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Chapter 7
PROCUREMENT
Activities related to obtaining products and materials from outside
suppliers in order to support manufacturing or resale organizations by
timely purchasing at the lowest total cost.
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Main content
1. Purchasing vs. Procurement
2. Sourcing Decisions
3. Supplier Decisions
4. Procurement Cycle
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1. PURCHASING
VS.
PROCUREMENT
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Supply Chain - Procurement - Purchasing
Supply Chain
Procurement
Purchasing
Source: digitalsupplychaintoday.com
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Definitions
Purchasing is responsible for acquiring all the materials needed by an
organisation.
Procurement includes added activities of planning, sourcing, identifying
potential suppliers, supplier selection, negotiation, contract management,
agreeing terms and supplier performance management.
Purchasing refers to the actual buying, while procurement has a broader
meaning.
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Importance of procurement
1. Form an essential link between organizations in the supply chain.
2. Give a mechanism for coordinating the flow of materials between
customers and suppliers.
3. Be responsible for organizing the need of a supply of materials
for every organization.
4. Be directly responsible for most of a company’s spending, and a
relatively small improvement can give substantial benefits.
5. If procurement is carried out badly the wrong materials are
delivered, in the wrong quantities, at the wrong time, with poor quality,
at too high price.
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Example
Last year, Wiesiek Limited had total sales of $108 million.
Their direct costs were $58 million for materials, $27 million
for employees and $12 million for overheads.
Q1. What is the effect of reducing the cost of materials by 1%?
Q2. If materials costs are not reduced, how much would sales
have to increase, or overheads fall, to get the same effect?
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Solution LOGO
Answer 1.
The actual profit last year: 108 – (58 + 27 + 12) = $11 million.
The cost of materials: 58 × 0.99 = $57.42 million if the material
cost drops by 1%
The profit rises to 108 – (57.42 + 27 + 12) = $11.58 million.
Thus, a 1% decrease in materials costs increases profits by 5.3%.
Profit as a percentage of sales rises from 10.2% to 10.7%.
Answer 2.
If materials costs do not change, and assuming that other costs
remain the same proportion of sales value then sales would
have to rise by 0.54% to get the same increase in profit.
To get the same extra profit, the fixed costs would have to fall by
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$0.58 million or 4.8%.
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Aims of Procurement
Organising a reliable and uninterrupted flow of materials into an
organisation.
Developing the relationships with user departments to
understand their needs.
Finding and working closely with good suppliers, and developing
beneficial relationships.
Buying the right materials and making sure that they have
acceptable quality, arrive at the time and place needed.
Negotiating good prices and conditions.
To guarantee that an organisation has a reliable supply of
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Organization of Procurement
The procurement is organised based on the type and size
of the organisation.
A small-sized A medium-sized A large-sized
organization organization organization
• A single buyer • A department • Hundreds of
responsible for with buyers, people co-
all purchases, expeditors, ordinating huge
policy and store-keeper, amounts of
administration. and clerks. purchases.
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2. SOURCING
DECISIONS
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Make-or-Buy Decision
Outsourcing refers to buying materials or components from
suppliers instead of making them in-house.
The make or buy decision is a strategic one that can impact an
organization’s competitive position.
Traditionally, cost has been the major driver when making sourcing
decisions. However, organizations today focus more on the
strategic impact of the sourcing decision on the firm’s competitive
advantage.
Generally, firms outsource noncore activities while focusing on
core competencies.
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Reasons for Buying or Outsourcing LOGO
Cost advantage: cost is an important reason for outsourcing and this
is usually true for standardized or generic supplies and materials for
which suppliers may have the advantage of economies of scale.
Insufficient capacity: the firm may be running at or near capacity,
making it unable to produce the components in-house.
Lack of expertise: the firm may not have the necessary technology
and expertise to manufacture the item.
Quality: purchased components may be superior in quality because
suppliers have better technologies, skilled labor, and the advantage
of economies of scale.
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Reasons for Making in-house LOGO
Protect proprietary technology.
No competent supplier.
Better quality control.
Use existing idle capacity.
Control of lead time, transportation, and warehousing
costs.
Lower cost.
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Make-or-Buy Break-even Analysis
While cost is rarely the sole criterion in strategic sourcing decisions,
break-even analysis is a handy tool for computing the cost-
effectiveness of sourcing decisions when cost is the most
important criterion.
Several assumptions underlie the analysis:
1. all costs involved can be classified as either fixed or variable cost,
2. fixed cost remains the same within the range of analysis,
3. a linear variable cost relationship exists,
4. fixed cost of the make option is higher because of initial capital
investment in equipment,
5. variable cost of the buy option is higher due to supplier profits.
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Example LOGO
Consider a situation in which a firm has the option to make or buy a
part. Its annual requirement is 15,000 units. A supplier is able to
supply the part at $7 per unit. The firm estimates that it costs $500 to
prepare the contract with the supplier. To make the part, the firm must
invest $25,000 in equipment, and the firm estimates that it costs $5 per
unit to make the part.
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Solution (1/2)
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Solution (2/2)
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3. SUPPLIER
DECISIONS
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Factors for Selecting Suppliers
1. Process and product technologies
2. Willingness to share technologies and information
3. Quality
4. Cost
5. Reliability
6. Order system and cycle time
7. Capacity
8. Communication capability
9. Location
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10. Service
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Approach to Choose the Best Supplier
Compare and Obtain the Request for
Look for
Build a long list of eliminate shortlist of quotation, and
alternative
qualified suppliers suppliers who are promising send it to the
suppliers
less desirable suppliers shortlist
Do a commercial Do a technical Do a preliminary
Arrange a pre-
evaluation to evaluation to see evaluation of bids
award meeting to Receive bids from
compare the costs if the products and eliminate
discuss bids with the shortlist
and other meet all those with major
the shortlist
conditions specifications problems
Discuss condition Arrange a pre-
Choose the
bids, which are commitment Award orders to
supplier that is
specific meeting to sort the preferred
most likely to win
conditions that out any last supplier.
the order 21
have to be agreed minute details
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Relative Power of Customer and Supplier
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Single sourcing Vs. Multi-sourcing
Advantages of Single sourcing Advantages of Multiple sourcing
• A stronger relationship between • Competition between suppliers reduces
customers and suppliers. prices.
• Economies of scale and price • Less chance of disrupted supplies by
discounts with larger orders. switching suppliers.
• Less quality variability. • Involving more organisations can give
• Easier communication and simpler access to wider knowledge and
procedures for regular orders. information.
• Easier to keep requirements, • Can deal more easily with varying
conditions and so on, confidential. demands
• Does not rely on trusting one external
organisation.
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4. PROCUREMENT
CYCLE
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Steps in the Procurement Cycle
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Paper-based Procurement Vs. E-procurement
The traditional approach to
With the development of
procurement is a manual,
information technology and the
paper-based system
Internet, many companies are
The manual system is slow moving toward a more automated,
and prone to errors due to electronic-based system
duplication of data entries during
Overcome the weakness of the
various stages of the purchasing
traditional approach.
process.
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Paper-based Procurement
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Drawback of Paper-based Procurement
Taking a long time to go through the whole procedure.
Relying on a lot of forms and paperwork which move around
different locations.
Needing a lot of people to complete, analyse, process, store and
generally deal with all the paper.
Having other people to supervise, manage and control the
administrative procedures.
Inevitable errors with so many documents and people involved.
Not giving attention to related systems, such as stock control.
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E-Procurement System
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Benefits of E-Procurement LOGO
Time savings: greatly reduces the time needed for transactions.
Cost savings: reduces costs, typically by 12–15%.
Accuracy: enhances the accuracy of communications between
buyers and suppliers
Real-time use: enables buyers to initiate bids and suppliers to
respond in real time on a 24/7.
Mobility: the buyer can communicate with suppliers regardless of the
buyer’s geographical location and time of day.
Trackability: allows submitters and buyers to track each purchase
requisition electronically through the process.
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