major activities,
which contribute to materials’ cost to a single materials management department. This
includes the primary responsibilities which are generally found in the purchasing
department, plus all other major procurement responsibilities, including inventory
management, traffic, receiving, warehousing, surplus and salvage, and frequently
production planning and control. Some companies also include customer service,
scheduling, shipping, materials handling, and physical distribution in their definitions of
materials management.

The specific form of materials organization most appropriate for one firm may not be the
best form for another. A brief discussion of two materials activities will illustrate why the

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unique nature of a specific firm’s operating activities influences its form of materials
organization so heavily. Assume that a plant purchases all the parts, components, and
subassemblies for the product it manufactures. In this situations, if production were
uniform, the production planning schedule and the purchasing schedule, allowing for lead
time, would be similar or identical. Consequently, for this firm to achieve optimal
material and cost control, production control should realistically be included in the
materials management department. Assume now that a plant manufactures all the parts,
components, and subassemblies that are used in producing its product. In this situation,
there may be very little similarity between the production planning and purchasing
schedules. Therefore, in this firm, a strong case could be made for locating production
control with in the production department.

In practice, the theoretical extremes discussed above seldom exist. For most firms, the
production planning and purchasing schedules overlap significantly. Unfortunately, this
frequently produces a continuing source of conflict. One of the paramount advantages of
materials management is that it forces co-ordination between purchasing and production
control. Purchasing and production control are both responsible for the on time delivery
of production materials. Division of this authority between two different operating units
inevitably leads to conflict. When materials do not arrive on time, production control is
seldom satisfied to work through the purchasing department. Frequently, production
control personnel proceed to expedited the late materials directly with the supplier. Since
the expediting of purchased materials and negotiation with suppliers are basic purchasing
responsibilities, conflict ensues. Such conflict is much more readily resolved when
production control and purchasing report to a single boss- the materials manager.

As with purchasing and production control, substantial benefits also accrue when
inventory management, value analysis, receiving, stores, and surplus and salvage are
placed in a materials management department.

Probably the single greatest benefit a firm receives from having a materials manager is
that this manager thinks as the president and other top vice presidents do-that is, in terms
of the firm as a whole. Managers of individual materials functions, such as purchasing,
inventory, and traffic usually are compelled to think more narrowly in terms of the

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unique responsibilities associated with their specific function. Consider a typical
situation. In practice, production and purchasing often develop a tacit agreement on
carrying a higher level of inventories than a good materials manager normally sanction.
High inventories protect production from manufacturing delays and purchasing from
production pressures. If top management complains of high inventories, production and
purchasing blame each other for the condition. One large firm, with sales exceeding $ 1
billion, recently reduced inventories over 25% after creating a materials management
organization and appointing an experienced top management person as its new vice
president for materials.

1.3 PURCHASING’S PLACE IN BUSINESS

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

these questions, the purchasing function will be observed from three points of view: first,
as a function of business, second, as one of the basic elements required to accomplish
productive work; and third, as the department responsible for outside manufacturing.

i) Purchasing as a function of business

Purchasing is one of the basic functions common to all types of business enterprise.
These functions are basic because no business can operate without them. All businesses
are administered or managed by co-ordinating and integrating these six functions:
1. Creation, the idea or design function.
2. Finance, the capital acquisition and financial planning and control function.
3. Personnel, the human resources and labor relations function.
4. Purchasing, the acquisition of required materials, services and equipment.
5. Conversion, the transformation of materials into economic goods and
services.
6. Distribution, the marketing and selling of goods and services produced.

The design engineering department, the finance or controller’s department, the personnel
or human resources department, the purchasing department, the production department,
and the sales or marketing department are the common industrial titles of the
organizational units responsible for performing these six functions. In non-industrial

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enterprises, the same functions must be performed, but they may be identified by
different names.

Depending on a company’s size, these basic functions may be supervised by a single

manager or by individual managers for each function. Regardless of how they are
supervised, they are performed by someone in every business. Some small firms, for
example, do not have a purchasing department; nevertheless, the purchasing function
must still be preformed. Sometimes it is performed by the president; at other times it is
performed by an executive who administers several basic functions, including
purchasing.
By its very nature, purchasing is a basic and integral part of business management. Why
is this fact important? For a business to be successful, all its individual parts must be
successful. It is impossible for any organization to achieve its full potential without a
successful purchasing activity. In the long run, the success of a business enterprise
depends every bit as much on the purchasing executive as it does on the executives who
administer the other functions of the business.

This is not to imply that all purchasing departments are of equal importance to the
success of their companies. They are not; their importance varies widely. The importance
of any individual business function within a specific organization is dependent on a
number of factors. Among these factors are the type of business, its goals, its economic
circumstances, and how the enterprise operates to achieve these goals. In some situations
purchasing can function in a perfunctory manner without jeopardizing a company’s
profit. These situations, however, are exceptions. Similar exceptions can be found in
marketing, finance, or any other function of business. For example, in a firm selling a
highly advanced technical product, the marketing department usually does not have
weighty responsibilities. Engineering excellence does more than efficient marketing
techniques to sell the product. On the other hand, marketing a highly competitive
standard product requires selling ability of the highest order. In such companies, the
marketing department has a position of major importance.

ii) Purchased Materials as Resources or Elements of productive work

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The basic goal of any industrial activity is the development and manufacture of products
that can be marketed at profit. This goal is accomplished by the appropriate blending of
what management authorities historically have called the five Mis: machines, manpower
materials, money, and management. Materials today are the lifeblood of industry. No
industrial organization can operate without them. Materials of the appropriate quality
must be available at the right time, in the proper quantity, at the needed location, and at
an acceptable price. Failure to fulfill any of these responsibilities concerning materials
adds to company costs and decreases company profit just as surely as do outmoded
production methods, inefficient personnel, and ineffective selling.

iii) Purchasing as the manager for outside manufacturing

The materials which go into a typical company’s products can originate from either of
two sources. The company’s production department is the first source; this department
converts raw materials into processed parts. The company’s purchasing department is the
second source. This department not only purchases raw materials, which the production
department converts into processed parts, but it also purchases finished parts and
components. The parts made by the production department are combined in assembly
with the items bought by the purchasing department to make the company’s final
products.

The percentage of industrial components being purchased externally is constantly

increasing compared with the percentage being manufactured internally.

The trend in manufacturing is toward the development of three distinct types of factories.
The first type does not make finished end products; it is equipped with costly high-
volume specialty machines and produces machined and fabricated parts in large
quantities at low unit cost. These parts are sold to numerous factories of the second and
third types. The second type of factory, like the first type, does not make finished end
products; it makes subassemblies. The required parts for the subassemblies come form
factories of the first type, or from the parts it makes, or from a combination of both. The
third type of factory makes finished end products. As economic circumstances dictate this
type of factory assembles the finished product from a combination of the parts it makes

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(usually parts that are unique to its product) and the standard parts or subassemblies it
buys from factories of the first and second types.

In the multiple-type factory system of today, any company generally uses two distinct
sources of supply: inside manufacture and outside manufacture. The production
department is responsible for inside manufacture, including the authority to schedule
production in economical quantities, and to do so far enough in advance to have materials
available when needed.

The purchasing department, on the other hand, has the responsibility and authority to
schedule the delivery of outside production. Purchasing executives have the same
managerial interests concerning their outside production as production executives have
concerning their internal production. Both must schedule accurately. Production
executives are interested in low unit costs and high quality. Purchasing executives are
interested in keeping their suppliers’ costs down. In addition, they are interested in
maintaining scheduled deliveries and good quality control to assure that production
schedules are met and to minimize the costs of inspection and unacceptable materials.

1.4 OBJECTIVES OF PURCHASING

The objectives of purchasing and materials management can be viewed from three levels:
(1) a very general managerial level, (2) a more specific functional or operational level,
and (3) a detailed level at which precise strategic buying plans are formulated.

From a top managerial perspective, the general objectives have traditionally been
expressed as the five rights which management expects the department to achieve the
acquisition of materials:

i) Of the right quality

ii) In the right quantity
iii) At the right time
iv) From the right supplier
v) At the right price

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A sixth factor implied in these items includes the desired services necessary for optimal
supply and utilization of the materials.

Even the casual observer will detect just a bit of the “apple pie and motherhood”
syndrome reflected in these five rights. Idealistically, they are all highly desirable. In
practice, the department can rarely fulfill them all equally, because in a given
procurement conflicts inherently exist between some of the objectives. Usually some
trade-offs must be made. From a practical point of view, materials personnel seek a
reasonable balance among them.
From an operating or functional perspective, then, it is necessary to probe more deeply to
develop a set of statements that provide practical and useful targets for decision-making
purposes. In this sense, the eight basic objectives of purchasing and materials
management are identified and discussed briefly below.

1. To support company operations with an uninterrupted flow of materials and

services.
This is the most fundamental of all purchasing and materials management objectives. In a
logistical sense this is a key reason for the existence of the department. Responsibility for
performance of the function is located in a single operating unit, there by facilitating co-
ordination and control of the supply activities.

2. To buy competitively: Buying competitively involves keeping abreast of the forces of

supply and demand that regulate prices and availability of materials in the market place.
At times; it also involves an understanding of a supplier’s cost structure, coupled with an
ability to minimize the supplier’s costs with in reason-then to negotiate price and service
arrangements that are fair relative to the supplier’s costs. A buyer who pays significantly
more than his or her competitor does for a given material or service generally is not
buying competitively.

3. To buy wisely: Buying wisely involves a continual search for better values that yield
the best combination of price, quality, and service, relative to the buyer’s needs. This
frequently involves coordination with users in defining the need. It may also involve co-
coordinating and reconciling users’ needs with suppliers’ capabilities to achieve optimal

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value considering both issues. A firm that purchases a silver-plated part when a copper
plated part could perform the function just as well usually is not buying wisely.

It is the combination of buying competitively and buying wisely that typically contributes
most to the profitability of the firm.

4. To keep inventory investment and inventory losses at a practical minimum .

Although maintaining a large inventory is one way to achieve objective number one, it is
also costly. Generally, speaking, most firms today pay in indirect costs between 25 and
35 percent of the average inventory value per year for the convenience of having the
inventory available. Hence, the materials management job is to achieve a reasonable
balance between the level of inventory required to support operation and the cost of
carrying the inventory.

Through proper buying, packaging, and storing, it is also the department’s objective to
minimize losses that occur as a result of deterioration, obsolescence, theft, and so on.

5. To develop reliable and effective sources of supply. Cooperative suppliers that are
willing to work with a buyer to help solve the buying firm’s problems and to minimize its
materials-related costs are an invaluable resource. Progressive buyers today tend
increasingly to “buy suppliers”, as opposed simply “buying products”. The identification,
investigation, selection, and in some cases development of competent and responsive
suppliers is a buyer’s paramount responsibility. It is difficult indeed for a firm to perform
optimally if it cannot depend on the planned performance of a reliable contingent of
suppliers.

6. To develop good relationships with the vendor community and good continuing
relationships with suppliers.
suppliers. Good relationships with suppliers are imperative, and good
relationships with potential suppliers are invaluable. The achievement of the preceding
objective on a continuing basis is virtually impossible if mutually satisfactory continuing
relationships are not maintained. Potential suppliers are much more interested and eager
to acquire a firm’s business if the buying firm is likely to be a “good customer”. And,
when a contractual relationship has been formed with a supplier, the myriad operating
problems that inevitably arise throughout the life of the contract are much more easily

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and effectively solved when the relationship is sound and mutually beneficial. Suppliers
naturally direct their research, provide advance information on new products and prices,
and in general give better service to such customers.

7. To achieve maximum integration with the other departments of the firm. It is

essential for buyers to understand the major needs of their using departments, so that
these needs can be translated into materials support actions. While these actions vary
from firm to firm, they normally require the purchasing and materials operation to
support a using department in one or more of its major responsibilities. The most
common types of support involve actions such as developing materials standardization
programs (in Co-ordination with on going design programs), forecasting future prices and
general business conditions, performing economic make-or buy analyses, and serving as
a repository of information and data from suppliers regarding new materials, processes,
prices, and materials availability.

8. To administer the purchasing and materials management function in a

professional, cost-effective manner.
Management should expect the preceding seven objectives to be achieved in a
professional manner at a cost that is commensurate with their value to the total
organization. This involves the acquisition and development of highly competent
personnel who are motivated to perform their responsibilities effectively, with the over
all goal of helping the firm maintain a competitive position in its industry. Such
personnel also serve as a reservoir of talent from which future executives of the firm can
be drawn.

A part of this composite effort also involves the development of operating policies and
procedures that facilitate accomplishment of departmental objectives at the lowest
reasonable operating costs.

All these objectives apply in principle to all categories of industrial buying activities:
manufacturing concern, governmental units, schools, hospitals, and all other types of
buying units that buy for consumption or conversion. A non profit activity, of course,
cannot seek to “maximize its profit”. It can, however, seek to maximize the benefits the

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organization receives from its appropriated or endowed birr. A principle common to all
types of purchasing activities is to obtain the greatest value from each birr the purchasing
department spends.

The third level focuses on detailed objectives that are developed when precise buying
plans are made (usually annually) for each of the major categories of materials the firm
uses in its operations. These objectives are spawned from the functional-level objectives
just discussed, and are applied to fulfill the specific needs associated with each type of
purchase. The precise set of objective for each material typically varies because the usage
requirements, the operating conditions, and the markets in which each material is
purchased usually are different.

1.5 INTERDEPARTMENTAL RELATIONSHIPS

A purchasing department exists to supply the needs of other departments in the company.
To a considerable extent the attitudes and reactions of these other departments toward the
purchasing department depend on the degree and kind of service that the purchasing
department extends and the nature of the existing interdepartmental relations.

Purchasing is constantly working with the other departments in the company, and thus it
is essential that mutual trust and cooperation prevail in order to foster efficiency. There
are areas where friction may develop between purchasing and other departments because
of misunderstanding over who should do the work. In many companies the materials
management form of organization has been introduced to minimize this friction and to
improve coordination among the materials departments. An organizational manual that
clearly describes the duties and responsibilities of each department help to minimize
conflicts of interest. Such manuals are becoming common place today, especially in
larger companies. The following paragraphs will be devoted to a brief discussion of some
of these interdepartmental relationships.

i) Purchasing and Production

Production and purchasing have the common goal of efficient and profitable operation;
however, their philosophies differ. A production executive quite naturally thinks in terms

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of having all he needs of the best materials. This philosophy can easily lead to excessive
inventories of unnecessarily high quality. The purchasing executive may find himself in
an unpopular position when he must contend for a reasonable quantity of the appropriate
quality. To a considerable extent, the relationships between these two departments can be
harmonized through the exchange of information which each department develops in the
normal course of its operations.

Production must keep purchasing informed as far in advance as possible about production
plans and schedules. With such information purchasing is able to plan its procurement
program intelligently so as to minimize emergency and “rush” orders. As changes in
production plans develop, they should be communicated to purchasing so that time is
available for vender selection, negotiations, and delivery. The production department
must be made to realize the “lead time” that exists between the issuance of a requisition
and receipt of goods. Efficient purchasing procedures can minimize this time but, at best,
production must work closely enough with purchasing in anticipating needs to allow for
the minimum “lead time”.

On the other hand, purchasing has certain responsibilities toward the production
department. The purchasing department must keep production informed of expected
arrivals, and must notify the production department promptly of any unusual delays so
that production may be rescheduled without plant stoppages.

The purchasing department has a valuable tool for the production department in its file of
vendor’s catalogs. These should be supplied on call to the production department.
Purchasing also has the responsibility of informing the production department about any
new materials, machines, or methods that come to the buyers’ attention through visiting
salesmen or trade literature. A buyer sometimes is instructed to secure samples for testing
by the production department. At other times a buyer should secure samples on his own
initiative and bring them to the attention of the production department for testing
purposes.

In many companies the purchasing and production departments share joint responsibility
for development of standards and specifications for materials and supplies to be

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purchased. In other companies purchasing merely has a voice in the matter, with
responsibility in the production department. The important thing is for the purchasing
department to make sure that wherever possible, standards conform to materials that are
readily available in the market and avoid unnecessary deviations that add to costs.

In the purchase of plant equipment, purchasing and production are but two of many
departments involved in the decision. Each, however, has a role to play in the purchase of
equipment. Production concerns itself with initiating the action and determining the kind
of equipment to be purchased. Purchasing surveys the potential suppliers who will be
requested to bid on the order and has an important voice in deciding who gets the order.
The treasures, the engineering department, some times the sales department, and often the
president participate in the decision.

ii) Purchasing and Engineering

The engineering department is primarily responsible for the design and specifications of
the products the company makes and the processes the company uses. Engineers in such
departments have definite ideas about the physical and chemical properties required in
the end product and know what materials have the desired properties. However, because
there frequently are several materials possessing suitable properties, it is important for
someone to determine which material can be purchased most advantageously. This is a
proper responsibility of the purchasing department.

A close working arrangement must be developed between the engineering and purchasing
departments. Engineering should not be so exacting that its demands override price and
market considerations, and purchasing must not stress price to the point where it
interferes with sound engineering requirements.

The two departments should complement each other; and close cooperation is essential
for smooth and successful relationships. Good engineering produces a product up to
company specifications, with both technical and market efficiency.

iii) Purchasing and Sales

Vo company can stay in business for long unless its products can be sold at a profit. The
purchasing department can help the sales department by buying at the lowest possible

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cost so that a company’s selling price can be competitive. About 50 percent of a typical
sales department sells has been purchased from others. The sales department can help
purchasing schedule its purchases effectively by apprising the purchasing department of
sales quotas and sales expectations. The sales department can be particularly helpful by
giving the purchasing department as much advance information as possible during
negotiations with customers for special orders and non-stock items.

In many companies the practice of reciprocity calls for the maintenance of close liaison
between purchasing and sales in order to properly effectuate the policy.
iv) Purchasing and Finance
Purchasing 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 purchasing-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 the major cause of business failure. Among the basic data
needed by an organization for proper planning of its working capital and cash-flow
positions are accurate sales forecasts and accurate purchasing schedules. It is just as
important for purchasing 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 favorable and completely
unexpected buying opportunities. A supplier for example, 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. (Include direct costs paid for making a specific product). This may be done because
it is in the long-term interest of the firm not to reduce its labor force. The potential
income from such unexpected buying opportunities must be weighted against the
potential income from other alternative uses of the company’s capital. Acquiring new
equipment, adding to plant facilities, and increasing sales and promotional efforts are
some of the alternative uses of capital that a company must consider. Usually, the
alternative offering the greatest income in the long run should be selected, since no firm
has enough capital to satisfy all requirements.

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Regardless of the price advantage obtainable, the right time to buy from the stand point of
business conditions is not always the right time to buy from the stand point of the
company’s treasury. If the purchasing department places orders to take advantage of
unusually low prices without consulting the finance department, the company could find
itself paying for these purchases with funds needed for other purposes. On the other hand,
if the finance department does not strive delightly to make funds available for such
favorable buying opportunities, the company may have to pay higher prices for the same
material. Therefore, it is routine procedure for all purchase requests to clear through the
finance department to ascertain that there is an uncommitted balance in the proper
account equal to the contemplated purchase.

v) Purchasing and Stores

If the stores department is independent of the purchasing department, the relationship
between the two is closer and more continuous than those between any other two
departments. On all shelf stock items the stores department initiates the purchase requests
on which the buyer acts. The buyer’s decision concerning a purchase is based on such
factors as rate of use, number of defective parts, and trends in the rate of use. This
information is most easily secured through the records of the stores department. The
buyer must keep the stores department informed on minimum stocks and reorder points
so that the stores department can keep its inventories at proper levels.

1.6 SUMMARY

Purchasing is closely related to other concepts like procurement and materials

management. In general purchasing can be called that function responsible for the
acquisition of required materials, services and equipment.

Purchasing is one of the integral part of business management. For a business to be

successful all the functional areas must be successful. It is impossible for any
organization to achieve its full potential with out a successful. It is impossible for any
organization to achieve its full potential with out a successful purchasing activity.

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The objectives of purchasing can be divided into two as general and specific detail
objectives. The general objectives are related to a top managerial perspective where as
the specific objectives are viewed from an operating or functional perspective.

Purchasing has a close working relationship with other departments like production,
engineering, sales, finance and stores. In order to minimize frictions and
misunderstanding the duties and responsibilities of each department have to be described
properly. In addition, departments have to exchange information which they develop is
the normal course of their operations.

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