Cll 1\PT[R

Tl-IE ROLE OF 1
PU RC.HAS lN G IN
THE VALUE CHAIN

I.EARN I NG 01'1 [CTIVES

After studying this chapter you i,,hould understand the following:
The role and importance of the purdt�ing and supply function in the value chain.
rhe difference between concepts such as ordering, buying, purchai,,ing,
procurement, sourcing, supply chain management and value chain management
and how these are interrelated.
New developments in purchasing and supply practices of organintions.
The most important elements of the purchasing function.

INTRODUCTION
As business is becoming more and more competitive, purchasing and supply chain man­ Purchasing
agement are increasingly recognized by top managers as key business drivers. Again and The 111c1.1rogem.ent of the
again it appears that purchasing professionals and supply managers can contribute signifi­ company's external
cantly not only to the company's bottom line, but also to its top line. Since most companies resources in such a way
today spend more than half of their sales turnover on purchased parts and services, effi­ that the supply of all
goods, services, capa­
cient and constructive relationships with suppliers are key to the company's short-term
bilities and knowledge
financial position and long-term competitive power. which are necessary for
Many companies cannot escape from exploiting the huge potential that purchasing and running, maintaining
supply chain management represents to them today. The following case study on British and managing the com·
Airways illustrates how companies can bring this potential to fruition. Given their need to pany's primary and
improve their overall operating margin, BA's purchasing staff needed to generate signifi­ support activities is
cant cost savings. Several high-level cross-functional teams were set up in the company to secured under the most
deal with this task. Apart from price, these teams looked into possibilities on how to reduce favourable corulitions.
supplier lead times, reduce inventory and increase quality levels. Next, they looked into
opportunities to reduce the number of suppliers dramatically to a mere 2000, leading to
more business per supplier and hence increasing the value of British Airways as a customer
to them. More collaborative relationships needed to be established. Given the huge number
of purchasing transactions, purchase orders, delivery documents and iuvoi..:es, British Air­
ways also put as a target to reduce its transaction costs in its relationship with suppl iers.

3
 4 SECTION I CORE CONCEPTS

and strive
operati on,
. Suffering from heavy international competition �d . .: . suppliers would be reduced to 2000 and key relation­ suppliers i
. a growing field of small European and US-barsed ·. ships would be built with existing suppliers. In this
i ··· competitors offering no frills service and cheap Benchmarking played an important role in inspir- takePortei
fares, in October 2001, British Airways decided to . •: ing BA's move to a more process-led organization. direct and
review its operations. The company needed to im- · BA used several vehicles to talk with other airlin� and conce
prove its operating margin dramatically to an un- and OEMs about procurement best practice8. It used reduction,
. precedented 10%. To get to that margin at its its participation in the One World alliance to share important
exi!'.itmg revenue rates, it determined that 1t would best purchasmg pracuces with other airlines. Nearly companie:
have to cut costs by $996 million. two years ago, BA established a strategic procure- this chapt1
Headcount wa& targeted for more than two-thirds · ment forum for blue chip UK-bai;ed companies that
of the cost cuts and BA unveiled plans to cut 13 000 · . · meets monthly to share these practices.
people or 20% of its staff including members of 1� 'We saw a big difference between the best-
purchasmg operations. Another area of cost reduc- practice companie8 and our practtce8, especially in THE
tion focused on how BA capturer, customers. Rather the absence of com,istent processes,' says Gavin
than paying lngh fees to travel agents and other Boswell, technology and performance manager at In many I
services to book customers on BA flights, the com.: BA. 'We wanted to get people in our organization to Therefore
pany d�igned a new pricing strategy to push traffic agree on the processes because they had too many value cha
to a self-service Web model for booking flights. . ways of doing things.' supply fu
Cutting costs· alone, however, was not enough. In order to foster standardization. purchasing of referen
·we realized that rather than jm,tgo through a cost- procei,s leaders were nominated, who would report to The vt
cutting e'lterche, we needed to fundamentally rethink the procurement director and who would be respon- achieved
the business model,' !lay!i Jonathan Counsell, head sible for ensunng BA set up best practice processes. different
of strategy and performance at BA. Standardiz.ed Currently, there are five process leaders in place �rt acfii
procurement proces'se8 were seen as one way to to identify and implement best practices in five tlon and l
transform BA's.newly trimmed procurement staff of areas: supplier relationships, strategy and perform- can be se
200 to become more strategic in sourcing the air- ance, "upplier negotiations, transactional procure- of these
hne's $6 billion annual buy, which 1s largely made ment and supply chain development They can
up of fuel, user charges, in-flight products such as The overhaul of the procurement department at whole pri
catering, engineering and airport services. The pur- BA is getting a lot of attention throughout the com- · Porte1
chasing operations at BA are centrahzed; its pro- pany from the executive level down and across. So pp. 39-
curement director reports directly to the CFO. Jar, apart from significant cost savings, 40% of UK-
BA outlined six major goals in its procurement based purchase orders are online and the supply .
overhaul. First it wanted to reduce total c�� by more base has been cut in half to 7000, well on its way to · II I

than $250 million. Second, 1t wanted to increase it& the goal of 2000 ...
online ordering to 80% of all matenasl and rservices.
Next it wanted to reduce procurement transaction Adapted fro:n 'B.".!:::�b A:..."Vl'iYS fu� tcl'kud $9% milhoo savi,-ig&
costs to $15 each. Also, the company's number of goa:•, Pr.i..Y-ha.smg, 8 August 2002 . .. Suppc
activ1t

Transaction costs
Tronsaction costs are the
costs that are associated
with an exchange between
two parties. The level of the
transaction costs depends
upon three importantfac­
tors: the frequency of the
transaction, the level ofthe
trun.wu:tion-spedfic inve.�t­
m('nts and the external wid
internal wic1mainty.
New solutions, based upon web-enabled information technology, are now available tc
companies. In order to be able to implement these new systems company wide, British
Airways needed to standardize its administrative and procurement processes.
The case study shows the new role that purchasing and supply professionals now play
in organizations. First, they have a strategic role to play in terms of analysing the purchas­
ing spend of the company, identify the key and commercial suppliers and, based upon this
data, develop differentiated supplier strategies. Next, their activities are tactical in charac­
ter: based upon the selected supplier strategy, purchasing professionals need to be able to
standardise purchasing processes, establish effective information links with their suppliers
-
CHAPTER 1 THE R.OLE OF PURCHASING IN THE VALUE CHAIN 5

and strive for continuous improvement of supplier performance. Finally, to fulfil their
operational role, these professionals need to secure efficient material supply from their Supply
suppliers in time, at the right quality and quantity and at the lowest overall cost. Supply includes at least
lation­
In this chapter, we discuss the role and importance of the purchasing function. We will purchasing, materials
take Porter's value chain as a point of departure to show that we need to differentiate between management, incoming
inspir­
direct and indirect purchasing (Porter, 1985). Some time is spent in defining important terms inspection and receiv­
latiort. ing. Supply is used
and concepts and we elaborate on the role which purchasing professionals may play in cost
drlines when relating to buying
reduction, and product and process innovation. The chapter concludes by describing some
It used based upon total cost of
important trends and developments, which may be perceived in the purchasing strategies-of ownership in. a manu-
> share
companies who are leading edge in purchasing and supply chain management. In this way, fattu.rinx envimnmf'/U.
Nearly
this chapter sets the stage for the remaining chapters in Section One.
rocure�­
ies that

e _ best­ THE ROLE OF PURCHASING IN THE VALUE CHAIN

ially in
Gavin
Iu many business strategics the concept of value chain management plays a central role. Value chain
1ager at
Thcrcfore this subject is elaborated on in this section. There wi.11 be an explanation of what manageme11t
ation to valui: chain management is. When describing the role and position of the purchasing and All stakeholders
,o many supply function in industrial companies, the value chain of Porter (1985) is taken as a term belonging Ill the same
of reference (sec Figure 1.1). value chain an, dwl­
:cha1sing
The value chain in Figure .1.1 is composed of value activities and a margin. which is lerrged to improve the
report to (huying) company's
achkwcd by these activities. Value activities can be divided into physically and technically
respon­ value proposition ro its
different groups of activities. Porter differentiates between primary activities and sup• final end customers i.e.
ocel'sses. port activities. Primary activities are those which are directed at the physical transforma­ consumers.
in place
tion and handling of the final products, which the company delivers to its customers. As
in five can be seen from Figure l. l distribution to the customer and providing services are parts J>rlmJJJ')' nctMlli!,
perform­
of these primary activities. Support activities enable and support the primary activities. Primary activities are
procure- They can be directed at supporting one of the primary activities as well as supporting the those activities that
are required to offer
whole primary process:
�ent at Porter differentiates between five generic categories of primary activities (1985,
the company's value
the COID"· proposition to its cus­
pp. 39-40): tomers. They consist of
cro1ss. So
¼i ofUK- inbound logistics,
operations, outbound
1e supply_·
its way to FIGURE 1.1 Purchasing and the value chain logistics, marketing
and sales and customer
service activities.
Firm 1nfr,;1structure
Human resource management Support activities
Support Those value activities
activities 'Technology development that are lt'</Uir<',l to
support the ,·om1mny ·.,.
1
I
Procurement primary activitil'.v..
711t'.l'e indu,k t•mnire­
mcnt, l<"ch1wfogy
• available to Inbound Outbound Marketing dewlopm,·111, human
wide, British log1st,s log1st1cs and sales r,,,,·oun-e.1· 111,magn1w11t
a11,J jiJl'ilititw manage­
nals now play ment (i.<'. tlwse a<'livi­
� the purchas- lies aimed at maintain­
1sed upon this Pnrn.iry .-inivitie\
ing th<' .firm·.,· i11fra.­
ical in charac­ str11r1ttre ).
i to be able to ' '110 •· 1 Jt.11"1!. 1-no,:; Porte
their suppliers r (1985)
 -
6 SECTION I CORE CONCEPTS

Services ■ Inbound logistics. These activities are related to receiving, storing and disseminating
Based on
Relate to a series of inputs to the production process, such as inbound transportation, incoming inspection,
more or less tangible
to the follow
materials handling, warehousing, inventory control, and reverse logistics.
activities, that normally ■ Primary ,:
take place in the inter­
■ Operations. Activities associated with transforming inputs into the final product, such
as machining, assembly, packaging, equipment maintenance, testing, printing and facil­ requireme
action between cus­ related to
tomer and supplier ity operations.
companie:
empl oyees, and/or • Outbound logistics. These are activities associated with collecting, storing, and physi­
physical resmm:es and following
cally distributing the final product to customers, such as finished goods warehousing,
sy.1·1nm. thill are materials handling, outbound transportation, order processing and scheduling. .:> Make (
offered as an infegrawd stocked
.,·olutinn to cu.,·wmer ■ Marketing and sales. These activities relate to advertising, promotion. sales. distribution Jedicat1
prohlem.v. channel selection. the management of channel relations and pricing. thcrcfrn
Procureme11t ■ Services. Activities associated with providing services to customers to enhance or arc stec
l'rocurement indwle.v maintain the value of the product, such as installation, repair and maintenance, training, 1 Make t,
all activities required parts supply and product adjustment. compor,
in order lo K"' 1he commo,
pm,iw:rfrom the sup­ Support activities are grouped into four categories: material
plier Jo its final ,k.vti­
JinginC<
nation. fl encompas.1·es ■ Procurement. Procurement relates to the function of purchasing inputs used .in tbe even p,.
the pu,rhasing fimc­ firm ·s value chain. These may include raw materials, supplies, and other consumabl.e
tion. stores, traffic arul Produd
items as well as assets such as machinery, laboratory equipment. office equipment and for exa.
transportation, i11rom­
buildings. These examples illustrate that purchased inputs may be related to primary
ing inspection, and These•
quality control and activities as well as support activities. This is one reason why Porter classifies procure­
ment as a support activity and not as a primary activity. radically
assurance, allowing manufacti
companies to make ■ Technology development. 'Technology' has a very broad meaning in this context, since planning:
supplier selection in Porter's view every activity embodies technology, be it know-how, procedures or where eve
decisions based on. technology embodied in process or product design. Most value activities use a technol­ a vast, fre
total cost of ownership ogy that combines a number of different sub-technologies involving different scientific
(TCO), rather than
through04
disciplines. directm
price. Procurement is
used when relating to ■ Human resources manag:llment. These are all the activities directed at recruiting, hiring.
■ iUpp1·1L �
buying based upon training, developing and compensation of all types of personnel on the company's pay­ se rvices
total cost of ownership roll, active in both primary and support activities.
in a project environment. lul urn
■ Firm infrastructure. The whole company is the customer of these activities. Infrastructure
Raw materials does not support one or more primary activities - rather, it supports the entire set of , comp
Materials which have company processes. Examples include management, planning, finance, accounting, lease-,
undt•r,:one no tran:ifor­ legal, government affairs. quality management and facilities management. In larger office
marion or a minimal f
companies. which olicn consist of diferent operating units, one sees these activities
tran.�/<Jm1utio11. and food a
divided among headquarters and the operating companies. This division of these tasks
they serve as the basis cleam
materials for a pro-
between the headquarters anti the business units is olicn the subject of discussion,
which is why it changes so frequently. macl1
tl111'fio11 pron•ss.
Airni
Ji'acililie.� manageme,11 All activities need to be performed in such a way that the total value generated by the
the '"11
Relates to the manage­ company, as perceived by its customers, is more than the sum of its costs. In Porter's terms, an:r.iu
ment (plt11mi11g, C.X<'l'lt- the total value of the company is determined by the whole of its sales value. The value
tion and nmrm/J, and
ht rcpc
chain, then, relates in fact to all activities, both inside and outside the company, that create lmlquc
the realization of hous­ value to thl' company's final customers. The margin reflects the rewards for the risks
ing and accommoda­ hllu
im:urred hy the company. Porter regards procurement as a support activity. He uses the I
tion, the services
related to these, and
term procurement rnther than purchasing since, as he argues, the usual connotation of
or/rc:r 111t:t1fl.\' i11 order purchasing is too narrow among managers (1985, p. 41). 'The dispersion of the procure­ Wpp
to enable the organiza­ ment function oflcn obscures the magnitude of total purchases and means that many pur­ I ll
tion to realize its chases receive little scrutiny.' Although thi'l statement was made many years ago, it s!·jjl �
mission true for many organizations today.

..._
 CHAPTER 1 THE ROLE OF PURCHASING IN THE VALUE CHAIN 7

unating Based on these observations the conclusion is that procurement should provide support
Jection, to the following business activities:
■ Primary activities. The procurement function should be able to meet the material
ct, such requirements related to inbound and outbound logistics, and, often more importantly,
1d facil- related to operations. Operations may have a different structure among manufacturing
companies. Usually manufacturing processes can be characterized according to the
d pbysi­ following categories.
housing, o Make (and distribute) to stock (MTS). Standard products are manufactured and
stocked, customers arc serviced from an end product inventory. Production is on Make t11 order (MTO)
tribution dedicated machinery, often in large hatches. Materials requirements planning (and Only raw materials
therefore also planning of pun:hascd products) is based on sales forecasts. Examples and components are
arc sLecl plate, and most maintenance, repair and operating supplies. kept in stock. Every
hancc or cusromer order is
trainin g, o Make to order (MTO). Products arc manufactured from raw material or the purchased
a sp,,,:i{ic pro;ca.
components inventory after a customer order has been received and accepted. This is f:xumples are the man­
common in situations with very large or customer-specific product ranges (e.g. packaging ufacture ,f cam a11d
materials) or buJk. pmdm.:ts that are very expensive to stock (e.g. insulation materials). basic cmutructi,m
o Engineer to order (ETO). All manufacturing activities from design to assembly and material.�.
.ed in the l'VCll purchasing of the required materials arc related to a spccilic customer order. L>irect material�
msumable Production is usually on multipurpose machinery, requiring highly skilled operators, All purchased 11wteri­
)ment and for example large customer-specific equipmcnL and machines and vessels. als and services that
o primary become part <if the
These contn1sting manufacturing situations explain why procurement activities may be compa11y 's value prop•
,s procure- radically different between companies and industries. Procurement operations for a osition. Th.ese include
manufacturer producing cars in large batches, controlled by a materials requirements raw materials, semi
1text, since planni ng system, may differ largely from those in a job-shop environment, like a shipyard, manufactured goods
cedures or where every vessel may be new to the organization and where materials are obtained from or halffabricates,
: a technol- a vast, frequently changing supplier base. Buying for primary activities will be referred to components and mod­
1t scientific throughout this book as 'production buying', 'buying of production items' or 'purchasing ules (identical to
direct materials'. Usually this area gets most of the attention from management. ROM-materials or
production material,r).
;ing, hiring, • Support activities. Procurement activities may also be related to supplying products and
pany's pay- services for the other support functions. Some e,tamples are the buying of: Investment goods or
o laboratory equipment for research and development capital equipment
,frastructurc ) computer hardware and software for the central computer department
Products which are not
�ntire set of consumed immediately,
accounting. o lease-cars for the sales force and senior management but whose purchasin[!.
nt. In larger '> office equipment for accounting value is depreciated
during its economic
:se activities '> food and beverages for I.he catering department life cycle.
f these tasks cleaning materials for housekeeping
f discussio11.
machinery and infrastructure, etc. Indirect materials
/Ill pun:hasnl maleri­
Again we see that the procurement func:tion aimed at providing supplies and services for als and services 1h01 do
crated by the the support activities may be very different in character. Some of the purchases to be made not become part of the
orter's terms,
are routine purchases (maintenance, repair and operating supplies; MRO-supplies) and may company's value prop­
1e. The value be repetitive and low in value. Other purchases may have a 'project character' and m<1y be osition. May be classi­
1y , that create unique and high valued (investment goods, computer systems. capital equipment, Ji,,,J il!to MRO-supplies.
for the risks buildings). inve.\lmntl �oods (ai.w,
·. He uses the In ge neral this type of purchase will be referred to as 'non production buying', 'pur­ rrj'erl'l'd to as m{Jital
unnolatioo of chasing indirect materials' or 'general expenses'. They may be classified into: MRO­ expenditure, or CAPEX)
f the procure­ �upplies, inves tment goods1 and services. The high variety of this type of purcha-.cs makes and services (identical
hat many pur­ it extremely difficult to support these by one uniform comp111cr information system or to non-BOM-materials
' ago, it still is or non-production
· Also referrect 10 as CAPEX (Capital Expenditure.). materials).
8 SECTION I CORE CONCEPTS

TABLE 1.1 Main differences between buying for primary activities and buying for support activities

Aspects Buying for primary activities Buying for support activities

FIGUJ

Product assortment L1m1ted to large Very large

Number of suppliers Limited, transparent Very large
Purchasing turnover Very large, considerable Limited
Number of purchase Considerable Very large
• lnt�rJ
ord<>rs
Avercige orde1 size High Small custo1
Control Depends on type of production planning L1m1ted. forernst--related or
pro1ect-relatt>d planning
Dec1s1on•making unit Engineering, manufoctunnCJ spec1ahsts Fr;;,qmented, varies with product or
dominant Sf'rVIC.e

buying procedure. The character of this type of purchases also explains why professional­
ism in purchasing is usually low. This is one reason why some international companies, No
which have s1;:t up special progr.imrnes in this area (such as IBM, Shell, Lucent, and Philips
Electronics), have reported high savings. Table 1.1 summarizes the most important differ­
ences between huying for primary and for support activities.

pla::iog
r1;mdli1
DEFINITION OF CONCEPTS • monitor
• foHow-t
Purchasing function The purchasing function t.ntditionally encompasses the process of buying. It involves supplie1
Covers activities aimed determining the purchasing needs, selecting the supp.lier, arriving at a proper price, speci­
al determining the pur­ fying terms and conditions, issuing the contract or order, and following up to ensure proper Figure
charing specifications
delivery and payment. Jn the old days it was argued that the purchasing function should It shows tJ
based upon 'fitness for chasing pn
use·, selecting the best
obtain the proper equipment, material, supplies and services of the right quality, in the
right quantity, at the right place and time, at the right price and from the right source The pw
possible supplier and p lanning,
developing procedures (Aljian, 1984, p. 3). ln this description, the purchasing function is regarded predominantly
as an operational activity. control. H
and routines to be able and interr
to do so, preparing and In practice, as well as in the literature, many terms and concepts nowadays are used in the
should su
conducting negotiati­ area of purchasing. However, no agreement exists; about the definition of these terms. Tem1s
on.1· will, tit,• .w,pplier in
sarily imp
like procurement, purchasing. sourcing. and supply management are used interchangeably.
urd"r lo 1•.1·1ahlish rm illus trated
agreement and to write Throughout this hook the dc!linition of purchm·ing is: A buye
up the legal contract, fronted w,
placing the order with 'Th<' mwwgnnenl of" !he company ·.1· <'Xlerna/ rrsourrC's in such II way 1ha1 the supply departm, 1
the selected supplier or of all goods. servin•.,-. ca['ahilities and krwwlcdg,• which arc 11N·e.1·st1rvfor running. is of ten,
to develop efficient pur- mailllaining um/ 111w111ging the compuny ·.1· prinwry and sup11ort 11ctivitic·s is .1·<·n1red at altemati-,1:
chase order and hand­ th<' most ./tll-'mlfable ,·mulitiom·. · forexarn1
ling routines, monito­ ,Ill ,:
ring and control of the The purclu1.1·i11g function in this definition covers spceitically activities aimed al: r
order in order to secure I
supply (expediting), ■ Jctcrmining lhe purchasing specifications (in terms of required quality and quantities) he
folkJwupand of the goods and services that need to he hought
evaluation (settling
• t-:clcl'.ting the hcst possihlc supplier and developing procedures and routines to be able
daim.�. keeping product
lo Jo this
and supplier files up-to­
date, supplier rating • preparing and conducting negotiations with the supplier in order to establish an agree·
and supplier ranlang). ment and to write up the legal contract
 CHAPTER 1 THE ROLE OF PURCHASING HH \Aflll 111'.dN 9

FIGURE 1.2 Purchasing process model and some related concepts

Purchasing function

Tactical purchasing Order function

Internal Selecting El<ped1tmg

supplier Ordering and Supplier
custcmer evaluation

ct or
♦
Sourcing
·-----·····----.-t+--
Supply
--�-�- ···---------• ..
* - * *..
- --
Buying
...,_---·----·---·------·----···•----
Procurement
ofessional­ Note: '=USA; .. =UK.
:.:omparnes,
and Philips
ttant differ-

placing the order with the scleded supplier or to develop effo.:ienL purchase order and
handling routines
■ monitoring and control of the order to secure supply (expediting) Expediting
■ follow-up and evaluation (settling claims, keeping product and supplier files up-to-date, Following up on a pur­
chase order to make
It involves supplier rating and supplier ranking).
sure that the supplier
price, speci­ Figure 1.2 schematically illustrates the main activities within the purchasing function. is going to perform as
nsure proper It shows that these activities are closely interrelated. This picture is referred to as the pur­ it has confirmed
ction should through his purchase
chasing process model.
Jality, in the The purchasing function does not include the responsibility for materials requirements order confirmation.
right source planning, materials scheduling, inventory management, incoming inspection and quality There are three types
·edominantly of expediting, i.e. rou­
control. However, in order to be effective, purchasing operations should be closely linked
tine status check.
and interrelated to these materials activities. In the author's opinion a purchasing manager advanced status check
re used in the should support each of the six activities mentioned above. However, this does not neces­
terms. Terms andfield expediting.
sarily imply that all these activities should he conducted by the purchasing department, as
rchangeahly. illustrated in the following example. Quality
A buyer who is responsible for maintenance, repair and operating supplies, is often con­ Quality refers to the
total offeatures and
fronted with the 'small-order problem'. Many requisitions which he receives from internal churu,·1ai.�tic·.1· 1!/' a
r the sup11fy departm ents concem simple products of low expense. Handling these requisitions. however.
product or service that
,r running. is often a laborious task if that buyer is to issue a purchase order for every requisition. An
bear on its ability to
: is secured at alternative may be to arrange for a so-called 'catalogue' agreement with a specific supplier. ,l'/lli-'f.V tl gif'C'I/ ne,•,/
for e xample, for the delivery of hand tools. In this arrangement he may establish the product (/11111,ric·,m Natio11af
range, which will be bought from that supplier including the list prices per product. He may Stwui,mb· l11S1i11tt1• ).
agree with the supplier that the latter will provide a web-enabled catalogue to his rnmpany, Q11a/il_Y is 111,·,·ring ml
irncd al:
1":lmb!:uJg ,,trtp1r.·;1io�-:: rnd t,.chrueal staff to order directly from the supplie . Furthermore, ( ifllemul or cxf1•r1wl)
r
ind 4uantitics) lie !hiW !lrt4�•In� s. b::.nuf; from that supplier tied to the total purchasing turnover for cuswnu•r ·.,· rC'quire­
l .! �ll\:lllft!� \'t:,\ :n� r.rmy communicate terms and condit ons of this contract to the staff l if mc111.1· Iha/ ha1•1• b,·n1
i
ines to he abk , :· . t ""1 · ••I,-/•;:.3. J.m:>11.zn t!l.e on-hne catalogue employees of this company can order wecn a cuMom,-r am/ a
r;':4:1,v·I\··-'- -- - · · ·
�'k:i,v ho:m d:,c. nppl:itr, \Y�thout involving the purchasing <lcpart1m.:nt. In this example it
fomwll_v agffed hl'f­

supp/ia.
blish an agre�· '.' tbe ta�k of the buyer to develop an overall commercial agreement with the supplier and
0 estabhsh
an electronic catalogue and an (electronic) order routine with that supplier on
10 SECTION I CORE CONCEPTS

the one hand and the internal customer on the other hand. In fact, what happens is that the favours for ,
ordering function is delegated, in a rather controlled way, to the internal customer. In this or partners)
manner it is possible to combine the purchasing power of the organization with optimal about find.in
flexibility and efficiency for the internal user, i.e. Technical Services. Purchasi
From the definition of purchasing it may be derived that its scope covers all activities for in such aw,
which the company receives an invoice from outside parties. Hence the playing ground of and interests
purchasing includes inter-company business, counter-trade arrangements, hiring of temporary within the o,
personnel from outside agencies and contracting for advertising. However, many of the activi­ ment, hence.
t ics for which the company may receive invoices from suppliers may be arranged without agement is t}
interference from the pun-hasi11g depart11wnt (this will he discussed later). Therefore the scope managed hy
or the purd,a,·ing function is usually much hroader th:m that of the purchasing department. h)lllCI" relatic
The term ordering refers to lhe placing of purchase orders with a supplier against previ­ position. Gi,
ously arranged conditions. Furthermore, this term will be used when purchase orders arc ground it is
placed directly with the supplier, without questioning the supplier's conditions and without Purchasi1
sufficient supplier market testing. Call-off orders fall into this category as well as telephone be describ9
orders for products hought from a supplier catalogue. Ordering is considered t.o he a part resources ai
of the purchasing prm:css. ln fact it rclat.es to the last three sleps of the purchasing process. raw materia
The use of the term 'tactical purchasing' refers to the first three steps. expectatiom
ft is diflicult to find a description of buying in management literature. It diffors from managemen
purchasing in the sense that it docs not encompass the first st.ep of the purchasing process. Moreover ii
This is in line with the practice of trading and retail companies (e.g. department stores), also with l<
Total c1J.�t 1Jf owner• where this tenn is most often applied. Here, discussions about the specifications of prod­ systems tot
sliip (TCO) ucts to be purchased are more limited than for industrial companies, since in many cases the contrac t
Relates to the total agement, fir
the supplier decides these. Buying therefore relates to the commercial activity of soliciting
costs that the company
competitive bids from a limited number of suppliers, and negotiating a final contract with to improve f
will incur over the life­
the lowest bidder. Several negotiation rounds may be required before closing a final deal. work closel
time of the product
that is purchased. Purchasing differs from buying and ordering in one important aspect: while specifications the product
may be a given in the situation of ordering and buying, these are challenged when it comes for the end
Sourcing X-Box, wh
to purchasing. In that case a discussion may start about the degree to which the specifications
Finding, selecting, Fl extronics.
are really fit for purpose. Features, which are not necessary for meeting the function which
contracting and mana­ X-Box's ca
ging the best possible the product needs lO fulfil, are skipped. This often leads to a situation where an (expensive)
source of supply on a supplier branded product is replaced by an identical product from a less known supplier.
worldwide basis. As seen from Figure 1.2 procurement is a somewhat broader term. It includes all activi­
ties required in order to get the product from the supplier to its final destination. [t encom­
Category
passes the purchasing function, stores, traffic and transportation, incoming inspection. and
A group of products
quality control and assurance. Many firms also consider environmental issues (as they are
whii:h ,·a11 he substi1u-
1ed for on,• anotha hy related to materials) as a part of procurement (see also Memo 1.1). This task has become
a cm1,,·11m<'r: ,�n1mpl,,.1· more important in recent years, with the increasing impact of environmental issues. Pro­
indude ,·ern1/s, curement is based on the total cost of ownership. When buying a copier it may be more
bakery, household pro­ import.ant lo look at the price per copy (based upon all costs associated), rather than the
ducts, body care and purchase price of t.he copier itself.
.l"O Of/. Another term oflcn used in the materials area is supply. This is somewhat more difficult
Sourcing strategy
lo gmsp, hccausc it appears that there are differences in connotation between North America
Identifies for a certain and Europe. Jn America 'supply' covers the stores function of internally consumed items
category from how such as office supplies and cleaning materials. However, in the United Kingdom and
many suppliers to buy, Europe, the term supply seems to have a broader meaning, which includes at least purchas·
what type of relation­ ing, stores and receiving. The governmental sector also uses this broader interpretation.
ship to pursue, con­ Supply is used when relating to buying based upon total cost of ownership in a manufactur­
tract duration, type of ing environment. Procurement is related to buying based upon TCO in a project driven
contract to negotwte manufacturing environment (like the construction industry, or the ship building industry).
for; and whether to A term which has become increasingly popular in the materials area is sourcing. This
source locally, region­
activity relates to developing the most appropriate supplier strategy for a certain commod­
ally or globally.
ity or product category. A sourcing strategy describes how many suppliers the company
 CHAPTER 1 THE ROLE OF PURCHASING IN THE VALUE CHAIN

favours for that commodity or category, what type of relationship to pursue (arm's length
Lt happens is that the
or partnership) and what type of contract to negotiate for (one year to multi-year). It is all Partner
nal customer. In this
about finding the best possible supplier for the company on a worldwide basis. A (supplier) partner 1
ization with optimal
Purchasing management refers to all activities necessary to manage supplier relationships defined as a jinn wit/
in such a way that their activities are aligned with the company's overall business strategies whom your company
)Vers all activities for has an ongoing buyei
and interests. It is focused on structuring and continuously improving purchasing processes
ne playing ground of seller relationship,
within the organization and between the organization and its suppliers. Purchasing manage­
s, hiring of temporary involving a commit­
ment, hence, has an internal aspect and an external aspect. The idea behind purchasing man­
er, many of the activi- ment over an extend(:.
agement is that if suppliers are not managed by their customers, customer relationships will be
be arranged without period. a mutual sha:
managed by the suppliers. Given the widespread acceptance of marketing management. cus­ inx of informmion a,,
o). Therefore the scope
tomer relationship and accounl management in business, suppliers usually are in a favournblc a sharing of risb an,
:basing department.
position. Given the cross-functional nature of purchasing management and its wider playing rewmrls resul1ing fru,
upphcr against prcvi­
ground it is also referred to in this text as supplier re.mun·e numa1<ement. the relationship.
n purchase orders arc
Purchasing management is related to supply chain managemenl. The latter concept can
onditions and without Purcha�·ing
be described as the management of all activities, information. knowledge and financial
y as well as telcphonc management
resources associated with the flow and transformation of goods and services up from the
,msidcred to be a part Rdllft-s to all activitie.
raw materials suppliers. componcm suppliers and other suppliers in such a way that the m,ce,1·,1-ary to manage
,e purchasing process.
expectations of the end users of the company are being met or surpassed. Supply chain supplier relmionships
)S.
management differs from purchasing in that it also encompasses all logistics activities. such a way that their
,rature. lt differs from
Moreover it entails the management of relationships not only with first tier suppliers hut activities are aligned
1c purchasing process.
also with lower tier suppliers. An example is Ford who urges its suppliers of exhaust­ with the company's
g. department stores), overall business stratt­
systems to use one steel contract. Both Ford and suppliers are huying st.eel; by combining
,pecifications of prod­ gies and interests.
the coutrm:t value all panics involved can benefit from better conditions. Value chain man­
s, since in many cases
agement, finally, builds on the former concept. Here the idea is that suppliers are challenged Request for
al activity of soliciting
to improve the (buying) company's value proposition to its customers. Usually the suppliers informatio11 (RF/)
1g a final contract with
work closc1y together with the (buying) company's technical and marketing staff to reduce Suppliers are invited
re closing a final deal. w submit general
the product's overall costs, add new designs or features to the product which are attractive
!ct: while specifications information that may
for the end customer and that make the product sell better. An example here is Microsoft's
tllenged when it comes help them to qualify
X-Box, which was originally developed by Microsoft, but which actually is produced by
.vhich the specifications for a potential tende1
Flextronics. Flextronics is crucial for the success of the X-Box in that it is determining the
ting the function which
X-Box's cost price and hence, the consumer price of the product (Carbone, 2002).
m where an (expensive)
less known supplier.
m. lt includes all activi­
tl destination. It encom­
tcoming inspection, and i\HMO I I surr, l[R R[LAl ION�HIPS Af VOLVO
ental issues (as they are
). This task has become VOLVO CORE VALUES Environmental Care expresses our commitment
rironmental issues. Pro­ to improve energy and resource efficiency and to
a copier it may be more Before applymg to be a Volvo Supplier you should reduce emissions in all �pects of our business,
c1ci<1tcd), rather than the understand and agree on Volvo's core values with a special focus on the use of our products in
expres.,ed as follow£: f<oc1ety,
somewhat more difficult
1 hetween North America Quality ts �"ur mindset. We provide products and
tcrnally consumed items �ervice,, foat can be tru,,ted. In all aspects of our VOLVO SOURCING PROCESS
1c United Kingdom and busines�. from product de'1elopment and manufac­
indudcs at least purchas­ ruring to dehvery and customer �upport, the focus is Enter the competttion to become a Volvo supplier.
is broader interpretation. t•n the customers' needs and expectat10ns.
mership in a rnanufactur­ �fety_relates ·to the use of our producu, in society. Request for information (RFI). The Supplier i&
TCO in a project driv en � t: strive to minimize the risks and comiequences of in"Vited to answer to a Requei;t For Infonnatlon col­
_
ship building industry). .,,.\:idenu. and tu improve �afety and work conditions lecting general data about his company and iu.
tls area is sourcing. This � r the drivers and vehtcle operators, products or services.
gy for a certain comm od-
1y suppliers the company
12 SECTION I CORE CONCEPTS

Evaluation. Volvo evaluates the RFI am,wers in Relationship FIGl

order to set up a hst of potential ·candidate<;
· to ■ Long-term relationship
receive request for quotation. ·
• Pro-active in reducing cost and improving per-
Request for quotation (RFQ). Supplier� are formance (propm,ing new features).
invited to quote on Volvo parts based on a package
of spec1fa:a11ons and drawings. Quality
■ Highest quality standards
Selection. After evaluating the RFQ answers aud e
the suppher·s profile (according to Volvo evaluation ■ Good management of your· lowr tit>r r,upplters

citena), Sourcmg Committeer, decide on the (low cost countrier,).

Suppher(s) to be awarded.
Supplier evaluation, Volvo Group U8e8 the Supplier
E\'aluation Model (SEM) to e\laluate its potential
OUR REQ1JIREMENTS and current suppliers. The SEM 1s implemented dur­
Strategy mg our selection proces8.

• Global partners, but supplying locally, including
local content markets
■ ConsidenngVolvo as a preferred customer when
giving access to innovation
■ Transparency in terror, of cost and strategy.
Development
■ Complete system suppliers where it adds value
• Technical skills/innovation skills
• Ref>ident enginee!$ when required.
Environment. Environmental care is a corporate L_
value for the Volvo Group. Already in the mission Source: ad
statement, we state that 'we use our e�pertl8e to cre­
ate transport-related hard and soft products of <;upe­
rior quality, safety and environmental care'. Suppli­
ers should actively contnbute to reduce the environ­
mental impact of present and future product!!. They
8hould be committed to reduce the environmental
impact of our manufacturing operations.
(Sowce· www volvo com)

Request for quotati.on

(RFQ)
IMPORTANCE OF PURCHASING TO BUSINESS
Suppliers are invited to
submit a detailed bid An analysis of the cost structure of manufacturing companies immediately shows the
which meets the importance of purchasing to organizations. In general the largest part of the cost of goods
requirements as laid sold (COGS) or sales revenues appears to be taken up by purchased materials and serv­
down in the requestfor ices. Figure 1.3 shows that the average purchasing value in relation to cost ofgoods sold
quotati.on against the
is approximately 50%. If the other business costs, which have an important purchasing
lowest possible price
(identical to request for component, are added to the purchasing value, the total amounts to approximately 68%.
1e11da). Titrough the DuPont chart (Figure 1.4), the effects of purchasing savings on the com­
DuPont analysis pany's return on investment can be illustrated. Figure 1.4 shows how a 2% saving on
Financial diag nostic purchasing related expenditure for a company (in this case Heineken) may lead to an
tool to calculate the improvement of the return on net assets (RONA) of 9%. Of course, the reverse is valid
company's return on also: due to a lack of a well defined purchasing policy and a lack of structure in the pur­
investment based upon chasing (decision making) process, the resulting lack of control on purchasing costs may
sales margin and capi­ lead to an unforeseen financial loss.
tal turnover ratio. The DuPont analysis shows that purchasing rnntrihuk'-S to improving the company's
Used to ,usess the RONA in three ways:
e_Ui•cl of a 2% pur-
chasing saving un the • Through reduction of all direct materials co�ts. This will immediately lead to ari
company's return on improvement of the company's sales margin, which in turn will affect RONA in u
investment (ROI). positive manner. A number of measures may lead to lower direct materials costs su,•ll
 CHAPTER 1 THE ROLE OF PURCHASIN< TIH- /Ill IC HAI:--.: 13

FIGURE 1.3 Purchased goods and services as a percentage of cost of goods sold

V •2..
V
Admin
ving per- Services
lb Capex
Spares
2 Trade-items
60-85 60-80 50-70 60-8(;
l/
�upplier!i I\ •-n-.•�••-

,.\
2::-::0 ·ic�-J ::v Proc:luction
: Supplier parts
potential
!nted dur- -·-·--- ----··- � �--_!
Retailers Cornp11ters Consumer Automotive Ph;mna SNvice fyr,ic.cil
ele<troniC\ 1ndu.\try \tructurE'
corporate
.e rois!>ion Source: adapted from Kluge { 19%)
iseto cre­
�5 of supe­
!'. Suppli­ f ll,lJ RE I I Impact of procurement savings on Heineken's overall ROCE (2007)
e envrron­
uct1,. They Total
romnental - revenue
12594
�
Capttal turnover
ratio
1 36
..__ .I. - Total
assets
12968
- capitalTotal
employed ..__

-
9268
Interest free
hab1kttes
NESS 3700
· RONA -x
i62% -·
:ly shows the
Total
cost of goods (18.0%) � revenue
ials and serv­
Operating --· 12594
of goods sold - lllCOffio:! �- -/- Personnel

-
n! purchasing 1503 2165
imately 68%. �
Sales
Total COi� I
margin (1666)
11 os:
'/'
s on the com-
2% saving on
11 93%
J
,ay lead to an (13.23%) - Total
revenue ( 10928)
Depree;���]
764
!verse is valid 12594
ure in the pur­
;ing costs may Raw matena!s,
consumables
andseMCes
the company's 8162 (74%)
(7999) (2%)
:ly lead to an
:;t RONA in a
ials costs such
14 SECTION I CORE CONCEPTS

as reduction of the number of suppliers, improved product standardization, applying

competitive tendering and looking for substitute materials. provide I
■ Through a reduction of the net working capital employed by the compun) This will ates cant
work out positively on the company's capital turnover ratio. There are many mc:asurcs they haw
which will lead to a lower capital employment. Examples are longer payment terms, they haw
Payment terms
Payment terms relate to reduction of (pipeline) inventories of base materials through just-in-time (JI'f) agree­ and 8ervi
what, how and when ments with suppliers, supplier quality improvement (which will lead to kss buffer stock needs to.
the bttyl'r will 11e1y for required) and leasing instead of buying equipment. ing the s
th,· pmcluc:ts and s£'rv­ concerns
iccs ddiven•d hy the ■ Through improving the company's revenue generating potential. Challenging suppliers wide,�
.w1pplin: for new product ideas and process improvements may lem.l to new customer value wlucb Cl'
propositions that in turn lead to higher margin new produds. Sin1.:e innovations in many ingexpe
industries today come from suppliers, procurement managers arc challenged lo mobi­ ·.Fort}
li:r.e their suppliers' expertise and to involve supplier technical experts early in the new h&beco
product development process. al cons�
lt can be concluded that purchasing policies fundamentally contribute to business SAP,O
success ill several ways. First, purchasing pol.icics can significantly improve sales mar­ providej
gins through rcaliz.ing substantial cost savings. A dollar saved in purchasing is a dollar to char,
added to the bottom line. Se1.:ond, through better quality and logistics arrangements detail. l
with suppliers, purchasing can contribute to a reduction of working capital ancl, hence, ispre1">e1
the company's cash position. Third, suppliers may contrihuk significantly, when ad­ cube' �
dressed properly, tu the company's innovation processes. However, as companies be­ cube aJ
come more dependent on their suppliers the strategic value of purchasing lies in ing eX{l
developing a world-class supplier base which is more competitive than that of the com­
pany's main competitors. Looking for the most competitive supplien, worldwide and
developing effective relationships with them should therefore be one of the most im­
portant concerns of any purc hasing manager. As has been demonstrated, even small C
improvements in the relationship with suppliers may have a significant impact on the
company's return on net assets. The purcli
The conclusion we can dmw from this discus.<;ion is that a-; the purchasing to sales ratio general, p
increases for a specific company, purchasing decisions wi11 have a more profound impact on
the company's returns. The same goes for the capital turnover ratio. A higher ratio will lead • R IWll
to a greater leverage of savings on direct materials costs. It is therefore important that compa­ a mini
nies keep track of their purchasing expenditure. Next, they need to manage their relationships ess. t
coal,:.
with suppliers in a professional way. In order to do that, detailed management infonnation is
required. Obtaining detailed purchasing spend information is in most large companies, how­ •
'I

ever, quite a challenge. Memo 1.2 provides some guidelines on how to proceed. end pl
this t

M[MO 1 2 SPfND MANAG[l'vHNT- l Hr rOUNOATION FOR EVE:.RY
PURCHASIN(j STRAI FGY
According to a &urvey, wh1ch was conducted by Pur­
chasmg Magazine m the United States m 2004, 71 %
of large American compame.s today have developed
fonnal sourcing program�. Of the respondents, 24%
reported to have su<;h sourcing programs underway.
The most unportant objecti'1es of sourcing program8
are cost-reductlon, 8tandard1zation, and preventing
reinvention of the wheel in supplier contract
. electr-
'
more.
Iii,·�•
•
negotJ.ations, generating supply market knowledge
and reducing supplier logistics lead tlme�.
Surprisingly enough, the most chfficult part of
developmg oourcmg strategies appeffi to be the col­
lection of detailed 8pend management information: in
many case<; the1se large companies do not have a clue
of what they purcha8e internationally. Financial and
accounting department<; simply are not equipped to
..
 CHAPTER 1 THE ROLE OF PURCHASING lN THE VALUE CHAIN 15

applying
provide tlus type of information. Large conglomer­ angles, i.e. purcha.,;;ing segmenh or categoriers, sup­
ates cannot,. without sigmficant efforts, a'!sess what pliers and mternal budget holder8 or departments. In
This will they have purcha<;ed at a certain <;uppher, what money thts way the purcba.$1ng spend cube i� an indispen�a­
measures they have spent on the acqui8ition of certain materials ble tool for developing specific purcha�ing and !iUp-
nt terms, and 1-en.-ices. In many cases this type of information pher 8trateg1e8.
IT) agree- needs to be obtained through contact-
1ffer stock mg the supphers ... A large problem
FIGURE 1. 5 The purchasing spend cube
· concerns the ab1sence of a corporate­
� suppliers wide, uniform article coding !system,
mer value which can be uised to classify purchas­
□sin many ing expenditure.
d to mobi­ Fot this reru.on spend management
.in the new has become a prime i'><;ue, Internation­ -0
C

al consultant� and IT providers (like

<1) �
0. .,
V1 =-=
o business SAP, Oracle, Peoplesoft and 12), today en<>.
--"'"'::,<>.
C

"'~
/
sales mar- provide specific wftw.u:e applications .c a,
� <>.
to chart purchasing expenditure m ::,
. is a dollar //Purchasing spend
·angemcnts
and, hence,
detatl. Usually, the purchasing spend
is presented through a so-called 'spend
cube' (see Figure 1.5). Tlus spend
�=======:.:=::::=====::::=-::;:/
Purchasing spend per
. // per interndl budget holder
i.e. departmen1

·, when ad­ purd,asing spend category

cube allows u1s to allocate purchas-
:1panies he­
:ing lies in ing expenditure from three different
of the com-
1dwide and
1e most im-
even small C LASSIFICATION OF PURCHASING GOODS
1pact on the
The purchasing process may concern a large variety of goods and, of course, services. [n
to sales ratio general, purchased materials and services can be grouped into the following categories:
n<l impact on
Raw materials. Raw materials are materials which have undergone no transformation or
atio will lead
a minimal transformation, and they serve as the basis materials for a production proc­
t that compa­
. relationships ess. We may differentiate between physical raw materials, such as iron ore, copper ore,
coal, and natural raw materials, such as grains, soya and coffee.
nformation is
:1panies, how- ■ Supplementary materials. These are materials which are not absorbed physically in the
end product; they are used or consumed during the production process. Examples of
this type of product are lubricating oil, cooling water. polishing materials. welding
electrodes and industrial gases
• Semi-manufactured products. These pmducls have already hccn prm:cssl.!d once or
more, and they will be processed furth��r at a later stage. They arc physkally present in
the end product. Examples are steel plate, rolled wire and plastic foils.
• Components. Components are manufaclurt,d goods which will not undergo additional
physic al changes, but which will be incorporated in a system with which there is a
knowledge functional relationship by joining it with other components. They are built into an end
product. Examples are lamp units, batteries, engine parts, electronic parts and transmis­
;ult part of sions. A distinction can be made between specific, customized components
, be the col­ and stand­
ard components. Specific, customized components are produced according
onnation: in to design or
specification of the customer, whereas standard components
:haYe a clue are produced act:on.ling to
specification of the supplier or an industry
inancial and . norm.
• 1:·1111 shc
d products or trade item�. These encompass all products which am purchased tu
equipped to be • 1, ,ir�, negligible
added value, either together with other finished products or
-
16 SECTION l CORE CONCEPTS
Global sot1rci11,:
l'nJ(lctiv<'ly i11te>:mti11>:
and l'1J-ordina1in>:
common items and
111<1/ccriuls, pmn·sse.�,
designs, technologies
and suppliers across
worldwide purchasing,
en1:ineering and oper­
ating locations.
manufactured products. Examples of this product category are accessories which are issues
supplied by car manufacturers, such as navigation systems, car stereo systems and alloy why 11
wheels and tyres. The manufacturer does not produce these products, but obtains them (IPO's
from specialized suppliers. Commercial products and articles sold by department stores adopt
are also in this category. being.
• Investment goods or capital equipment. These are the products which are not consumed langua
immediately, but whose purchasing value is depreciated during its economic life cycle. ■ Suppli
In general the book value is stated on the balance sheet annually. Investment goods can their r
be machines used in production, but they also include computers and huildings. These With I
examples illustrate the varied character of this rnteg,)ry of goods. rnateri
■ Maintenance, repair and operating materials (MRO items). These products, sometimes co-opt
referred to as indirect materials or consumable items. rcprc!<cnt materials, which are purch,
necessary for keeping the organii'.ation running in general, and for the support activities Next,
in particular. These products arc often supplil:'d from stock; examples are office supplies, capabi
cleaning materials and copy paper, but also maintenance materials and spare parts. becom
■ Services. Services arc activities which arc executed by third parties (suppliers, contrac­ qualit�
tors, engineering firms), or other business units of the company, on a contract basis. Mrn;J.C·
Services can range from providing cleaning services and hiring temporary labour to • Early:
having a new production fac.:ility for a chemical company designed by a specialized in indt.
engineering firm (a colllractor). ment l
develci
Having defined the most important categories of purchased goods and services we now organi:
tum to a short description of major new developments going on in the area of purchasing sionalt
and supply management.
It shou
in hou
functic
NEW DEVELOPMENTS IN PURCHASING prereq1
innov
and rif
Many companies are now confronted with diminishing growth opportunities, which results enablil
in a situation where an increase in turnover can only be realized at the expense of the
competition and only with a great deal of effort. This leads to increased pressure on sales ■ R,·'"11·
oblig
prices and consequently on cost prices and margins, which causes two development�. On
Theo
the one hand it has resulted in shifts of power between purchasing and selling parties in
made
many markets. Due to the fact that in many cases the market ha-. changed from a seller's­
intere­
.
market to a buyer's-market, the role of the buyer is now more dominant than a number of
such 1
years ago. On the other hand the increasing pressure on sales prices and margins has
(
resultt!<l in an increased pressure on direct materials-related costs. Because the purchasing
pricei, determine the sales prices in the industrial sector to a large extent, the company will Europ
be constantly on the lookout for opportunities to keep these prices as low as possible. As beco,
a rcsuIt of both developments, the purchasing and supply strategies of industrial companies tiom.
have undergone 1m1jor changes. Several examples of these changes are presented below:
■ Leveraged purchasing and supply strategies. In companies with several manufacturing
planL'>. important. purchasing advantages can be realized by combining common pur­
cha:-.inv; requirements. A trend towards leveraged or co-ordinated purchasing strategies
is apparl,nt in many large, European companies, across national borders. Traditionatly
this was already common for raw materials, which most of the time were contracted at
a corporate level. At present, however, a similar approach is used for the purchase of
computer hardware and software, capital goods and components.
■ Global sourcing. As the curnpauies' competitive position is directly related to the com­
petitiveness of its supply ba-;e, companies have adopted a global scope towards sourcing

;ssories which are
systems and alloy
;, but obtains them
, department stores
:i are not consumed
conomic life cycle.
vestment goods can
nd buildings. These
,roducts, sometimes
nalerials, which arc
the support activities
:s are office supplies,
and spare pans.
s (suppliers, contrac­
, on a contract basis.
temporary labour to
:ncd by a speialized
c
s and services we now
the area of purchm,ing.
-I.ASING
ottunities, which results
d at the expense of th�
reased pressure on sales
s two developments. On
ng and selling parties in
changed from a seller's­
minant than a number (if
prices and margins has
.. Because the purchasing
cxtenL the company will
:es as low as possible. As
�s of industrial companies
ges are presented below:
1ith several manufacturing
combining common pur·
1atcd purchasing str ategies
onal borders. TraditionallY
:he time were contracted at
is used for the purchase of
nents.
directly related to the co?1"·
Jbal scope;: towards sourcing
CHAPTER 1 THE ROLE OF PURCHASING IN THE VALUE CHAIN 1�
issues. Components are increasingly sourced from foreign, low cost countries, a reason
why large manufacturing organisations have set up International Purchasing Offices
(IPO's) in different regions of the world. Purchasing professionals, hence, are forced to
adopt an international scope towards their supply markets. Supplier benchmarking,
being able to deal with different cultures effectively, being able to negotiate in different
languages have become prerequisites for today's purchasing professional.
■ Supplier integration. Modern information technology enables companies to improve
their materials planning and supply systems, internally but also in their relationships
with suppliers. Information technology significantly improves productivity within
materials activities. An integrated approach of materials management requires close
co-operation between production planning, inventory control. quality inspection and
purchasing. To achieve successful integration, system standardization is a prerequisite.
Next, suppliers should he seamlessly integrated within thc,'i\� applications. Hence, the
capability of a supplier to link up to the buyer's manufacturing and planning systems
becomes of a much higher concern in order to be able to apply concepts like total
quality control, quick rcsponi.c logistics and just in time scheduling sw.:cessfully (sec
Memo 1.3 for an example of UPS and Dell).
Early supplier involvement in new product development. /-. 1•::.-1e and more innovations Early s1,,pplier
in industry come from suppliers, getting them involved early in the new prnduct develop­ involvement (ESI)
ment process becomes an issue of prime concern. 111 many industries both the rapid Situation where the SUi
development of technology and !he cost related to developing new products force large plier is involved by tlu
organisations to work more closely with their suppliers. In doing so purchasing profes­ buyer in an early stag,
f of the new product
sionals need to alter their traditional ways o working and relationships with suppliers.
development process.
It should be decided at an early stage what pa.rt of the dcvelupmenL process will be done
in house and what part will be delegated to suppliers. Being able to work in cross­
functional development teams and a sound technical background also become important
prerequisites. Purchasing professionals should be able to solve the issue of how to reward
innovative suppliers for their contributions and ideas on new product development. Gain
and risk sharing agreements replace the traditional price negotiations and agreements,
enabling a more intensive and long-term relationship with these suppliers.
■ Re.-::�- •> :'c 1• cments. Companies operating on the international market<; are often
,1hbg� In compensate (part ot) their sales turnover by counter-purchase obligations.
The np.:nwg. up of the Eastern European bloc and some Southea,;t Asian countries has Corporate social
11uJ� 11\lltnter trJde an actual issue. Buying from these countries may even open up responsibility
tmi?rt!sung ak, opportunities. Purchasing becomes increasingly involved in fulfilling How to contribute to
•1cl1 nhh�auon,; bett,ir world, a bette1
,; Corporate Social Responsihility and busine% integrity. f.1 ,vtromnental problems in many erwironment a11d bet,
Fut pc-ar1 .::01:ntries become more and more prevalent. National government-; have
labour conditions. T,
idea is to d,.,velop bu
Ill' ·om,;. ,,ui�ter in their regulations on this point. In Germany, for instance, strict regula­ llC's.1· ,mlutions in su,
tions on industrial and consumer packaging recently came into fom.\. In due course all way that requiremer,
supetfluous packaging needs to be avoided (e.g. blister packaging and the box-packaging of the current world
of toothpaste); aluminium cans are charged and need to be recollected. Manufacturers of population are met
packaging will increasingly be held responsible for its disposal after use. This is one without doing harm
reason why Volkswagen constructed its latest Golf (the Rabbit in North America) in such the needs offuture h
a way that the different parts and components can be easily disa.,scmhkd and reproc­ erations. Companie,
essed at the end of the car's lifespan. Volkswagen has even founded its own rework need to balance the
i111c1i•.1·ts <H' ,:u.�lonw
facilities for this purpose. Apart from environmental issues there is a growing pressure
empioyec.1·, th<' en.vi;
from the public that products should be clean, and come
from countries with free trade. me111 (lfu/ i1.,· share­
Child labour has become an issue of particular
concern, implying that purchasing profes­ holders, i.e. serving
�'.011.11..� �:IJ.Ortk. secure that the products that they buy come
from sources of high intcg­ needs of 'People,
nty. These issues pose new and important
challenges to purcha">ing,. Plan<'t, Profit'.
18 SECTION I CORE CONCEPTS

Memo 1.3 provides an illustration of some of the challenges that lie ahead for purchasing different lo
professionals and supply chain managers. received th,
AlthougJ
,'v\rM.0 I.J WHAT"S AJ-l[i\0? explaining
Porter's opi
As 1.upply chain strategies mature, a major part of a the way of building value-cbam models to undep;tand We have ei
business will involve managing the external value both product and logi£tics cos� as well as technology.
manager to
supply chain. Important will be the need to numage They will need to decide where resemch, develop­ savings. As
cost'> strategically at all levels of the i,upply chain. ment, and design will occur m the value chain. on its purcl
Supply managers will find they are doing more busi­ Supply chain leaders over the next five years will manageme,
ness with outside i,uppl!ers than inside ones. They also need to decide the extent to which their compa­ improve thi
wtll be working much more with Tier 1 and Tier 2 mes create unique desigm1 or standardize, and at In shapi
supphers to take costs out of products. They will what levels �n the product or service they do these connotatior
require ongoing development, cost reduction, and tlungs. Creating entirely unique de&1gn� risks crea­ buying and
innovation on a collaborative basis among all partic­ tion of production difficultie,; and/or features that chain man:
ipants in the supply chain. don't mean anything to customers. The ideal will be purchasing
Many supply chain managers will be deeply to 6tandardize - at the right level - and make unique change the
mvolved in building e-sourcing and supply portfolios. only what is important to the customer. Most com­ the need tc
Many will be forced to make more infonned �-ions panief! have a long way to go in makmg this work on tion of sur
about whether to � industry-sponsored consortia, a con&istent basis. arrangeme,
build private exchanges, or use markets. Many will purchasing
need sophisticated aMortments of e-sourcing, supply� Source. R M Monc1Jui J11,r J P Morgan, Purchasing, 6 June,
and collaboration tools. They will need to do more in 2002, pp 26-28

It can be appreciated from this discussion that purchasing and supply represents a busi­
ness area which is being confronted with many changes and challenges. Most of the prob­
lems, however, require intensive interaction, communication and co-operation with other
disciplines in the organization. Purchasing and supply is developing increasingly as a busi­
ness function which cul'> across other disciplines. Managing the purchasing and supply
function requires a thorough understanding of the purchasing processes that take place
within the organization. Only then can these challenges be dealt with effectively.

Supply chain
management
The m,mr11:eme11t of all
m:tiviti<'.I", i11(ormation,
knowledge a,u/jinandal
n>.w,urces a.1·.wwiat<'tl
with th,, }low and lmm­
ji.mnatirm ofJloods cmd
scrvi,-C's upfmm the•
mw lllfllr:ria/.1·
suppliers, c-omJ>om!lll
suppliers 1.111-d othc-r
.mppfit,n· i.11 such 11 way
that 1/w expe,:fatiom 1i
f a process orientation rather than a functional orientation towards purchasing issues.
the end users of the
company are met or
surpassed.
SUMMARY
Globalisation of trade, the fast development of information technology and ever increasing
consumer demands are changing the international competitive landscape. As a result, compa­
nies are changing their business processes. Positioning the company at the right place within
the value chain ha<; become a prime concern for top managers. For this reason companies
started to rethink their core and non-core activities. With their core activities companies try to
develop and offer a distinctive value proposition to their targeted customers. Non-core activi­
ties are increa'lingly outsourced to specialist suppliers. This has put purchasing and supply
management in the spotlight Given the high purchasing to sales turnover ratio which can be
ohserve<l nowadays in many companies, purchasing and supply chain management has de·
vcloped into one of the key business drivers. Its main purpose is to develop a competitive,
world-das.,; supply hase for the company. In order to be able to do so companies need to adopt
Purchasing encompasses everything for which the company receives an invoice. Based
upon this broad scope of purchasing we have differentiated between dired and indifeCI
purchasing. Both are important activity domains within purchasing, though each hru- J

head for purchasing
dels to undep;tand
veil as technology.
research, develop-
1alue chain.
text five year� will
ibich their compa­
:andardiz.e, and at
vice they do these
designs ri&k<, crea•
ud/or features that
& The ideal will he
- and make unique
stomer. Most com­
iaking this work on
an, Pu,d1.u•11ng, (j June,
ipply represents a busi­
nges. Most of the prob·
�o-operation with other
i­
5 increasingly as a bus
purchasing and sup ply
·ocesses that take place
;rith effectively.
,logy and ever increasing
;cape. As a result, compa­
y at the right place within
:0r this reason companies
activities companies try to
1stomcrs. Non-core activi­
,ut purchasing and supply
1rnovcr ratio which can be
1ain management has de-
lo develop a competitive,
:o companies need to adop
t
1urchasing issues.
•
re(;etves an mvo · Based
· 1ce.
!twe en dire ct and · direct
in
iasing, though each bil.• a
CHAPTER 1 THE ROLE OF PURCHASING IN THE VALUE CHAIN
different logic due to their different characteristics. Traditionally direct purchasing has
received the most attention. However, this picture is rapidly changing.
Although developed some years ago, Porter's Value Chain is still a useful concept for Value Chain
explaining the role which the purchasing function has for many companies. Contrary to Composed of value
Porter's opinion, we have stressed the strategic importance of purchasing to organizations. activities and a ma,
We have explained our view by using the DuPont model. This enables the purchasing which is achieved b
manager to demonstrate the sensitivity of his company's financial results to purchasing these activities. Vab
savings. As we have seen, the leverage effect of purchasing can be enormous, depending activities can be divi
into primary activit,
on its purchasing-to-sales ratio and its capital turnover ratio. Purchasing and supply chain
and suppon activiti
management can contribute in several ways, both in a quantitative and qualitative way, to 1hc margin repre.1·e.
improve the company's bottom line. 11 can also help to improve the cocilpany's top line. the value that custo,
In shaping their purchasing and supply chain strategics, companies can usc different i•rs want to pay extt
connotations and definitions related to the scope of purchasing. ranging from ordering, for the company's
buying and purchasing lo procurement, sourcing, supply (chain) management and value 1'.{f<_,rts l'OlllJIUfCd WI
chain management. As the activity goes through ea1.:h or these delinitions the scope of !he cost.� that wae
purchasing broadens as well as its impact lo the business. New chall.cnges lying ahead will required j,,r these.
change the scope and role of purcha.�ing within organisations. The most important ones arc
the need to develop leveraged purchasing and supply strategics, global sourl!ing. integra­
tion of suppliers in both materials and new product development processes, reciprocal
arrangements, and socially responsible purchasing. Without doubt these challenges will put
purchasing and supply chain management more in the spotlight in many organizations.
ASSIGNM r1':TS
Take the annual report of an industrial company Calculate the purchasing
value in relation to the turnover. Calculate the effect of a 2 and 5% !.aving on
the purchasing value.
Do the same for a 2 and 5% increase in the purchasing value ceteri.s
paribu'i. Dei,cnbe the elements in the DuPont chart (Figure l.4) that are
affected by putchasmg policy directly or indirectly.
What would you consider to be purchasing''> added value to a company?
Mention at least three areas where purchasing can contribute. What would
you con<;ider to be purcha�ing's core and non-core activities?
What arc the major differences between purchasmg, procurement, sourcing
and supply management? Would you consider the purchasing function to be
part of l>upply chain management or would you favour the reverse? D1scw,s.
What are the maJor difference:, between the activities of the purchasing
funct1on and the activities conducted by the purchasing department'? Do you
think it l8 important to differentiate between thefie two concept�? Why?
The chapter describes a number of new developments in purchas.ing and also
addreHscs the aim for total quality control in compames. Def>cribe the maJor
CO&equences of total quality control on the purchru.ing function m general
and on the relationships with suppliers in parttcul:.u.
REFERENCES
'·: 1/··· ·•r · <',· ·v.,, '··"
, ·. . 'Hr·· �·.) 1·a·,;rchasing Handbook, New York: M c(jraw-Hill.
�;/;::,\ ._ ClOI))) 'Olltsourcing the Xbox', Purchasing, 15 Augusl.
• '·· ·•1 .E. YlllSJ Competitive Advantaf?e, New York: The Free Press.