Chapter 2: Purchasing

Management
Lecturer: Pham Thi Trang, Ph.D.
 Chapter objectives
After completing this chapter, you should be able to:
• Understand the role of supply management and its strategic impact on an
organization’s competitive advantage.
• Have a basic knowledge of the traditional purchasing process, e-procurement, public
procurement and green purchasing.
• Understand and know how to handle small value purchase orders.
• Understand sourcing decisions and the factors impacting supplier selection.
• Understand the pros and cons of single sourcing versus multiple sourcing.
• Understand centralized, decentralized and hybrid purchasing organizations.
• Describe the opportunities and challenges of global sourcing and understand how
globalization impacts supply management. 2
Lecture outline
In this chapter, you will learn about:
1. The Role of Supply Management in an Organization
2. The Purchasing Process
3. Sourcing Decisions: The Make-or-Buy Decision
4. Supplier Selection
5. How Many Suppliers to Use
6. Purchasing Organization
7. International Purchasing/Global Sourcing
8. Procurement for Government/Nonprofit Agencies
9. Ethical and Sustainable Sourcing Defined
10. Summary 3
 Purchasing in SCM Purchasing profession

The purchasing profession:

the act of obtaining
merchandise; capital Merchants
equipment; raw materials; Industrial
- Wholesalers
services; or maintenance, buyers
repair and operating (MRO) - Retailers
supplies in exchange for
money or its equivalent.

whose primary
Primary focus of this task is to
who primarily
chapter: purchase raw
purchase for
materials for
Industrial buyers resale purposes
conversion
purposes
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The Role of Supply Management in an Organization

Many successful businesses are treating purchasing as a key strategic process 5

Source: U.S. Census Bureau, 2016 Annual Survey of Manufactures.

The Role of Supply Management in an Organization
The primary goals of
purchasing:
• Ensure uninterrupted
flows of raw materials
at the lowest total cost.
• Improve quality of the
finished goods
produced.
• Maximize customer
satisfaction.
• Purchasing can contribute to these objectives
by:
 Actively seeking better materials and
reliable suppliers
 Working closely with and exploiting the
expertise of strategic suppliers to
improve the quality of raw materials
 Involving suppliers and purchasing
personnel in product design and
development efforts
6
The Role of Supply Management in an Organization
(Continued)

The Financial Significance of Supply Management

Profit-Leverage Effect
A decrease in purchasing expenditures directly increases profits before
taxes (assuming no decrease in quality or purchasing total cost)
Return on Assets (ROA) Effect
A high ROA indicates managerial prowess in generating profits with
lower spending (caveat - ROA ratios vary from one industry to
another)
Inventory Turnover Effect
Increased inventory turnovers indicate optimal utilization of space and
inventory levels, increased sales, avoidance of inventory obsolesce

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The Role of Supply Management in an Organization
(Continued)

The Financial Significance of Supply Management

Profit-Leverage Effect

Profit Leverage Effect

Simplified Increase Decrease
P&L Sales 10% Cost 10%
Gross Sales 1,000,000 1,100,000 1,000,000
- Cost of Goods Sold (50%) (500,000) (550,000) (450,000)
= Gross Profit 500,000 550,000 550,000
- Sales, General, & Administrative (45%) (450,000) (495,000) (450,000)
= Profit Before Tax 50,000 55,000 100,000
Change in Profit 10% 100%

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The Role of Supply Management in an Organization
(Continued)

The Financial Significance of Supply Management

Return on Assets (ROA) Effect

Return on Assets Effect

Simplified Increase Decrease
P&L Sales 10% Cost 10%
Gross Sales 1,000,000 1,100,000 1,000,000
- Cost of Goods Sold (50%) (500,000) (550,000) (450,000)
= Gross Profit 500,000 550,000 550,000
- Sales, General, & Administrative (45%) (450,000) (495,000) (450,000)
= Profit Before Tax 50,000 55,000 100,000
Assets 500,000 500,000 500,000
Return on Assets 10% 11% 20%

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The Purchasing Process – Manual Purchasing
(older system)
Step 1- Material Requisition/Purchase Requisition –
Stating product, quantity, and delivery date. May originate as a planned
order release from the MRP system. Traveling requisition used for
recurring orders.
Step 2- The Request for Quotation (RFQ) –
Buyer identifies suppliers & issues a request for quotation (RFQ) for routine
items or a Request for Proposal (RFP) for highly technical products.
Supplier Development is used to develop supplier capabilities.
Step 3- The Purchase Order (PO) –
Is the buyer’s offer & becomes a binding contract when accepted by supplier.
When initiated by the supplier on their own terms, the document is a sales
order. The Uniform Commercial Code (UCC) governs transactions in the
U.S., except Louisiana.
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 The Purchasing Process – Manual Purchasing
S u p p lie rs P u r c h a s in g S t o ra g e / W a re h o u s e U s e rs/ R e q u is it io n A c c o u n t in g
START
M a te r ia ls M a t e r ia ls
R e q u is it io n M a t e r ia ls R e q u is it io n
No
MR 1 A v a ila b le ? MR 1
MR 2 MR 2
MR 3
Yes

Is s u e P O
M a te r ia ls
R e q u is it io n
P u rch a se P u rch a se MR 1
O rd e r O rd e r MR 2
PO 1 PO 1 A c c o u n t in g
PO 2 PO 2
PO 3 MR 2 In f o r m a t io n
M R F ile Is s u e f o r c h a r g in g t h e
PO 4
M a te r ia ls
M a t e r ia ls + a p p r o p r ia t e
d e p a rtm e n t
DO 3
DO 2

D e liv e r y P O F ile
O rd e r PO 3
DO 1 M R F ile
DO 2

MR 2

S h ip
M a te r ia ls
MR 2
DO 2 + A c c o u n t s P a y a b le
PO 2
M a t e r ia ls M a t e r ia ls +
PO 2
D e liv e r y
O rd e r D e liv e r y
DO 1 O rd e r
DO 1
IN V 2

In v o ic e
IN V 1 In v o ic e
11 IN V 1

Figure 2.1
 The Purchasing Process
Traditional Manual Purchasing System
1 day 2 2 hours
hours
Search Fill in Send to Buyer prints
goods requisition buyer order
1 day

2 hours 1 day 1 day

Matching
Accountant 12
invoice
 The Purchasing Process
Electronic Procurement Systems (e-Procurement)
Step 1- Material user inputs a materials requisition –
Relevant information such as quantity and date needed.

Step 2- Materials requisition submitted to buyer –

At purchasing department (hardcopy or electronically).

Step 3- Buyer assigns qualified suppliers to bid –

Product description, closing date, & conditions are given.

Step 4- Buyer reviews closed bids & selects a supplier

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The Purchasing Process (e-Procurement)

14
The Purchasing Process (e-Procurement) (Continued)

1 hour 30 mins

Search goods Order on Delivery

web
1 day

30 mins

Payment Generate invoice 15

The Purchasing Process (e-Procurement)
(Continued)

Advantages of the e-Procurement System

1. Time savings
2. Cost savings
3. Accuracy
4. Real time
5. Mobility
6. Trackability
7. Management
8. Benefits to the suppliers 16
 e-Procurement System: Procurement Credit
Card/Corporate Purchasing Card
Place order Authorized
End-user
suppliers
organization
Receive goods/services
Provide Receive Submit
Make
data payment transaction
payment

How P-card works

Merchant acquirer
Card issuer
Process Request
Request Provide
payment authorizatio
authorization authorization
n
Process payment Process payment

Processor Request Request 17

authorization Network authorization

 Vertical integration of supply chain
Supplier 1 Supplier 2 Supplier n

Manufacturer 1 Manufacturer 2 Manufacturer n

Vertical

Warehouse/DC 1 Warehouse/DC 2 Warehouse/DC n

Retailer 1 Retailer 2 Retailer n

Customer 1 Customer 2 Customer n

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Horizontal
Vertical integration of supply chain (Continued)
• Advantages

1. No reliance on suppliers • Disadvantages

2. Potential access to
monopolizing suppliers 1. Expensive
3. Economies of scale 2. Reduces flexibility
4. Knocking off most 3. Loss of focus
popular brand-name 4. Not likely to have a culture
products that supports both retail
5. Lower costs stores and factories
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 Sourcing Decisions: The Make-or-Buy
Decision
Outsourcing Reasons for Making
refer to buying materials or 1. Protect proprietary technology
components from suppliers
instead of making them in- 2. No competent supplier
house. 3. Better quality control

Reasons for Buying or Outsourcing 4. Use existing idle capacity

1. Cost advantage 5. Control of lead-time,

transportation and warehousing
2. Insufficient capacity cost
3. Lack of expertise 6. Lower cost
4. Quality
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 Make-or-Buy Break-Even Analysis

Consider a hypothetical situation in which a firm has the option to make or

buy a part. Its annual requirement is 15,000 units.
A supplier is able to supply the part at $7 per unit. The firm estimates that it
costs $500 to prepare the contract with the supplier.
To make the part, the firm must invest $25,000 in equipment and the firm
estimates that it costs $5 per unit to make the part. 21
 Make-or-Buy Break-Even Analysis

Break-even Analysis
Break-even Point, Q

Total Cost to Make = Total Cost

to Buy
 $25,000 + $5Q = $500 + $7Q
 Q = 12,250 units

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 Break-even point Practise
• 4/p.71

23
 Break-even point Practise
• 5/p.71

24
 Break-even point Practise

• 6/p.71

25
 Break-even point Practise
• 7/p.71

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Supplier selection
1. Process and product technologies
2. Willingness to share technologies and
information
3. Quality
4. Cost
5. Reliability
6. Order system and cycle time
7. Capacity
8. Communication capability
9. Location
10. Service 27
 How Many Suppliers to Use
Sole sourcing:
refers to the situation when the supplier is the only available source
Single sourcing:
refers to the deliberate practice of concentrating purchases of an item
with one source from a pool of many potential suppliers.
Reasons Favoring a Single Supplier Reasons Favoring Multiple Suppliers
1. To establish a good relationship 1. Need capacity
2. Less quality variability 2. Spread the risk of supply interruption
3. Lower cost 3. Create competition
4. Transportation economies 4. Information
5. Proprietary product or process 5. Dealing with special kinds of businesses
purchases
6. Volume too small to split 28
 Purchasing Organization
Centralized purchasing:
is where a single purchasing department, usually located at the firm’s corporate
office, makes all the purchasing decisions, including order quantity, pricing policy,
contracting, negotiations and supplier selection and evaluation.
Decentralized purchasing:
is where individual, local purchasing departments, such as at the plant level, make
their own purchasing decisions
Advantages of Centralized
1. Concentrated volume Advantages of Decentralized
2. Avoid duplication 1. Closer knowledge of requirements
3. Specialization 2. Local sourcing
4. Lower transportation costs 3. Less bureaucracy
5. No competition within units
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6. Common supply base
International Purchasing/Global Sourcing

Quality of
overseas Delivery
speed
products

Lower the
price of Countertrade
materials Why
global
sourcing?
30
 Procurement for Government/Nonprofit Agencies
Public procurement or public
purchasing: refers to the
management of the purchasing
and supply management
function of the government
and nonprofit sectors, such as
educational institutions,
hospitals and the federal, state
and local governments
• Principle 1 – Consider whether a material/product is needed before purchasing it or not.
• Principle 2 – Purchase a product considering the various environmental impacts over its
life cycle - from extraction of raw materials to disposal.
• Principle 3 – Select suppliers who make a conscious efforts to care for the environment.
• Principle 4 – Collect environmental information on products and suppliers. 31
Ethical and Sustainable Sourcing Defined
Ethical sourcing policies should include:
• Determining where all purchased goods come from and how they are made;
• Knowing if suppliers promote basic workplace principles (such as the right
to equal opportunity and to earn a decent wage, the prohibition of bonded,
prison or child labor, and the right to join a union);
• Use of ethical ratings for suppliers alongside the other standard
performance criteria;
• Use of independent verification of vendor compliance;
• Reporting of supplier compliance performance to shareholders;
• Providing detailed ethical sourcing expectations to vendors
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 Summary
Over the last decade, the traditional purchasing function has evolved into an integral part of
supply chain management. Purchasing is an important strategic contributor to overall
business competitiveness. It is the largest single function in most organizations, controlling
activities and transactions valued at more than 50 percent of sales. Every dollar saved due
to better purchasing impacts business operations and profits directly. Purchasing personnel
talk to customers, users, suppliers and internal design, finance, marketing and operations
personnel, in addition to top management. The information they gain from all this exposure
can be used to help the firm to provide better, cheaper and more timely products and services
to both internal and external customers. Savvy executives are thus turning to purchasing to
improve business and supply chain performance.

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