urchasing refers to a business or organization attempting to acquire goods or services to accomplish the goals of the enterprise. Typically the word "purchasing" is not used interchangeably with the word "procurement", since procurement typically includes Expediting, Supplier Quality, and Traffic and Logistics (T & L) in addition to Purchasing
Purchasing managers/directors, and procurement managers/directors guide the organization's acquisition procedures and standards. Most organizations use a three-way check as the foundation of their purchasing programs. This involves three departments in the organization completing separate parts of the acquisition process. The three departments do not all report to the same senior manager to prevent unethical practices and lend credibility to the process. These departments can be purchasing, receiving; and accounts payable or engineering, purchasing and accounts payable; or a plant manager, purchasing and accounts payable. Combinations can vary significantly, but a purchasing department and accounts payable are usually two of the three departments involved.
Historically, the purchasing department issued Purchase Orders for supplies, services, equipment, and raw materials. Then, in an effort to decrease the administrative costs associated with the repetitive ordering of basic consumable items, "Blanket" or "Master" Agreements were put into place. These types of agreements typically have a longer duration and increased scope to maximize the Quantities of Scale concept. When additional supplies are required, a simple release would be issued to the supplier to provide the goods or services.
Another method of decreasing administrative costs associated with repetitive contracts for common material is the use of company credit cards, also known as "Purchasing Cards" or simply "P-Cards". P-card programs vary, but all of them have internal checks and audits to ensure appropriate use. Purchasing managers realized once contracts for the low dollar value consumables are in place, procurement can take a smaller role in the operation and use of the contracts. There is still oversight in the forms of audits and monthly statement reviews, but most of their time is now available to negotiate major purchases and setting up of other long term contracts. These contracts are typically renewable annually.
This trend away from the daily procurement function (tactical purchasing) resulted in several changes in the industry. The first was the reduction of personnel. Purchasing departments were now smaller. There was no need for the army of clerks processing orders for individual parts as in the past. Another change was the focus on negotiating contracts and procurement of large capital equipment. Both of these functions permitted purchasing departments to make the biggest financial contribution to the organization. A new terms and job title emerged - Strategic sourcing and Sourcing Managers. These professionals not only focused on the bidding process and negotiating with suppliers, but the entire supply function. In these roles they were able to add value and maximize savings for organizations. This value was manifested in lower inventories, less personnel, and getting the end product to the organization's consumer quicker. Purchasing manager's success in these roles resulted in new assignments outside to the traditional purchasing function - logistics, materials management, distribution, and warehousing. More and more purchasing managers were becoming Supply Chain Managers handling additional functions of their organizations operation. Purchasing managers were not the only ones to become Supply Chain Managers. Logistic managers, material managers, distribution managers, etc all rose the broader function and some had responsibility for the purchasing functions now.
In accounting, purchases are the amount of goods a company brought throughout this year. They are added to inventory. Purchases are offset by Purchase Discounts and Purchase Returns and Allowances. When it should be added depends on the free On board (FOB) policy of the trade. For the purchaser, this new inventory is added on shipment if the policy was FOB shipping point, and the seller remove this item from its inventory. On the other hand, the purchaser added this inventory on receipt if the policy was FOB destination, and the seller removes this item from its inventory when it was delivered.
Goods brought for the purpose other than direct selling, such as for Research and Development, are added to inventory and allocated to Research and Development expense as they are used. On a side note, equipments brought for Research and Development are not added to inventory, but are capitalized as assets.
The traditional role of purchasing is to purchase materials conforming to specifications such as physical dimensions and the lowest bids. Most organizations still view purchasing as a tactical one with a short sighted approach. The tactical role of purchasing is underlined by the fact that most firms don't have purchasing function in the corporate boardroom.
Purchasing as a tactical function is confined to clerical processes such as bid invitation, order management and payment. But purchasing is a complex function that manages suppliers for operation, new product launches and market planning. The strategic role envisages supplier involvement for increasing the efficiency of the business itself. This transition from tactical to strategic to engage suppliers is a long term process and therefore considerable change management processes.
The objective of strategic purchasing is to manage suppliers to reduce cost of materials and engage them in downstream processes and also to reduce the cost of purchasing. The implementation of IT in purchasing enables automation of many of the processes such as bid management and evaluation, order management and payment processes such as handling of invoices. The automation reduces errors in the purchase to pay cycle and increases process efficiency.
With increased competition and globalization, strategic purchasing involves sourcing supplies at the global level to reduce costs, better quality products. The global sourcing enables a firm to forge long term relationships with vendors who have the synergy and to share best practices and solutions. By having the supplier closely work with the firm, more products are launched quickly in the market and fewer inventories of finished products unsold are stored in warehouses.
Strategic purchasing enables firms to enter the ecommerce arena to source supplies online. According to Porter's five forces theory, suppliers are seen as a force in the success of a product or firm and they are classified as either weak or strong. A chain is as strong as its weakest link. Strategic purchasing integrates suppliers into the network and collaborates to develop them.
In a traditional organization, the role of purchasing is to simply purchase and the means was to negotiate and to have a confrontational attitude with the vendors. This led to the concept of 'buying power' of organizations into the management literature. For instance, large organizations squeezed every cent from their suppliers by using their buying clout.
Purchasing solutions are based on vendor, geographic and technology specific. Whatever be the solutions, the goals are reduced cost, higher quality and reliability. Purchasing is a complex process with so many variables that the organization may not have control on many of them. For instance, currency fluctuation is an important variable that affects the buying decision. The degree of centralization in an organization plays a major role in purchasing solutions.
A purchasing organization may have single or multi vendor for a product item. Vendor specific solution is based on whether to have multi vendor arrangement to reduce the risk of dependence on one vendor or to forge a long term relationship with a single vendor. Geographic specificity is determined to reduce the risk of dealing with different cultures, systems or to reduce the costs. For instance, Wal-Mart sources a significant portion of its requirements from Low Cost Regions (LCR).
Once orders have been placed, there is generally a short period of time available to a firm to put an inventory management plan in place before the supplies are delivered. Inventory management helps a firm to decide in advance where these supplies should be stored. If a firm is getting supplies of small-sized goods, it may not be much of a problem to store them, but in the case of large goods, one has to be careful so that the warehousing space is optimally utilized.
Finally, the increasing globalization trends and competition force the businesses to outsource purchasing and to concentrate on the core activities. Each solution has its own merits and de-merits depending upon the context such as product category, policy intervention. In essence, purchasing has evolved from being a back end service provider to a strategic partnership role.
Businesses compete in the real world with core competency. The core competency can be, for instance, excellence in design and low cost manufacturing. The purpose of businesses is to satisfy customers. Businesses, with its number of functions and process flows, have to add value to the product in order to satisfy customers. The satisfaction of customers is attained by providing value for money experience.
The value addition in each stage of the process flow is dependent on the cost of that particular process and the perceived value addition. If the cost exceeds the perceived value or the perceived value is not significant, businesses have to look at that process. Outsourcing is one of the ways to solve a business problem. It is a process by which a process flow is given to the third party, thereby utilizing the resources for any other value added activity.
The value addition in purchasing depends upon the criticality of the items purchased. In the Bill of Materials, usually 80% of the items are recurring and non-critical. The remaining 20% of the items are critical because of their high cost-low volume nature, which means large inventories are not necessary. In industries such as automobiles, where early stage supplier involvement is necessary for design and modular manufacturing, outsourcing of purchasing will not make sense.
Outsourcing saves cost by eliminating costs of purchasing such as processing and labor costs. This is possible for the third parties because their core competency is in purchasing and they excel at it. Some of the outsourced activities are proposal management, contract management. Proposal management includes preparing proposals, bids and qualifying bidders by inviting bids for projects. Contract management helps manage third parties who provide non-critical items such as office supplies, prepare contracts and negotiations.
Outsourcing works well in private as well as government enterprises. Most of the service providers have consulting services and purchasing services. Their fee structure is based on flat management transaction fees and/or retainer fees plus profit sharing on the savings accrued.
Here is series of steps which define a process for achieving higher levels of inventory accuracy. Your success or failure will be determined by your implementation of these steps.
Acquisition Process: The revised acquisition process for major systems in industry and defense is shown in the next figure. The process is defined by a series of phases during which technology is defined and matured into viable concepts, which are subsequently developed and readied for production, after which the systems produced are supported in the field. The process allows for a given system to enter the process at any of the development phases. For example, a system using unproven technology would enter at the beginning stages of the process and would proceed through a lengthy period of technology maturation, while a system based on mature and proven technologies might enter directly into engineering development or, conceivably, even production. The process itself includes four phases of development:
Selection of Bidders: This is the process where the organization identifies potential suppliers for specified supplies, services or equipment. These suppliers' credentials (qualifications) and history are analyzed, together with the products or services they offer. The bidder selection process varies from organization to organization, but can include running credit reports, interviewing management, testing products, and touring facilities. This process is not always done in order of importance, but rather in order of expense. Often purchasing managers research potential bidders obtaining information on the organizations and products from media sources and their own industry contacts. Additionally, purchasing might send Request for Information (RFI) to potential suppliers to help gather information. Engineering would also inspect sample products to determine if the company can produce products they need. If the bidder passes both of these stages engineering may decide to do some testing on the materials to further verify quality standards. These tests can be expensive and involve significant time of multiple technicians and engineers. Engineering management must make this decision based on the cost of the products they are likely to procure, the importance of the bidders' product to production, and other factors. Credit checks, interviewing management, touring plants as well as other steps could all be utilized if engineering, manufacturing, and supply chain managers decide they could help their decision and the cost is justifiable.
Other organizations might have minority procurement goals to consider in selection of bidders. Organizations identify goals in the use of companies owned and operated by certain ethnicities or women owned business enterprises. Significant utilizing of minority suppliers may qualify the firm as a potential bidder for a contract with a company or governmental entity looking to increase their minority supplier programs.
This selection process can include or exclude international suppliers depending on organizational goals and criteria. Companies looking to increase their pacific rim supplier base may exclude suppliers from the Americas, Europe, and Australia. Other organizations may be looking to purchase domestically to ensure a quicker response to orders as well as easier collaboration on design and production.
Organizational goals will dictate the criteria for the selection process of bidders. It is also possible that the product or service being procured is so specialized that the number of bidders are limited and the criteria must be very wide to permit competition. If only one firm can meet the specifications for the product then the purchasing managers must consider utilizing a "Sole Source" option or work with engineering to broaden the specifications if the project will permit alteration in the specifications. The sole source option is the part of the selection of bidders that acknowledges there is sometimes only one reasonable supplier for some services or products. This can be because of the limited applications for the product cannot support more than one manufacturer, proximity of the service provided, or the products are newly designed or invented and competition is not yet available.
Bidding Process: This is the process an organization utilizes to procure goods, services or equipment. Processes vary significantly from the stringent to the very informal. Large corporations and governmental entities are most likely to have stringent and formal processes. These processes can utilize specialized bid forms that require specific procedures and detail. The very stringent procedures require bids to be open by several staff from various departments to ensure fairness and impartiality. Responses are usually very detailed. Bidders not responding exactly as specified and following the published procedures can be disqualified. Smaller private businesses are more likely to have less formal procedures. Small private firms are more likely to have informal procedures. Bids can be in the form of an email to all of the bidders specifying products or services. Responses by bidders can be detailed or just the proposed dollar amount.
Most bid processes are multi-tiered. Acquisitions under a specified dollar amount can be "user discretion" permitting the requestor to choose who ever they want. This level can be as low as $100 or as high as $10,000 depending on the organization. The rationale is the savings realized by processing these request the same as expensive items is minimal and does not justify the time and expense. Purchasing departments watch for abuses of the user discretion privilege. Acquisitions in a mid range can be processed with a slightly more formal process. This process may involve the user providing quotes from three separate suppliers. Purchasing may be asked or required to obtain the quotes. The formal bid process starts as low as $10,000 or as high as $100,000 depending on the organization. The bid usually involves a specific form the bidder fills out and must be returned by a specified deadline. Depending of the commodity being purchased and the organization the bid may specify a weighted evaluation criterion. Other bids would be evaluated at the discretion of purchasing or the end users. Some bids could be evaluated by a cross-functional committee. Other bids may be evaluated by the end user or the buyer in Purchasing. Especially in small, private firms the bidders could be evaluated on criteria or factors that have little if anything to do with the actual bid. Examples of these factors are history of the bidder with the company, history of the bidder with the company's senior management at other firms, and bidder's breadth of products.
Technical Evaluation: Technical Evaluations, evaluations of the technical suitability of the quoted goods or services, if required, are normally performed prior to the Commercial Evaluation. During this phase of the procurement process, a technical representative of the company (usually an engineer) will review the proposal and designate each bidder as either technical acceptable or technically unacceptable.
Commercial Evaluation: Payment Terms (/b) Cost of Money - Cost of Money is calculated by multiplying the applicable currency interest rate multiplied by the amount of money paid prior to the receipt of GOODS. If the money were to have remained in the Buyer's account, interest would be drawn. That interest is essentially an additional cost associated with such Progress or Milestone payments. Manufacturing Location - The manufacturing location is taken into consideration during the evaluation stage primarily to calculate freight costs and regional issues which may be considered. For instance, in Europe in is common for factories to close during the month of August for summer holiday. Labor agreements may also be taken into consideration and may be drawn into the evaluation if the particular region is known to frequent labor unions. Manufacturing Lead-Time - the manufacturing lead-time is the time from the placement of the order (or time final drawings are submitted by the Buyer to the Seller) until the goods are manufactured and prepared for delivery. Lead-times vary by commodity and can range from several days to years. Transportation Time - Transportation time is evaluated while comparing the delivery of goods to the Buyer's required use-date. If Goods are shipped from a remote port, with infrequent vessel transportation, the transportation time could exceed the schedule an adjustment would need to be made. Delivery Charges - the charge for the Goods to be delivered to a stated point. Bid Validity Packing Bid Adjustments Terms and Conditions Seller's Services Standards Organizations Financial Review Payment Currency Risk Analysis - market volatility, financial stress within the bidders testing.
Negotiating: Negotiating is a key skill set in the Purchasing field. One of the goals of Purchasing Agents is to acquire goods per the most advantageous terms of the buying entity (or simply, the "Buyer"). Purchasing Agents typically attempt to decrease costs while meeting the Buyer's other requirements such as an on-time delivery, compliance to the commercial terms and conditions (including the warranty, the transfer of risk, assignment, auditing rights, confidentiality, remedies, etc).
Good negotiators, those with high levels of documented "cost savings", receive a premium within the industry relative to their compensation. Depending on the employment agreement between the Purchasing Agent (Buyer) and the employer, Buyer's cost savings can result in the creation of value to the business, and may result in a flat-rate bonus or a percentage payout to the Purchasing Agent of the documented cost savings.
Purchasing Departments, while they can be considered as a support function of the key business, are actually revenue generating departments. For example, if the company needs to buy $30 million USD of widgets and the Purchasing Department secure the widgets for $25M USD, the Purchasing Department would have saved the company $5M USD. That savings could exceed the annual budget of the department, which in effect would pay the department's overhead - the employee's salaries, computers, office space, etc.
Selection and Award: This is the process an organization utilizes to procure goods, services or equipment. Processes vary significantly from the stringent to the very informal. Large corporations and governmental entities are most likely to have stringent and formal processes. These processes can utilize specialized bid forms that require specific procedures and detail. The very stringent procedures require bids to be open by several staff from various departments to ensure fairness and impartiality. Responses are usually very detailed. Bidders not responding exactly as specified and following the published procedures can be disqualified. Smaller private businesses are more likely to have less formal procedures. Small private firms are more likely to have informal procedures. Bids can be in the form of an email to all of the bidders specifying products or services. Responses by bidders can be detailed or just the proposed dollar amount.
Most bid processes are multi-tiered. Acquisitions under a specified dollar amount can be "user discretion" permitting the requestor to choose who ever they want. This level can be as low as $100 or as high as $10,000 depending on the organization. The rationale is the savings realized by processing these request the same as expensive items is minimal and does not justify the time and expense. Purchasing departments watch for abuses of the user discretion privilege. Acquisitions in a mid range can be processed with a slightly more formal process. This process may involve the user providing quotes from three separate suppliers. Purchasing may be asked or required to obtain the quotes. The formal bid process starts as low as $10,000 or as high as $100,000 depending on the organization. The bid usually involves a specific form the bidder fills out and must be returned by a specified deadline. Depending of the commodity being purchased and the organization the bid may specify a weighted evaluation criterion. Other bids would be evaluated at the discretion of purchasing or the end users. Some bids could be evaluated by a cross-functional committee. Other bids may be evaluated by the end user or the buyer in Purchasing. Especially in small, private firms the bidders could be evaluated on criteria or factors that have little if anything to do with the actual bid. Examples of these factors are history of the bidder with the company, history of the bidder with the company's senior management at other firms, and bidder's breadth of products.
Post-Award Administration: Post-award administration typically consists of making minor changes, additions or subtractions, which in some way change the terms of the agreement or the Seller's Scope of Supply. Such changes are often minor, but for auditing purposes must be documented into the existing agreement. Examples include increasing the quantity of a Line Item or changing the metallurgy of a particular component.