Unit 4 Purchasing Management.

(work in progress…)
1. The Procurement Function
To carry out their productive activity, companies use the functional division of labor,
separating tasks into their main activities. Thus, tasks related to manufacturing are
integrated into production departments, those related to commercialization into
marketing, and those related to procurement into purchasing departments. The work of
each of these departments can be seen as a subsystem of the organization.
Below, we will examine one of the units into which the company is divided: the
procurement function (Fig. 4.1).

Figure 4.1. The procurement function involves several company departments.

●​ Production

o​ Assignment of materials for the production process.

●​ Warehouse

o​ Requesting materials for the production process.

o​ Estimation of needs.

●​ Purchasing Department

o​ Order placement.

●​ Suppliers

o​ Order fulfillment.

o​ Order receipt.

The need for this function arises due to several factors, summarized as follows:
●​ Seasonal variations in prices.

●​ Volume discounts on purchases.

 ●​ Uncertainty in both product demand and delivery times from suppliers.

A. Concept of the Procurement Function

The procurement function comprises activities carried out to select, acquire, and
store the raw materials necessary for the production process.
As with any other activity performed by the organization, the set of operations carried
out within the procurement function must be structured to enhance human resource
performance, reduce costs, and ensure that the company remains competitive in its
environment .
The importance of a good procurement policy is evident for several reasons:
●​ It is the company's main relationship with the supplier, and buyer is interested in
knowing how soon the requested product will be received.
●​ From an economic standpoint, the company benefits from keeping minimal
stock of materials. However, maintaining high inventory levels can lead to
additional costs (maintenance, storage, etc.) and reduce the company's
competitiveness.

B. Objectives of the Procurement Function

Among the objectives of a good procurement policy, we can highlight the following :
●​ Minimizing Costs

o​ Minimize inventory investments.

o​ Reduce storage costs to the lowest possible level.

o​ Minimize losses due to damage, obsolescence, or perishable items.

o​ Minimize departmental personnel costs.

●​ Maximizing Service

o​ Ensure sufficient inventory so that production is not interrupted by

shortages of raw materials and other supplies.
o​ Optimize investment so that production does not lack raw materials and
other goods.
o​ Establish an efficient inventory information system.

o​ Maintain an efficient inventory transportation system.

Balancing the procurement function.

Cost and service should be balanced. However, the forces of one objective or the
other, depending on their importance at any given time, will cause it to tilt one way or
the other. The procurement department, like other company areas, must contribute to
the organization’s final objectives. Therefore, its efforts must be directed toward
continuously restoring the balance of the scale.
Controlling costs Businesses that use just-in-time (JIT) manufacturing techniques
depend very heavily on their suppliers. JIT manufacturers need supplies delivered at
regular intervals and at specific times. JIT manufacturers do not hold stocks of
materials and components, so a break in supply leaves them vulnerable. If a supplier
fails to deliver, or delivers the wrong order, the manufacturer may have to close down
production for a time. This could be very expensive. Having good suppliers therefore
reduces the costs of holding stock. It can also prevent costly delays.
Reliability and customer satisfaction For JIT manufacturers suppliers need to be
100 per cent reliable. Their role is critical. Many suppliers feeding JIT manufacturers
have located their own operations very close to their customers. This helps to reduce
the chances of a break in supply and fosters good relations. Even businesses that do
not operate JIT will need reliable suppliers. For example, most large supermarkets
receive daily deliveries of fresh fish. If these supplies did not arrive on time
supermarkets might not be able to offer their customers the range of fish they have
come to expect. This could result in lost sales and disgruntled customers.

Activities
1.​ What is the functional division of labor? Who were its main drivers?
2.​ What are the functions of the purchasing department?
3.​ What are the reasons for the existence of the procurement function?
4.​ What costs should be balanced in the procurement function? What services
should be maximized?
5.​ Draw a diagram of the procurement function.
6.​ Why is it not advisable to have excessive materials in inventory?
2. The Purchasing Function
The execution of purchases within the company is part of the broader procurement
function.
The purchasing function is responsible for the process of acquiring supplies and
materials, in the necessary quantity, with adequate quality, and at a convenient price,
ensuring they are available to the company when needed.
The purchasing department is tasked with receiving requests for necessary materials,
seeking adequate suppliers (as studied in Unit 2), and ensuring timely management so
that materials arrive at the company’s inventory.
We observe how the procurement function, in addition to managing purchases, also
includes the operations of receiving and storing materials.

Important
The purchasing function must consider these three aspects:
●​ Price.

●​ Quality.
 ●​ Delivery time.

A. Objectives of the Purchasing Function

The purchasing function has the following objectives:
●​ Ensure continuity of supply.

●​ Guarantee the quality and quantity of supplies.

●​ Define the inventory level, avoiding stockouts and losses due to obsolescence
or deterioration.
●​ Investigate new supply sources.

●​ Maintain acquisition and stock maintenance costs at appropriate levels.

To achieve these objectives, specific actions need to be taken regarding:

●​ Specifications for the products to be acquired. If these products are
standardized, pre-established rules must exist; otherwise, necessary
descriptions must be provided to carry out the purchase effectively.
●​ Details of the authorizations for purchase requests and placing orders with the
selected supplier.
●​ Quality control policies for purchases, evaluating supplier capacity and
verifying their compliance with quality and delivery terms, ensuring the best
supplier is selected for the best price, meeting quality standards, and delivering
on time.
Based on the above, we can summarize the purchasing function as a set of activities
that significantly distinguish it from other departments, including:
●​ Researching supply sources.

●​ Searching for, selecting, and evaluating suppliers.

●​ Controlling required product specifications.

●​ Managing negotiations: including prices, conditions, and delivery terms.

●​ Monitoring operations performed with suppliers, agreements, and established

conditions.
●​ Maintaining an updated product catalog with information on technical
characteristics, item codes, identification, and pricing.
●​ Preparing orders, determining quantities and launch dates.

●​ Receiving orders and performing quality control.

Tips and Advice

Success always starts with a good purchase. This is the first step in the production
process, where cost and quality control begin.
B. The Purchasing Department
There are basically two models for designing the purchasing department:
●​ Horizontal Model: One department is responsible for all the company’s
purchases.
●​ Vertical Model: A purchasing unit is established in each department.

The evolution of the purchasing department is linked to the increase in market

competitiveness. In sectors such as automotive components, consumer electronics, or
chemicals (where margins are small), the need for a purchasing department becomes
a priority to minimize procurement costs.
Important
To carry out its functions, the purchasing department must constantly coordinate with
the storage, manufacturing, distribution, finance, and administration departments.

C. The Kraljic Matrix

The Kraljic Matrix (Fig. 4.2) is a model in which the company's purchased products
are grouped based on two parameters:
●​ The purchase’s impact on the company's results.

●​ The supply risk of these products.

The matrix is divided into four quadrants:

1.​ Leverage Products: These are products where there is a wide supply in the
market. Their price is essential to the final selection decision, and their impact
on results is significant. Companies focus on obtaining competitive offers.
2.​ Strategic Materials: These require careful planning because their absence
would significantly impact production. These materials often form part of
high-value components. The purchasing strategy focuses on building alliances
with suppliers.
3.​ Routine Products: These combine low economic impact with low supply risk.
The business strategy for these products involves simplifying administrative
processes, standardizing and reducing references, reducing the number of
suppliers, and implementing contracting systems to streamline the process.
4.​ Bottleneck Materials: These inputs don’t have a high financial impact on the
total product cost but cause a bottleneck in production if absent. These are
often small, specialized parts with specific information requirements. Despite
their small size and value, the absence of such products halts production. The
strategy for these cases is to ensure an adequate supply, minimizing stock
while incurring minimal storage costs due to their low volume and monetary
value.
Figure 4.2: Along the axes of the Kraljic Matrix, companies can analyze any parameter
that fits the four divisions.
Practical Case 1
SanSeng Company specializes in manufacturing televisions with 3D LCD technology.
This technology is relatively new, and the company's sales have been growing at a rate
of 25% in recent years. However, market potential is starting to decline due to the
introduction of new competitors, and sales are expected to stabilize at a growth rate of
only 3% in the coming years.
The company is recognized in the market for its high quality and constant innovation.
However, it is noticing that the market is evolving rapidly, with previously small
manufacturers aggressively entering the competition. Pricing has become the most
significant factor. SanSeng is concerned about being pushed out of the market and is
working to react accordingly.
The management has proposed a cost-reduction initiative by reviewing all components
of the logistics system. You are tasked with presenting a strategic study of supplier
relationships based on the Kraljic Matrix.
For this study, the company has selected four categories of components to analyze
with suppliers:
●​ Electronic circuits.

●​ LCD screens.

●​ Packaging.

●​ Technical standards.

Axes of the Matrix

The matrix’s axes are defined as follows:
●​ Importance: Based on the contract’s value and its contribution to competitive
advantage.
 ●​ Required technology: Based on the number of suppliers capable of delivering
the required products.
Purchases for 2012
The company's purchases for 2022 for each component were as follows:

Expense 2022
Component
(M€)

Electronic circuits 3

LCD screens 7

Packaging 0,3

Technical standards 0,025

Total 10,325

Market Study Conclusions

1.​ Electronic Circuits
Although there is a limited number of suppliers meeting quality and quantity
standards, only three are available for this component.
o​ Required Technology: 6.

o​ Competitive Advantage: 5.

2.​ LCD Screens

Can be manufactured by many suppliers, particularly from Asia.
o​ Required Technology: 2.

o​ Competitive Advantage: 3.5.

3.​ Packaging​
There are many suppliers for this type of product. The company, however,
prefers not to stock excessive amounts, requiring weekly deliveries.
o​ Required Technology: 1.5.

o​ Competitive Advantage: 1.5.

4.​ Technical Standards

Few suppliers can certify these technical booklets, which must legally
accompany the product.
o​ Required Technology: 4.

o​ Competitive Advantage: 0.5.

Analysis Process
Step 1: Categorizing Components
●​ Electronic circuits: Strategic product.

●​ LCD screens: Leverage product.

●​ Packaging: Routine product.

●​ Technical standards: Bottleneck product.

Step 2: Calculating Component Values​

Assign values to each component based on importance and competitive advantage,
weighting both factors equally (out of 10).

Component Purchases Competitive Advantage Average

Electronic circuits 3 5.00 4

LCD screens 7 3.50 5,5

Packaging 0.3 1.00 0.6

Technical standards 0.025 0.50 0,4

Step 3: Positioning Results in the Kraljic Matrix​

The matrix positions components as follows:
●​ X-Axis: Required technology.

●​ Y-Axis: Importance.

●​ Quadrants:

o​ LCD screens: Leverage product.

o​ Electronic circuits: Strategic product.

o​ Packaging: Routine product.

o​ Technical standards: Bottleneck product.

Activities
7. The company Todos Iguales, S.A. specializes in the manufacturing of uniforms. At
the end of the fiscal year, the company evaluates the results of its purchasing
department and observes that its efforts are not being properly directed, as a significant
number of orders are approved as "emergency" orders. In this context, and alongside
other initiatives, it was decided to reorganize the functions in this area. To achieve this,
the company opted to use the Kraljic methodology to optimize efforts.
For the analysis, the company decided to consider two factors:
1.​ Financial Impact: This represents the percentage of the basic cost, with a
weighting of 100%.
2.​ Supply Risk: Calculated as the result of two factors:
o​ Material origin, with a weighting of 60%.

o​ Number of suppliers, with a weighting of 40%.

Obtained Data

Material % Base Cost Origin Number of Suppliers

Blue drill fabric 21% Importation 6

Buttons 20% Importation 2

White cotton fabric 17% Importation 4

Labels 15% Local 5

Plastic bags 15% Local 4

Thread 12% Local 3

3. Stages in the purchasing process

1.​ Requisition
2.​ Negotiation
3.​ Place order
4.​ Chase delivery
5.​ Clear invoice
Purchasing usually begins when the purchasing department is notified of a particular
need. For example, a firm's stores or a particular department may send a requisition
form asking for more stationery. The purchasing department will then act on this. Most
purchases are repeat purchases from regular suppliers. Orders are placed with the
supplier at previously agreed prices and delivery is accepted under previously arranged
terms. New products may need different materials and new suppliers. This will involve
a period of search and negotiation, as the buyer tries to find the best deal. If there is a
delay in delivery, it is the purchasing department's responsibility to find out why and
speed up delivery. Once the goods have arrived the invoice is checked and then
payment can be made.
In manufacturing the purchasing department works closely with the production and
finance departments. Most purchasing is carried out on behalf of the production
department. The finance department needs information about purchases to make
payments and record the transactions.
'The importance of purchasing is likely to vary according to the nature and size of the
business. In many service industries purchasing is not very important. This is because
materials are only a small fraction of the total cost of the final product. For example,
hairdressing involves very little purchasing, as production involves a skill and uses few
materials. However, a large manufacturer requires a large amount of materials,
components etc. and so the firm will employ a purchasing department made up of
specialists.
4. Choosing effective suppliers
It is important for a business to evaluate suppliers. A poor supplier may delay
production, which can be costly. When choosing suppliers a business is likely to use a
number of criteria to evaluate their reliability.
Price For many businesses the price charged by suppliers will be the most important
criterion when choosing a supplier. If businesses can lower the costs of raw materials,
components and other services they will make more profit. Price will be particularly
important if there is little difference in the quality of the material being purchased. For
example, when finding an electricity supplier, only the price is likely to be considered.
Payment terms Payment terms can vary enormously. Payment terms usually refer to
the length of the credit period and the method by which payment must be made.
Businesses will tend to prefer long credit periods - 90 days or more perhaps. The
method of payment is not likely to be a big issue today, although not many businesses
will want to pay in cash unless there are significant discounts.
Quality Businesses will need good quality materials and services. They cannot
produce good quality products themselves if they use poor quality materials. For
example, a business that fits high quality kitchens cannot use poor quality tiles and
kitchen units.
Capacity If a business is going to buy very large quantities from a supplier, it will want
reassurance that the supplier has the capacity to meet demand. If there is a danger
that the supplier may run out of capacity, supplies may be threatened which could
disrupt production. A business may also consider the capacity of a supplier if it is likely
that the business would be expanding in the near future.
Reliability Businesses want suppliers that deliver goods when they say they will. They
also want the correct order first time. Suppliers that are late and prone to making
mistakes in orders will be avoided.
Flexibility Many businesses prefer suppliers that can offer a flexible service. For
example, can they change orders at the last minute or can they deliver a day early?
Flexible suppliers make operations management easier when planning production.
Exercise 19. McPhersons Ltd is a chain of twenty butchers operating in Scotland and
the North of England. Its head office is attached to the shop located in Leeds. All the
purchasing is currently undertaken at head office and the meat is delivered in bulk to a
warehouse in Leeds. The firm employs a driver to distribute orders to the various shops
twice a week. The board of directors is considering the decentralisation of the
purchasing function, since the discounts from bulk buying are not particular significant.
If decentralisation takes place each shop manager will receive a £2,000 p.a. salary
increase. The discounts lost from bulk buying are expected to total £20,000 p.a. Cold
storage, handling and distribution costs are expected to fall by £50,000 in total and
administration costs will be £5,000 lower in total. It is expected that the quality of the
meat will improve when purchasing is the responsibility of the shop managers.

a)​ Advise the company whether or not decentralisation is a worthwhile change in

operational policy, in purely financial terms.
b)​ Explain the non-financial advantages and disadvantages to McPhersons of
decentralising purchasing.
Vendor rating
The measurement of suppliers' performance is called VENDOR RATING. A business
must choose criteria which could be used to measure the performance of a supplier.
A simple vendor rating system is shown in Table. The supplier is awarded a mark for
performance based on five criteria. For example, the supplier has a good price record,
scoring 18 out of a possible 20. Adding the scores gives a total vendor rating of 71/100.
When deciding which supplier to choose, a firm is likely to pick the one with the highest
rating. If a business feels that some criteria are more important than others, it may give
them more value using a weighting system.
One problem with this system is how to judge a supplier's performance against given
criteria. It may be possible to use records. But sometimes evaluation may simply be
based on the subjective opinion of a manager.
Table: A simple vendor rating system

Criteria Maximum Score Actual Score

Quality 20 17

Price 20 18

Delivery 20 10

Communication 20 12

Flexibility 20 14

Total 100 71

eSourcing
eSOURCING is the use of Internet technologies and electronic communications in the
whole purchasing process. It is a systematic approach that can handle all stages in the
purchasing process including identifying appropriate suppliers, tendering, negotiation
and award and contract management. The various eSource tools available enable
buyers and suppliers to connect and agree a contract quickly and efficiently in order to
improve the company's competitiveness. eSourcing significantly reduces the length of
time spent on the whole purchasing process. It also reduces the need for paper-based
systems and labour-intensive processes. In general, eSourcing helps to improve
operational efficiency and can benefit both buyers and suppliers. Buyers benefit from
eSourcing for following reasons.
●​ Faster sourcing process and faster results - time reductions of up to 70%.
●​ Elimination of face-to-face meetings, travel time, and geographical barriers.
●​ More transparent, uniform and predictable pricing.
●​ Improved enforcement of corporate purchasing policies.
●​ Increased process transparency.
●​ Better supplier measurement.
Suppliers can also benefit from eSourcing for certain reasons.
●​ More efficient and objective sourcing process and more level playing field.
●​ Easier to respond - negotiations and travel are eliminated.
●​ Lower selling costs.
●​ Improved convenience for buyers, leading to more transactions.
Exercise . Vi-Spring manufactures high quality beds. A feature of its large range is the
ability to offer customers a wide variety of personalised options. It markets its
well-known products around the world through a number of large and small retailers.
Founded over 100 years ago, the company now emplovs 180 people and is located in
Plvmouth. Devon.

The company has recently adopted a just-in-time (JIT) approach to production.

Vi-Spring now holds a very low stock of raw materials. Stocks required for production
come in on a JIT basis from around two hundred suppliers, of which thirty are key
sources. The majority - mainly those providing cotton ticking, padding and webbing -
are in the North of England. Delivery of an order is on a next-day basis; other materials
are on a longer lead time.
The company prefers to build close and reliable relationships with its suppliers,
regarding them as key business partners. If a problem develops, rather than dropping a
supplier Vi-Spring will work with it to overcome the issue concerned.
a)​ Why is the reliability of suppliers so critical for Vi-Spring?
b)​ Do you think Vi-Spring has good relations with its suppliers? Explain your
answer.
Exercise . IXO Instruments Ltd

Based in Southampton, IXO instruments Ltd is a privately owned company. It operates

in the market for high-value, handheld test instruments. Its products are sold through a
network of national catalogue houses, regional stocking distributors and international
master distributors. The company has become one of the largest manufacturers and
suppliers of test equipment. It has built an enviable reputation for providing innovative
products offering unique and patented designs with features, functions and reliability at
an affordable price. IXO is ISO 9001:2000 certified. Its products include portable
meters for the measurement and testing of light, sound, temperature, humidity, airflow
and water quality.
IXO has a supplier base of 120 but is always looking for new suppliers to keep costs
down. The family who own the company set demanding financial targets, which often
means that managers continually have to cut costs. At the moment a vendor rating
system is used to find new suppliers. Recently a new supplier was found for a
component in a new printer. The component is a circuit board and is called FFD 339.
Table 2 shows some of the information that was used to find the new supplier.
Unfortunately, last year, the operations manager had to take early retirement due to ill
health. A new manager was appointed and it was apparent that she wanted to make a
number of operational changes. She was particularly concerned about the treatment of
suppliers. She felt that IXO could not develop effective relations with suppliers if they
continually looked for cheaper ones. To improve operational performance with regard to
suppliers, she was extremely keen to make use of eSourcing in the organisation.
Table : Supplier information for FFD 339
Supplier name Price Quality Reliability Flexibility Payment terms Total

Reynolds Ltd 18 8 7 8 6

AGT 12 8 9 9 5

Adco 14 6 7 5 8
Veelle 8 9 9 9 9

Williams & Co 20 8 6 4 5

Note: All criteria are marked out of 10 except for price which is given more weight and
marked out of 20.
a)​ How does IXO Instruments Ltd choose effective suppliers?
b)​ Which is the most important criterion for IXO when choosing suppliers? Explain
your answer.
c)​ Which of the suppliers shown in Table would have been selected by IXO
Instruments Ltd? Explain your answer.
d)​ Analyse IXO's current relationship with suppliers.
e)​ Evaluate the possible benefits to IXO Instruments Ltd if they adopt eSourcing.
5. Decision to buy, produce, or rent an asset
When a company is faced with the decision to buy, produce, or rent an asset, there are
several factors to consider in order to determine the best option. By carefully evaluating
these factors and following a structured decision-making process, a company can
determine the most suitable option for acquiring an asset, whether it’s buying,
producing, or renting. These factors include:
Cost Considerations: The upfront cost of purchasing an asset can be significant.
Companies need to assess if they have sufficient capital or if financing is needed. If
opting to produce, consider the costs of raw materials, labor, technology, and other
resources required. Compare the long-term renting costs with the one-time purchase or
production cost. Sometimes renting can be more expensive in the long run.
Duration and Frequency of Use: For assets needed for a short-term project or
infrequently, renting may be more cost-effective. If the asset is essential for long-term
operations, purchasing or producing it might be a better investment.
Maintenance and Upkeep: Owning an asset requires maintenance, which can be
costly. Evaluate if the company has the capability and resources to manage these
costs. Renting typically shifts the maintenance burden to the lessor.
Technological Obsolescence: Consider the risk of the asset becoming outdated. In
industries where technology evolves rapidly, renting might be more beneficial to stay
up-to-date.
Financial Implications: Purchasing can impact cash flow significantly. Renting might
be a better option if maintaining liquidity is crucial.
Tax Benefits: Owning an asset can offer tax advantages like depreciation. Leasing
may provide tax benefits as well (e.g., lease payments as tax-deductible expenses).
Operational Flexibility: Renting provides more flexibility, allowing companies to adapt
to changing business needs more easily. Owning or producing an asset might limit
operational flexibility but can provide stability.
Control and Customization: Owning or producing an asset allows for customization
and full control over its use. Renting might limit how much the asset can be modified or
used.
Short Questions
1. Why is it important to develop effective relations with suppliers?
2. How important is the role played by suppliers for JIT manufacturers?
3. What are the different stages in the purchasing process?
4. What is the difference between centralised and decentralised purchasing?
5. State two benefits of centralised purchasing.
6. State four benefits of Sourcing to buyers.
7. State three benefits of Sourcing to suppliers.