Purchasing and Supply Management Stting 1

Purchasing and Supply Chain
Management Samenvatting
geschreven door
Sjoerdwalen
www.stuvia.com
Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Dit document is auteursrechtelijk beschermd, het verspreiden van dit document is strafbaar. maand verdienen?
Stuvia - Koop en Verkoop de Beste Samenvattingen
Chapter 1: The Role of Purchasing in the Value Chain

Leaning objective:
- The role and importance of the purchasing and supply function in the value chain
- The difference between concepts such as ordering, buying, purchasing, procurement,
sourcing, SC and value chain management, and how these are interrelated.
- New developments in purchasing and supply practices of organizations.
Introduction
- Purchasing: the management of the company’s external resources in such a way that the
supply of all goods, services, capabilities and knowledge which are necessary for running,
maintaining, and managing the company’s primary an support activities is secured under the
most favorable conditions.
- Purchasing professionals play 3 different
o Strategic: analyzing the purchasing spend, identify key and commercial suppliers, and
based upon this data, develop differentiated supplier strategies
o Tactical: based upon selected supplier strategy, standardize purchasing process,
establish effective information links with suppliers and strive for continuous
improvement of supplier performance
o Operational: secure efficient material supply from their suppliers at right time,
quality, quantity and for lowest overall cost.
The Role of Purchasing in the Value Chain

- Value chain: is composed of value activities and a margin, which is achieved by these
activities. Value activities are divided into physical and technically different groups of
activities. Porter differentiates between primary activities and support activities.
Primary activities
- Inbound logistics: related to receiving, storing and disseminating inputs to production
process
- Operations: activities associated with transforming inputs int final product
- Outbound logistics: activities associated with collecting, storing and physically distributing
the final product to customers.
- Marketing and sales: relate to advertising, promotion, sales, distribution channel selection,
pricing and channel relations
- Services: providing services to customers to enhance or maintain the value of the product
Support activities
- Procurement: function of purchasing inputs (raw materials), supplies, machinery etc.
- Technology development: know-how, procedures or technology embodied in processes
- HRM: directed to recruiting, hiring, training, developing and compensations of personnel
- Firms infrastructure: supports entire set of company processes. Examples are planning,
finance and facility management.
According to Porter, the procurement should provide support to the following business activities:
- Primary activities (direct purchasing): the procurement should meet material requirements is
different manufacturing processes; Make to stock, make to order, and engineer to order.

- Support activities (indirect purchasing): laboratory equipment, lease-cars, office equipment,

etc.
Definition of concepts
The purchasing function is covers activities aimed to:
- Determine the purchasing specifications
- Selecting the best possible supplier and developing procedures and routines
- Preparing and conducting negotiations with the supplier
- Placing the order with the selected supplier
- Monitor and control of the order to secure supply (expediting)
- Follow-up and evaluation
Purchasing function: activities aimed t determining the purchasing specification based upon fitness
for use selecting the best possible supplier and developing procedures and routines able to do so.
Total cost of ownership: relates to the total cost that the company will incur over the lifetime of the
product that is purchased.
Sourcing: Finding, selecting, contracting and managing the best possible source of supply
Category: group of product which can be substituted for one another by a consumer
Sourcing strategy: identifies for a certain category from ow many suppliers to buy, what type of
relationship to pursue, contract duration, type of contract to negotiate for, and whether to source
locally, regionally or globally.
Partner: firm with whom your company has an on-going buyer-seller relationship, involving a
commitment over an extended period, a mutual sharing of information and a sharing of risks and
rewards resulting from the relationship.
Purchasing management: relates to all activities necessary to manage supplier relationship in such
way that their activities are aligned with the company’s overall strategies and interests.
Value chain Management: idea is that supplies are challenged to improve the (buying) company’s
value proposition technical and staff to reduce the products overall costs.
Importance of Purchasing to Business

The DuPont analysis shows that purchasing contributes to improving the company’s RONA in 3 ways:
- Through reduction of all direct material cost: measures like number of suppliers, improved
product standardization, competitive tendering, substitute materials.
- Through reduction of the net working capital employed by the company: longer payment
terms, reduction of (pipeline) inventory, supplier quality improvements

- Through improving the company’s revenue generating potential: challenging suppliers for
new product ideas and process improvements.
Classification of Purchasing Goods

The purchasing process my concern a large variety of goods, and of course, services. In general,
purchased materials and services can be grouped into the following categories:
- Raw materials - Investment goods or capital
- Supplementary materials equipment
- Semi-manufactured products - Maintenance, repair and operating
- Components materials (MRO / indirect materials)
- Finished products or trade items - Services
- Investment goods or trade items
Challenges and changes in Purchasing context

- Global sourcing - Resource scarcity
- Leveraged purchasing and supply - Supplier integration
strategies - Early supplier involvement and new
- Corporate social responsibility and product development
business integrity
Chapter 2: Industrial Buying Behavior: Decision-Making

in Purchasing
Learning objectives:
- Major differences between organizational and consumer buying behavior
- The key elements of the purchasing process
- The various roles in a buying decision-making unit
- The involvement of the purchasing department in the acquisition of various goods
- How to model organizational buying behavior and network-theory
Introduction
Budget: serves as a vehicle for delegating activities and responsibilities to lower management level in
the organization.
Organizational Buying Behavior: Basic Characteristics

Buying processes: includes determining the purchasing needs, selecting the suppler, arriving at a
proper price, specifying terms and conditions, issuing the contract or order, and follow up to ensure
proper delivery and payment.
Characteristics of industrial markets:

- Professional purchasing
- Derived demand: most companies sell to other companies. Few manufacturing companies
deliver directly to the end-user. For this reason developments in industrial markets are often
influenced by changes which occur in the end-user markets.
- Inelastic, fluctuating demand: due to complex decision-making, the price-elasticity in
industrial markets its often lower than consumer products.
- Geographical concentration


- Large order quantities and large amounts of money involved

- Limited number of customers
The major difference between consumer sector and industrial is related to interaction and (mutual)
interdependency between buyer and seller. B2B is characterized by long-lasting relationship.
Models of Industrial Buying Behavior

The purchasing process differs two stages: (1) variables that affect the buying process and (2)
variables that affect buying behavior.
Variables that affect the buying process

- Characteristics of the product: raw materials vs spare parts, differs from financial
importance, their technical complexity and SC risk.
- Strategic importance of purchase: the higher the importance, the more involved general
management will be. This is not only about the money, but also about bottleneck products.
- Sums of money involved in purchase: as the money involved increase, so does the
management role.
- Characteristics of purchasing market: as risk becomes higher, more disciplines will be
involved in the process
- Role of purchasing department in organization : this varies per organization. The internal
structure of the organization generally governs the way in which the purchasing decisions are
made.
- Degree to which the purchased products affects existing routines in the organization : when
the decision will be more complex, take more time and require the involvement of more
disciplines as the products that are to be purchases require adjustment in internal
organization or necessitate educational training.
Variables that affect the buying decision
Webster and Wind define two variables:
- Task variables: are related to the tasks, responsibilities and competences assigned by the
organization to the persons involved in the purchase decision-making process
- Non-task variables: are related to the personalities of the persons involved in the purchase
decision-making process
Decision-making unit (DMU) / Buying center:

- Users: people who will work with the product, either individual or as a group
- Influencers: able o affect the outcome of the purchasing process by means of solicited or
unsolicited advice
- Buyers: who negotiates with the supplier about terms and conditions
- Decision-maker: actually determines the selection of suppliers.

- Gate-keepers: who control the flow of information from supplier towards the other members
of DMU.
The Purchasing Process
The purchasing model shows how the different purchasing activities are interrelated.
- Aligned with business needs (technical specifications/supplier selection)

- Process approach (quality of output is determined by extent of quality of subsequent steps)
- Defining the interfaces
- Determining responsibilities.
- Combining different skills, types of knowledge and expertise
- Straight rebuy: relate to the acquisition of a known product form a known supplier
- New-task situation: when the organization decides to buy a completely new product,
supplied by an unknown supplier
- Modified rebuy: when organization wants to purchase a known supplier, or an existing
product from a new supplier
- E-procurement solution: web-enabled solution to support procurement process.
The Specification Phase

Purchasing requirements are determined and the company is also faced with the make-or-buy
question. In general, purchasing managers differentiate between:
- Functional specification: functionality which the product must have for the user
- Technical specifications
both functional and technical specifications are part of a wider concept, which Is referred to as
purchase order specification. This document consists of:
- Quality specifications - Legal and environmental
- Logistic specifications requirements
- Maintenance specifications - A target budget
Supplier selection Phase

Consists of 4 steps:
1. Determining the method of subcontracting
2. Preliminary qualification of suppliers and drawing up the ‘bidders list’
3. Preparation of request for quotation and analysis of the bids received

4. Selection of the supplier (long/short bidders list)
Negotiation and contracting

There are several important aspects of the purchasing agreement:
Prices and terms of delivery
In general the buyer should insist on a fixed price, arrived at through competitive bidding or
negotiation. In practice, different price arrangements are used in purchase agreements:
- Fixed-price plus incentive fee contract : is designed to motivate suppliers by means of
rewards to execute the work above the agreed standard. The incentives do not have to relate
to immediately visible cost reductions
- Cost-plus contract: this type of contract may have different forms: with percentage free,
fixed free, or guaranteed maximum. Mostly more expensive for buyers
- Cost-reimbursable contract: is usually based on fixed hourly rates for labor and equipment
- Agreement with price-adjustment: (Price change clauses) (similar to escalation clauses). This
type is used mainly for agreements with a long-term delivery, or when very specific, market
sensitive materials are processed.
Terms of payment
It is common practice that payment takes place in several terms, partly because the supplier will
have to make large investment to be able to produce the desired product.
Penalty clauses and warranty conditions
Agreements about performance of goods, guarantee of specifications, conditions etc. speaks for
itself.
Other agreements
- General terms of purchase: standard legal and commercial conditions that will apply to every
purchase order issued by the buyer
- Purchase order confirmation: document that is used by suppler in which they agree to
perform according to buyers purchase order
- Battle of forms: disputes that may arise over whether the supplier or buyer general terms
and conditions will apply to a commercial transaction.
Ordering Process
- Routine buying: relates to the acquisition of a known product from a known supplier
- Purchase order /material order requisition : description of internal customer requirements
for goods and or services needed to be obtained from supplier, which will serve as the basis
for the purchase order.
Follow-Up and Evaluation of the Buying Process

Buyers role continues even after the order is received. Warranty claims and penalty clauses need to
be settled. Purchasing and supplier files need to be updated and archived. Supplier and project
evaluations need to be finalized and filed.
E-Procurement
e-procurement solutions can be divided into three types:
- Electronic marketplace
- Electronic auctions
- Order-to-pay solutions: systems that are used to manage the ordering process, ranging from
requisition, to ordering, supplier delivery and payment.

Electronic auctions are divided between:

- Open RFI/RFP: potential suppliers are requested by the buyer to qualify before the actual
auction will take place.
- Reversed auction: which is used by buyers to enforce competitive bidding among a limited
number of prequalified suppliers based on a starting price that is lowered during the auction
- Forward auction: used by suppliers to enforced bidding among a number of prospective
buyers based on a starting price that is increased during the auction.
Third type of e-procurement solutions is electronic catalogues and ordering systems: used for more
efficient ordering handling, improved logistics and improved and better-controlled payments. May be
integrate with company’s ERP-system.
By using electronic catalogue, more purchasing transaction can be brought under contract, as a result
of which the percentage of maverick buying can be reduced considerably.
Major Bottlenecks and Problems

Bottlenecks and problems, found with the purchasing model:
- Supplier or brand specifications - Poor administrative processes
- Inadequate supplier selection - Too much emphasis on price
- Personal relationship - Delivery problems
- Lack of good contractual agreements
Chapter 3: The Purchasing Management Process

Introduction
The objective of this chapter is to systematically answer the question of what it takes to
professionalize purchasing as a key business driver, building on previous chapters. This chapter
describes the basis principles underlying modern purchasing and SCM, and the key elements of the
purchasing management: ‘all activities necessary to manage supplier relationships in such a way that
their activities are aligned with the company’s overall business strategies and interests.’
Primary Tasks and Responsibilities

Based on framework developed earlier, the following tasks responsibilities are considered to be core
to the purchasing function. In each organization, the purchasing and supply managers must consider:
- Operational excellence: securing timely and undisturbed availability of purchased goods and
services, both short and long term
- Cost control and reduction of all purchasing-related spend : spend-management task. Reduce
indirect cost by reducing waste and buffers.
- Risk management: reduce risk of exposure in relation to supply markets
- Continuous improvement: process innovation

It is not necessary that all purchasing processes are structured in the same way. Whether a
purchasing decision needs to be aligned exactly according the company’s agreed purchasing policies
and procedures will be decided by the strategic importance that is represents to the company.
Professionalizing Purchasing: A Few Principles

This section described the major principles of purchasing policies. Preferably, purchasing should be
based on a sound business orientation, reflect a cross-functional approach and be directed at
improving the company’s bottom and top line.
Business alignment
Developing a purchasing and supply strategy requires a thorough understanding of the company’s
overall business policy.
Integrated, cross-functional approach

Purchasing decisions cannot be made in isolation, and should not be aimed only at optimization of
purchasing performance. Purchasing decisions should be made taking into account the effects of
these decisions on the other business activities. Therefore purchasing decisions need to be based on
optimizing Total Cost of Ownership, or creating the maximum value for the company’s purchasing
spend, rather than going for the lowest price.
Performance driven
There should consistently be looking for improving the price/value ratio of the goods and services
bought by the company. They should relentlessly seek to improve supplier performance. Constant
outlook for new promising suppliers.
Purchasing Management Process

Purchasing and supply strategies and operations, need to be aligned with the company’s overall
product/market strategies in a dynamic way. To achieve this, purchasing managers need to
consistently adapt their purchasing management process. Analogous to the management cycle, the
following successive elements are identified in managing purchasing and supply:
1. Purchasing and supply (market) research
2. Determining purchasing and supply objectives

3. Determining purchasing and supply

strategy
4. Action planning
5. Implementation
6. Control and evaluation
Purchasing and supply (market) research

Can be defined as the systematic gathering,
classification and analysis of data
considering all relevant factors that
influence the procurement of foods and
services for the purpose of meeting present
and future company requirements.
It is used to first support purchasing
policies and decision making. Purchasing
research may have internal and external focus
Purchasing and supply objectives, strategy and planning

Based upon the firms overall objectives, purchasing objectives will relate to cost reduction, reduction
of supplier base improving product quality, lead time reduction and so on. Important decisions need
to be made in terms of supplier strategies. (sourcing policy, direct vs indirect buying, make or buy
analysis, integration between purchasing and other functional areas, standardization etc.)
Implementation of purchasing policy
Control and evaluation

Purchasing management must see to it that both results and activities that have been planned are
realized within the available financial resources. To do so, this must be checked against purchasing
plans. As figure 3.4 shows, the purchasing management process is a closed loop. If one of the
elements get insufficient attention, the effect will be that activities will get out of control.

How Purchasing and Supply Management Develops Over Time

The professional development of the purchasing function in organizations can be analyzed form
different angels or aspects. Most authors assume a stage-wise or step-wise development of
purchasing and supply management within organizations with the following characteristics.
- Integrated final stage - Supplier management
- Purchasing organizational status - Supplier relationship
Major drivers, which influence how purchasing and supply management will develop over time, are:
- Business context - Top management commitment
- Company strategy - Functional leadership
- Systems development
Based on this, the follow purchasing development model is introduced

Stage 1 ‘Transaction orientation: serve the factory’

Primary task is to find appropriate suppliers and ensure that the company’s operations processes do
not run out of raw materials and supplied components. There is no explicit purchasing strategy.
Stage 2 ‘Commercial orientation: lowest unit price’

A proactive type of purchasing manager is recruited who can negotiate credibly with suppliers for
lowest price. Striving for the lowest unit cost requires some independence from functions such as
product development, engineering and manufacturing. As a result, purchasing has more autonomy.
Stage 3 ‘Co-ordinated purchasing’

Led by a strong central purchasing department to implement uniform buying policies and systems,
the emphasis here lies on cross unit co-ordination and compliance with nationally negotiated
contracts. This stage, for the first time there is some kind of strategy formulation, aimed at capturing
the benefits from internal co-ordination and synergy.
Stage 4 ‘Internal integration: cross-functional purchasing’

At this stage the emphasis is on cross-functional problem solving with the objective of reducing total
lifecycle cost and not just the unit cost of purchased components. These cross-functional efforts
often include involving key suppliers as join problem solvers, which implies a move from
confrontational to more partnership sourcing. Purchasing performance management is done in the
form of internal customer satisfaction surveys and benchmarking
Stage 5 ‘External integration: supply-chain management’

This stage is characterized by an explicit outsourcing strategy combined with extra attention to
collaborate with SC partners on product development and preproduction planning. The purchasing
function concentrates on creating maximum leverage of the company’s external resources. Suppliers
are actively involved in new product development and process improvement and often reside within
the company. There are residential engineering teams, and improvement teams with members from
different disciplines, diversions and organizations (suppliers).
Stage 6 ‘Value Chain orientation’

The purchasing strategy in this stage will be based on the recognition that most important for success
is delivering value to the end-customer. To satisfy the needs in end-customer markets,
subcontractors seek support among their suppliers. Suppliers are consistently challenged to support
the company’s product/market strategies and to actively participate in product development.

Chapter 4: Buying Business Services

Learning objective
- Understand increasing importance of buying of services
- The difference between buying services and buying goods
- Different views on buying services and implications for purchasing process
- Importance of stakeholder management for buying services
- Specific areas of attention in specifying services, and selecting and contract service provider
- Importance of professional contract management
Introduction
The purchasing function at service providers is usually in one of the first stages of the purchasing
development model. However, a number of service companies have made significant progress in
achieving purchasing excellence. Services are not only bought by service providers, but also by
manufacturing companies. Services are difficult to translate to specifications and volume prediction.
The Increasing Importance of Services

- Service companies the purchase to sales ratio is usually only 10-50 percent. For service
providers the largest part of their total cost is related to personnel.
- When buying services, personal relationships were deemed more important than cost
consideration. This is primarily due to the fact that services are actually produced in close
collaboration and interaction between buyer and seller.
Differences between Goods and Services

- The differences between buying services and goods are many. These differences are due to
the special characteristics of services: going through the different stages of purchasing
process is more difficult for services than for goods.
- Services: ‘a process consisting of a series of more or less tangible activities, that normally
take place in the interaction between customer and supplier employees, or physical resources
and systems, that are offered as an integrated solution to customer problems’.
- Services are differentiated from goods through 4 basic characteristics: intangibility,
perishability, heterogeneity and simultaneity.
- Service level agreement (SLA): describes the performance which needs to be delivered by the
supplier.

Towards a Classification of Services

For a first classification of services the purchasing portfolio approach (Chapter 7) can be used.
However, a more popular way is based upon their physical characteristics. Axelsson and Wynstra
proposed a classification of services, where distinction is made between:
- Facility services (cleaning, catering, - Research and development and
security) technical services (technical
- Financial services (banking service, maintenance)
leasing, salary administration) - Transportation and distribution
- Professional services (legal) services
- Information and communication - HR-services
technology service (computer help - Marketing services
desk)
This classification is based upon the functional environment in which the service is consumed. There
are many ways to classify services. It is important to realize, that the way in which companies classify
services will affect purchasing decision-making and will also influence the operational phase that
follows after contract closure.
The Pre-Contractual Stage

We will discuss three important stages of the pre-contractual stage – the tactical purchasing process
– i.e. specifying, selecting and contracting services
Specifying: defining the scope of work for service providers

The scope of work for service providers can be specified in three different ways:
- Specification of the inputs that will be used by the service provider : the contract is aimed at
describing the resources and capacities that will be used by the service provider to produce
the requires service.
- Specification of the throughputs, or the process that needs to be in place in order to produce
the requested service: based upon general description of the work that needs to be
accomplished, both parties agree on the activities that will be performed by the service
provider (project planning).
- Specification of he outputs (or outcome) that need to be generated by the supplier : the
buyer is explicit in terms of the results that need to be accomplished and delivered by he
service provider (KPI/SLA).
Selecting service providers

The more intangible the service is, the more the time buyer will spend on prequalifying and pre-
selecting the future service provider. Hereby, the supplier references and reputation are important.

Contracting for services

When buying services, it is often not so clear when the contracted performance has been delivered
by the service provider. At the contractual stage, it is important to agree on what criteria will be used
to assess the quality of the service provided by the service provider. Both parties need to agree on
KPI’s.
The Post-Contractual Stage

- Having agreed on the contract, the most important stage in the purchasing process is yet to
follow. At this stage the buying organization and the service provider should actively
collaborate to establish a successful service. The interaction between buyer and supplier is
continuous is nature, as in the situation where internal activities have been outsourced to an
outside service provider and in which service provider staff actually reside within the buying
organization.
- Here it becomes clear how successful the previous purchasing activities actually have been.
- Contract managers: responsible for selecting the right contract, contract negotiation and
contract compliance by buyer and seller.
- Creating and effective link
between the tactical purchasing
process and the operational
stages of the project and
contract execution is extremely
important. It means that
operational staff members in
company are consulted at an
early stage about how activities
actually take place.
Involvement of Purchasing
in contracting of services
- The higher the importance of the
service (critical service), the
more company experts are
involved. Internal experts may have long-term experiences with service providers, leading to
excellent interpersonal relationships. When tight interpersonal relationships between
internal customer and supplier exist, it will be difficult for nay buyer to interfere.
- If the expectations and ways of working between purchasing department and other
departments are not aligned, competence problems and friction between parties involved
will be the result. Therefore purchasing and the internal customers need to be aligned on the
role and importance of professional supplier management. An important objective may be to
seek control and good governance in all supplier relationships.

Chapter 5: Contract Management for Complex Projects

Learning objective:
- Understand perspectives that can be used to manage contracts in complex project setting
- Different elements of the contracting process
- How to identify and overcome opportunism in contractual relationships
- What contract models exist and when to apply them
- How to decide about different pricing and payment mechanisms for contracts
Introduction
When dealing wit projects, buying is not sufficient. In general a wider connotation of contracting or
contract management is used in project business. Contracting for projects is different from buying
goods and services, since projects are by definition unique. Projects need to go through all steps of
purchasing process model.
Contract Management and Contracts: Agency Theory

- Parties that operate in value-chains are linked to each other through contracts. Contract
management is about deciding on the right type of contract for the product, service or
project to be delivered. Next, it is about managing the contract after contract negotiation
and closure.
- Contract management stages: consists of pre-contractual stage, the contract negotiations
and closure stage, and the post-contractual stage. These stages are interrelated.
- Bounded Rationality: different contractual perspectives due to incomplete information and
self-interest.
- A good contract does not only focus on product or services delivery. Is also takes into
account the goals and objective of the end customer.
- A major problem that underlies contract management, is how to transform a conflict system
into a cooperative one. Agency problem: conflict of interest between buyer and seller due to
conflicting goals and information asymmetry. The main focus on the agency theory is on how
to determine the most efficient an effective contract between parties, who differ in terms of
risk-aversion, self-interest, bounded rationality, information effort and experience.
- Agency theory differs two types contracts:
o Behavior-oriented contacts: specify how the agent, should deliver the work
o Outcome-oriented contracts: specification of desired outcome of contractor work
(rather than activities and tasks)
- It is assumed that outcome-based contracts are more effective in curbing agent
opportunism: situation where agent will act primarily out of self-interest.
- Moral hazard: risk that both contractual parties will primarily pursue their own interest.
- Conflict of interest: buyer wants to pay as little as possible and seller charge as much as
possible
- Conflict system: contractual relationship where parties pursue different objectives.
- Co-operative system: parties act rationally in the name of a common objective
- Three different types of contracts:
o Fixed-price contract: contractor agrees to work based on a fixed sum
o Reimbursable/time and materials contract: contractor agrees to work based upon
compensation of all actual costs incurred plus profit margin
o Unit-rate contracts or charter contracts : contractor receives a fixed sum per unit of
worked completed.

The Contracting Process

Contracts may go through different stages and may have different lead times. In reality, the following
stages may be identified in the contracting process
Pre-contractual stage
1. Basic design and engineering. This stage includes the activities which are required to arrive at
a technical specification of the project. i.e. feasibility of the project, functional and basic
design, which may result in more detailed project description and technical specifications
2. Tendering. This stage the buyer communicates the future project to the market. Private
companies have more freedom than governmental. Suppliers should have sufficient time in
order to prepare their proposal, risk plans and contacting their suppliers.
Contractual stage
3. Contract negotiation and closure. Most bidders wont make it to this phase. Based on a
number of competitive bids, the buyer will reselect one or two suppliers to negotiate.
Contract execution
4. Detailed project engineering and planning . After landing the contract,, the engineering
department will take care of detailed technical specifications and drawings. Based on this,
budgets are prepared for man-hour spend.
5. Subcontracting and procurement. When agreement has been reached on the main contract,
the agreements with the subcontractors and materials suppliers should be finalized. Here
there are different options. (1) choose for back-to-back agreement, to make sure all major
performance clauses of main contract are mirrored in contracts with subcontractors and
suppliers. (2) they may hose to go for best competitive bid, selecting the subcontractors and
suppliers on the lowest price possible (3) mix of previous.
6. Project execution. Project work is commenced before all contracts have been finished.
Variations in contractual agreements need to be discussed, agreed and documented.
7. Testing and delivery. As project moves beyond its major milestone, work needs to be
approved by the buyer or their representative/engineer.
8. Maintenance and guarantee period. After delivery of work, the contractor and supplier
remain liable for defects and failures
Post-contractual stage
9. Claims. Long after project has finished, legal counsels and lawyers may be busy for years to
settle claims from the buyer and or subcontractor.
Problems in Contract Management

Contracts reported following issues in the relationship with clients:
- Misalignment of objective between client and supplier.
- The buyer is lacking sufficient knowledge and expertise
- Active involvement of engineering and other consultant (finding more problems is more cost)
- Contract management (more businesslike)
- Inefficient decision-making
- Frequent scope- and planning changes
- Misunderstanding of what has been agreed
- Payment problems

- Local political pressure

Perspectives on Contract Management
Whatever contract is made among the parties involved, contracts may be perceived from different
perspectives. Here, we introduce the following four perspectives:
- Dyadic perspective: contract parties are limited to the buyer and the supplier. This
perspective applies when parties allocate all risks among themselves and think that all
problems related to their agreement need to be solved by themselves.
- Supply-chain perspective: contract parties are aware, when negotiating the agreement, that
the completion of the work will depend largely on the contribution of suppliers and
subcontractors and other suppliers downstream their supply-chain. The SC perspective is
used when major suppliers or specific supplier capacity and expertise are key to success of a
project
- Value chain perspective: the buyer, subcontractors and suppliers are aware that they have
one common interest: to jointly serve the current and future interest of the end-user. All
contract parties are aware that they may influence the project results and are mutually
interdependent. This perspective usually results in gain- and risk-sharing agreements.
- Network perspective: builds on previous ones and recognizes that no company can act in
splendid isolation. All parties are aware of the interdependencies which may exist in the
relationships of other companies that belong to the same industry.
Contract Models
At this stage of the contract cycle it has become clear what ype of contract will be closed with the
client. Alternatives here are:
- Construction-only contract: the contractor constructs the project in accordance with the
design provided by the client
- Design and construct (D&C): contractor designs and provides, in accordance with the client’s
requirements, plant and/or other works. (recommended for building or engineering projects
designed by the client)
- Contract for engineer-procure-construct (EPC) projects/turnkey projects : suitable for the
provision on a turnkey basis of a process or power plant, where (1) a higher degree of

certainty of final price and time is required, and (2) the contractor takes total responsibility
for the design and execution of the project, with little involvement of the client.
- Design-build-finance-maintain (DBFM) contract : contractor completes work at own risk and
gets paid on long- term payment after delivery.
- Design-build-finance-maintain-operate (DBFM-plus) contract : contractor completes and
operates work at own risk and gets paid based upon actual performance.
Basic understanding of contract models is important, since every contract defines the responsibilities
and liabilities among contract partners.
Contract Building Blocks: Pricing and Payment mechanisms in

Contracts
Pricing mechanics
On contract reward scheme, the buyer chooses whether the contractor’s work will be pid based on a
fixed price or a cost-reimbursable basis. When work is executed on fixed-price, the client orders the
contractor to perform the required activities at a fixed price, and to have the work completed by a
predetermined date.
Cost-reimbursable contracts, if combined with proper incentives for all contracts involved and if well
managed, may represent an effective vehicle to allow for effective collaboration between buyer and
contractor. It represents a situation where all parties involved work on an open-book calculation,
resulting in full transparency.
To determine which has the favor, depends on factors like;
- Scope and comprehensiveness of the specification
- Available time
- Technical expertise
- Knowledge of the industry
A third contract which is used is unit-rate contract/charter contract: contractor receives fixed sum for
per unit of work completed. These contracts determine the cost per activity for repetitive or
standardized ad routine work. Fixed price is good for cost control (better for small projects)
Additional arrangements on pricing

In practice, additional pricing mechanisms and arrangements are used in contracts:
- Fixed-price plus incentive fee contract : designed to motivate contractors by means of reward
to execute the work above the agreed standard.
- Reimbursable contracts: are used in situations where the work cannot be specified
adequately, or when a fixed price constitutes too big a risk for both the contractor and the
buyer
- Target sum contracts: targets are agreed in respect of cost, time an when applicable planned
performance. Next, formulae are devised for the distribution between parties to the contract
of the gains or losses arising from actual variations of targets.
- Unit-rate contracts: based on fixed hourly rates for labor and equipment. However, without
bonus or penalty clause these contracts provide little incentive to minimize labor hours or
cost.
- Agreement with price-adjustment (escalation, i.e. price change clauses ): used mainly for
agreements with long lead times, or when very specific, market-sensitive materials are used
in the project.
When contracting for equipment, it is recommended to record optional prices for future deliveries of
spare parts, and when appropriate, service rates.

Payment terms
- Milestone payment: payments are made based upon deliveries made for each project
planning stage
- Bank guarantee: by the bank of the supplier that supplier will meet its obligation
- Concern guarantee: holding company secuers payment for agreed sum in case business unit
may fail in making payments
- Performance bond: written guarantee form a third party guarantor.
Penalty clauses, liquidated damages and warranty conditions

- Performance guarantee: the contractor guarantees that actual output or outcome of the
work to be delivered
- Liquidated damages: sum that will be paid in case the contractor fails to deliver works
according to the clients specification
- Penalty clause: payment by the contractor in case of partial failure in delivery of works.
Subcontracting and Project Execution

- Back-to-back agreements: key subcontractor contracts reflect all conditions of the main
contract. For strategic supply partners full business alignment should be realized. Back-to-
back agreements are helpful in creating a SC, i.e. value chain orientation.
Contract governance
A contract is a vehicle to serve and facilitate the collaboration
between parties involved. The contract can be aimed at: (1)
meeting the projects objective and (2) meeting the business
objectives and strategic goals of the final customer. A
collaborative attitude towards contract management requires
careful orchestration of four dimensions of the interaction
between buyer and supplier:
- Information flow: parties need to agree on what
information will be provided by whom, at what time,
what form etc. moreover, it should be agreed what
information will be exchanged between parties during
the project.
- Goods flow: agreements on how materials will be
delivered to the work and when the work will become property of the buyer
- Cash flow: parties need to arrange for specific agreements on when payments will be mae
against what warranties.
- Relationship: the human factor is key to project success. Specific arrangements are needed
on how to improve and maintain relationship quality among all the key stakeholders involved

Chapter 6: Public Procurement

Learning objective:
- Understand the principles which are at the basis of public procurement and tendering
- The specific characteristics of public procurement policy
- The content and scope of the European Public Procurement Directives
- The content and all of the six purchasing procedures for public procurement
- The specific problems that may occur when executing these purchasing procedures
The Nature of Public Procurement

Public procurement involves disciplines such as economics, public administration, public finance and
law in its broadest sense. Successful tendering by public authorities requires a thorough
understanding of all of these disciplines. The purchasing policy of public authorities has some specific
characteristics:
- Legality of tendering and public accountability. This holds that private companies may sue
public authorities for not being compliant with the public procurement directives.
- Public authorities’ activities are not subjected to the rules of free markets. They are funded
by tax incomes. Commercial incentive are almost totally absent in public institutions, thus,
there is no drive to create the best value for taxpayer’s money
- Managing the finances. i.e. a budget needs to be spend within the year it is allocated to. Goal
is to spend all the budget.
Legality of the tender procedures, public accountability, the absence of commercial incentives and
the budget system are prime reasons for the slow development of procurement as a discipline within
public authorities.
Public Procurement Law

Public procurement law: prescribes in a formal way how to go about government contracts, i.e. how
to deal with suppliers and how to award public contracts. The objective of procurement law is to
make the European market for public contracts accessible to all providers and suppliers regardless of
their nationality.
In December 2011 the Commission announced two proposals for new procurement directives, both
for public authorities and the utilities. These proposals have to complementary objectives.
- Increase in efficiency of public spending to ensure the best possible procurement outcomes
in terms of value for money.
- Allow governmental buyers to make better use of public procurement in support of common
societal goals such as protection of the environment, higher resources and energy efficiency,
combating climate change, promoting innovation etc.
Principles of Public Procurement

The Treaty established a number of fundamental principles which apply to public procurement. One
of these fundamental principles is the prohibition against discrimination because of nationality. The
other are equal treatment, transparency and proportionality.
Non-discrimination
The principle means that it is prohibited to discriminate suppliers, directly or indirectly, on grounds of
nationality. So it may not include requirements that only national companies can delivery.

Equal treatment
The principle must guarantee that the contracting authority will not discriminate whatsoever. This
principle stipulates equal treatment of all tenderers, during all stages of the purchasing process.
There should be equal playing level for all tenderers
Transparency
The principle of public procurement transparency means that the tenderer must be selected in a
transparent manner and according to a prescribed procedure. Procurement procedures are public.
Proportionality
The principle means that requirements in the specifications and for the supplier must have an
obvious link with and be proportionate in relation to the subject matter of the contract.
Scope of the European Directives on Public Procurement

Scope
With regard to the public procurement scope of the European Directives, we need to differentiate
between to whom the directives apply and what contracts need to be tendered according to these
directives.
Directive 2004/18 applies to public authorities such as governmental institutions, regional or local
authorities and bodies governed by public law. The latter may include specific research organizations,
universities, academic hospital, educational institutions etc.
Public procurement principles: four major principals underlie each of these procurement directives.
These are non-discrimination, equality, transparency and proportionality.
Framework agreements
The contracting authorities have the possibility of implementing framework agreements. This is an
agreement between one or more contracting entities and one or more suppliers, the purpose of
which is to establish the terms of governing contracts to be awarded during a given period, in
particular with regard to price and, where appropriate, the quantities envisaged. They are used to
deal with repetitive supplier in an efficient manner.
Excluded assignments
As for every legalization, the European directives on public procurement arrange for expectations.
They may fall into two categories:
- There are contracts for which the European regime is not at all applicable and
- There are contracts for which special arrangements are made.
The first category is referred to as exclude contracts. The second category is referred to as negotiable
European contracts. The latter category will be discussed in more detail below. (notices and public
procurement procedures: procedures that public institutions need to adhere to when making
purchasing decisions. Different procedures are:
1. Open procedures 5. Negotiated procedure without prior
2. Restricted procedures publication of a contract notice
3. Competitive dialogue 6. Design contest.
4. Negotiated procedures with prior
publication of contract notice
The following public contracts are not subject to the European directives:
- Acquisition and rental of existing immovable property, unless it concerns the rental or
acquisition of building which has been specifically designed for the contracting authority

- Contract Ministry of Defense

- Secret assignments or assignments aimed at protecting state security
- Intra-public assignments: assignments for work given by one public authority to another
public authority.
Threshold values
Threshold values: represent the purchasing volumes beyond which public institutions are obliged to
follow European legislation when making their purchase decisions. There are different threshold
values for work, suppliers and services.
Notices and Public Procurement Procedures

Notice
A European tender starts with a contract notice. It is in fact an advertisement through which the
contracting authority invites interested parties to submit a proposal. The notice states the
characteristics, the specific requirements related to the assignment and the selection criteria that
prospective providers should meet Change in terms 52 before formal notice. Advantage notice:
prospective suppliers and providers will be informed early about the intended tender, so they can
prepare properly.
European procurement procedures

European procurement procedure is defined as: ‘total set of rules and regulations that are aimed at
selecting the best supplier for the best product against the best conditions, recognizing European
laws and regulations.’ It includes:
- Open procedure
o Idea is that every market party within the EU should be able to subscribe to a public
tender.
- Restricted procedure with prior publication of a contract notice
o Each EU supplier and suppliers from GPA countries may compete for contracts that
are tendered through this procedure. This procedure is different from the previous
one in the fact that the tender process is split into two distinct stages: ‘the stage of
selecting suppliers that are interested’, and ‘the stage in which the preselected
suppliers are invited for tender’.
- Competitive dialogue.
o A special procedure, which may be applied by a contracting authority in specific
circumstances and for very complex projects. It is not relevant for the public utilities
sector. A project is complex when the contracting authority is not able to come up
with a detailed specification and when the legal and financial terms cannot be
defined. First pre-selection of qualified parties is made. Next, parties are consulted
for the solutions that best fit. Dialogue ends when the contracting authority has
selected the best possible solution.
- Negotiation procedure with publication of the contract notice
o Here, the contracting authority can negotiate face-to-face with market parties about
the contents, execution, and cost related to the contract. The negotiation procedure
can be used with or without (prior) announcement. It starts with a pre-selection of
interested and qualified parties. The negotiation procedure with a contract notice
can be applied by contracting authorities only in very specific cases:
 When, in case of a public or non-public procedure or competitive dialogue,
irregular bids by suppliers have been obtained

 When the bids have been solicited are in fact unacceptable

 In very specific cases where the cost related to executing the assignment
cannot be estimated in whatever way due to unforeseen circumstances.
- Design contest
o Procedure that is used to obtain a plan or a design based on competition between
expert parties. The design is to be judged by a professional hurry and market parties
may be rewarded in terms of a monetary value or otherwise. It is used in
architectural work, but also in complex ICT architectures
Procurement Process
Defining specifications
A specification is a description of what the contracting authority intends to buy. They are important
since they have the input for the consecutive stages of the purchasing process model. It will appear,
that specifications not only will be decisive for what supplier qualification criteria to use, and what
contract award criteria to use, these will also determine the actual contract to be agreed upon with
the supplier. One of the principles to be met during a European purchasing procedure is the principle
of Proportionality. This means that the specifications and conditions should be in line with the nature
of the assignment and linked to the subject of matter. Any brand and supplier specific specifications
are forbidden.
Supplier selection
- Selection criteria are the requirements that the contracting authority will use the select all
preselected suppliers. Bid-award criteria are used to evaluate the detailed supplier
proposals. Mixing up the supplier selection criteria and award criteria is a frequently made
error in public procurement practice and, hence, the basis of many cases that have been
brought to court.
- For contracting authorities selection criteria can be divided into two distinct categories:
exclusion criteria and suitability criteria. Exclusion criteria relate to the personal situation of
suppliers and are further divided into mandatory and optional grounds of exclusions.
Mandatory exclusion criteria are participation in a criminal organization, corruption and
fraud with financial interests of the European Union and money laundry.
- Suppliers which were not selected, are to be informed about the reasons for decline.
Soliciting bids and awarding contracts

- The final stages of the tender process relate to evaluating the bids received, the initial award
of the bid, informing non-selected parties about refusal and, finally, awarding the contract to
the supplier selected. When evaluating the bids received, the contracting authority may
choose between the lowest price and the most economically advantageous bid. When going
for the lowest price, only the price will be considered.
- When going for the best economic offer, other aspects than price will play a role; quality,
technical merit, aesthetics, functional or environmental characteristics, running cost etc.
- When the buyer may come to the conclusion that the assessment grid needs to be changed,
it does not have any other option than to stop the procedure and start a new one. This is a
great disadvantage of the current European procurement legislation.

Implications for Public procurement

- In general, the European directives on public procurement have met great resistance, as
much in the public procurement community, as in the circle of government managers and
politicians. This resistance is caused by relentless complaints concerning the complexity of
directives themselves, their lack of flexibility, the terms that need to be adhered to for
publication and answering questions, the fact hat the directives do not stimulate supply chai
collaboration and innovation sufficiently, and the complex (project) administration that is
required for the application of these directives.


Chapter 7: Purchasing and Business Strategy

Learning objective
- Understand changing international business context & how companies strategically respond
- The increasing strategic role of the purchasing function
- Role of purchasing in strategic management literature
- How to develop purchasing excellence
- How purchasing can support the company’s business strategy
- Global sourcing as a potential sourcing strategy.
The Strategic Role of Purchasing

Due to increased outsourcing of business activities, purchasing and supply management has
developed into a functional domain of strategic relevance. As suppliers gradually became more
important for the competitive positioning of the firm, research in the field examined topic such as
SRM, collaborative networks and early supplier involvement. ‘Strategic purchasing’ focuses on
integrating the purchasing and supply function with other functional domains within the firm.
Purchasing’s Role in Strategic Management Theory

Strategic planning and marketing theories
A first sign of strategic change after WWII was presented
by Ansoff, who introduced the SWOT matrix and the
strategic growth matrix. When pursuing growth, Ansoff
presented four different routes: (1) market penetration,
(2) product development, (3) market development and (4)
diversification).
Going for market share was supported by the Boston
Cosulting Group, who introduced its famous Market
Growth-Market Share matrix.
The idea of this matrix was to spread financial risk and be
selective when investing in new products and markets.
Competitive strategy
Development in IT together with different view on purchasing (move toward procurement Porter).
Also McKinsey introduced the 7S model, which shows that apart form hard factors such as strategy,
structure and systems, companies also needed to pay attention tosoft factors such as staff, style,
skills and superordinate goals. Porter introduced purchasing – supplier management – as an
important driver of competitive performance.
Innovation strategy and competence management

When discussing competitive strategy in the nineties, innovation emerged as an important driver of
competitive strategy and profitability.
- Resource-based view of the firm : theory that business success is primarily achieved through
deploying a company’s unique resources. Successful companies seemed able to utilize their
resources better and more effectively than their competitors.
- Core competencies: those activities through which the company achieves sustainable
competitive advantage
- Non-core competencies: those activities that are conducted within the company that do not
contribute to sustainable competitive advantage.

From internal to external resource management

In parallel to the resource-based view of the firm, their researchers have suggested that rather than
internal resources, the way firms deal with their external resources determines a firm’s
competitiveness. The central proposition in the resource dependency theory: is that firms change as
well as negotiate with their external environment in order to secure access to the resources, which
they need to survive.
Strategic management thinking: implications for purchasing and supply management
Towards Purchasing Excellence

With regard to the strategic management processes, the following processes need to be defined,
conceptualized and implemented:
1. Insourcing/outsourcing: when the activity contributes to achieving competitive advantage, it
should be insourced, else it should be outsourced.
2. Develop commodity strategies: at this stage, the company needs t develop a clear and
detailed picture of its purchasing spend. Such strategy provides guidelines on whether or not
to pursue product standardization and reduce product variety, whether or not reduce
number of suppliers, what type of relationship etc.
3. Establish and leverage world class supply base management : supply base management is
part of every commodity strategy. It covers how many suppliers will be dealt with for a
certain commodity, what conditions and qualifications the best in class supplier should meet
and how the best suppliers will be selected. Here suppliers are staged and benchmarked.
4. Develop and manage supplier relations: in order to do so, suppliers need to be grouped into
distinctive categories.
5. Integration of suppliers in product development : once selected the best-in-class suppliers,
companies next should focus their efforts on building constructive relationships with
suppliers in the area of new product development. Technical experts from suppliers become
part of R&D teams
6. Supplier integration into the order fulfillment process : idea is that manufacturer and supplier
ultimately have one mutual objective, whish is to satisfy the final customer as best.
7. Supplier development and quality management : at this stage suppliers are challenged
actively to provide new ideas for improvement. These ideas may relate to product design,

manufacturing technology and other business process. Ideas and suggestions are carefully
considered ad action is taken to implement them. Suggestions are seen as source of
innovation and improvement.
8. Strategic cost management: this concept includes the identification of all costs, cost drivers
and strategies aimed at reducing or eliminating cost throughout the SC. Developing cost
models and value stream mapping are important concepts and vehicles at this stage. Idea is
that both parties work jointly. With end customer to realize cost savings.
Enabling processes
Besides giving attention to these management processes, purchasing managers also need to
recognize six enabling processes following the view of Monczka. These processes can be described as
follows:
1. Establish globally integrated and aligned purchasing and SC strategies and plans : strategic
priorities should be reflected in the incumbent purchasing strategies and plans. It is
important that rules and guidelines are available on how to developed and implement such
plans. Therefore, the templates to be used as well as how to structure the process of
decision-making should be outline top-down.
2. Develop organization and teaming strategies: purchasing strategies and plans need to be
developed in close collaboration with all stakeholders concerned, and the strategies and
plans need to be communicated and shared. In general, training and education are
mandatory in order to change the often traditional view on purchasing.
3. Deploying globalization: international companies need to pursue an international and global
approach toward their sourcing strategies. Requires good feel for other cultures
4. Develop purchasing and SC measurements: this process is aimed at developing and setting up
periodic reports to the management based on a limited number of well-chose key
performance indicators. These indicators, will relate to cost savings that have been realized,
supplier performance, lead time reduction, inventory reduction etc.
5. Develop and implement enabling IS/IT systems : to be able to produce effective purchasing
management information, investments in advanced IT systems are necessary.
6. Establish human resource development and training : company Is as good as people that
work for it. HRM is aimed at defining the right competence profiles for the purchasing
position involved, recruitment, training etc.

Purchasing Portfolio Analysis: Principles

Key in developing purchasing and supply strategies is the issue of influencing the balance of power
between the company and its key suppliers. The balance should be according to Kraljic, be in favor of
the buyer. Else, the company may suffer from being too dependent on a specific supplier, who may
be able to pass on their requirements and conditions to their customers. In developing effective
supplier strategies, the following questions are helpful:
- Does the present purchasing strategy support our business strategy and does it meet our
long-term requirements?
- Are the strategic products and services sourced from the best-in-class suppliers?
- What percentage of our purchasing requirements is covered by long-term contracts
- To what extent are internal operations benchmarked against those of specialist suppliers?
Kraljic’s purchasing portfolio: a matrix indicating for quadrants, represented for basic supply
strategies, based upon financial impact and supply risk represented by a specific product category. In
this approach the purchasing turnover and the supplier base are analyzed on the basis of two
variables:
- Purchasing’s impact on the bottom line of the company : the profit impact of a given supply
item is measured against criteria such as cost of materials, total cost, volume purchased etc.
the higher the volume or amount of money involved, the higher the financial impact of
purchasing on the bottom line.
- The supply risk: measured against criteria such as short-term and long-term product
availability, number of potential suppliers available, cost of changing supplier, inventory risk,
geographical distance. Sourcing a product from just one supplier without an alternative
source of supply, in general will represent a high supply risk.
Combining these variable yields a two-dimensional matrix with four quadrants. Each offering
different interest to the company:
- Strategic products: these are high-tech, high-volume which are often supplied at customer
specification. Only one source of supply which cant be changed in short term without
incurring considerable cost. Looking at the balance of power between the parties involved
one can differentiate between three different sub-segments:
o Buyer-dominated segment: requirements are in fact imposed on the supplier by the
buyer/manufacturer

o Supplier-dominated segment: through technology and carefully designed marketing

strategies the supplier actually has the customer ‘locked in’ a relationship
o Balanced relationship: neither of the two parties dominates the other. They have
mutual interest in keeping the relationship stable.
- Leverage products: these products can be obtained from various suppliers at standard
quality grades. They represent a large share of the end products cost price and are bought at
large volumes. A small change in price has a relatively strong effect on the cost price of the
end product. Using e-auctions may be useful here to arrive at competitive prices in an
efficient way.
- Bottleneck products: these items represent a relatively limited value in terms of money but
they are vulnerable with regard to their supply. They can only be obtained from one supplier
- Routine products: few technical or commercial problems from a purchasing point of view.
Usually have small value per item and there are many alternatives. Problem is cost of
handling is higher than product itself.
Four basic supplier strategies

For every segment of the portfolio a different strategy is possible:
- Performance-based partnership: require a centralized or coordinated purchasing approach.
Depending on the relative power position of the different parties involved, the purchasing
policy for strategic products will be aimed at partnership or collaboration. Goal is to create
mutual participation based on re-planned and mutually agreed cost and operational

improvement targets. An essential aspect of this strategy is thorough selection of the

supplier. Quality system: the collection of methods and procedures used for quality
management.
- Competitive bidding: for leverage products a purchasing policy based on the principle of
competitive bidding or tendering will be pursued. There will be no long-term relationships.
Buyers will adopt a multiple sourcing strategy (buying at low cost while maintaining quality
and supply)
- Securing continuity of supply: purchasing policy concerning bottleneck products should focus
on securing continuity of supply. At the same time activities are conducted aimed at reducing
the dependence on these suppliers. Done by developing alternative products and looking for
alternative suppliers. However, cost involved in these action often exceed te cost saving
obtained. Risk analysis to determine the most important bottleneck items is short, middle
and long term is necessary.
- Category management and e-procurement solutions. MRO products require a strategy which
is aimed at reducing administrative and logistic complexity. Buyers will have to work out
simple but efficient ordering and administrative routines with suppliers.
The use of purchasing portfolio leads to differentiated purchasing strategy. It points out that
suppliers represent a different interest for a company.
For a buyer the product might have a different strategic importance than for the supplier. Therefore,
the Dutch windmill is introduced. This portfolio allows the buyer to mirror his view to the one used
by the supplier.

Chapter 9: Category Sourcing: Getting Better

Performance from Suppliers
Learning objective:
- Understand why in most deals with suppliers there is room for cost-savings
- Understand what it takes to develop a sourcing strategy
- Identify different elements of a category sourcing plan
- Know how to assemble a cross-functional sourcing team
- Identify KSF for successful implementation of sourcing strategies.
Reasons Underlying Cost-Savings Potential In Purchasing

The following are reasons why slack in materials costs and prices may exist:
- Traditional purchasing: buyers are only involved late, if at all in the purchasing decision
process and the company actually deals with a fixed group of familiar suppliers. Specific
policies on purchasing or on how to deal with suppliers are hardly developed.
- Continuous and relentless competitive bidding among a fixed group of suppliers. In many
cases purchasers regularly sound out competition among their often known suppliers by
playing them off against each other. Get lowest cost from one supplier, and go with that
lowest bid to another supplier. This takes valuable time and promotes silent agreements
cartels between suppliers
- Overspecification: technical specification are defined by R&D and technical department only,
without any input from purchasing specialist or suppliers. This means that technical
requirements are imposed on suppliers which are not necessary for the functionality of the
product.
- Price increases in general are automatically passed on to the next in line (French fries
principle).
- Supplier cartels in (international) supply markets. Cartels in European economies still do exist.
- Supplier’s customer relationship programmers. Many suppliers avoid the discussion on how
to improve their value proposition to their clients. Rather, they spend time and money on
customer relationship programs.
How to Identify Cost-Savings Potential

Any cost saving program in purchasing starts with a thorough analysis of he company’s purchasing
spend by means of a cube. Based on this, a category tree is set-up, which identifies the company’s
most important direct and indirect spend categories. It is defined as: a group of coherent products or
services, bought from the supply market that are used in our company to satisfy internal and external
customer’s demand.
In assessing the cost-saving potential of a certain spend category, purchasing managers may use
different criteria. Cost-savings potential may be dependent on the following factors:
- Customized versus standard (off-the-shelf) specification
- Modular versus component buying
- Buyer-supplier dependence
- Number of suppliers involved in last tender
- Scope of last tender
- Type and age of contract
- Market price versus cost price differential
- Level of purchasing involvement

Category non tree Purchasing prioritization matrix
The following is a list of activities that are required when conducting a feasibility study:
- Definition of caterogy and sub-categories
- Overview of current and future purchasing spend
- Most important stakeholders and actors involved
- Analysis of current supply base
- Future company requirements and needs
- Legalization that may affect requirements and buying process.
- Overview of resourcces that are needed to build and implement detailed category sourcing
plan (identifies the sourcing strategy for a certain category)
Developing a Sourcing Strategy

Based upon a thorough analysis of the company’s future requirements and the company’s current
supply base, the future souring strategy needs to be decided for every spend category. An important
question is whether the supply base needs to be reduced or expanded and where suppliers should
come from, together with what kind of relationship and contract.
Issues that should be addressed by a category sourcing strategy are the following:
- Single vs. multiple sourcing - Buying on contract or buying on spot
- Global vs. local sourcing basis
- Partnership or competitive - Price agreement vs. performance
relationship agreement
Category Sourcing Planning

Category sourcing as a concept includes three stages: ‘category planning’, ‘category sourcing’ and
‘category implementation’.
- Category sourcing plan needs a strong link to the overall business goals and strategies. Next,
stakeholders must be identified, in order to effectively involve these and in a timely manner
in category planning process. The analysis of current and future spend s reviewed, together
with current and future requirements. This is the basis for defining the targets and
objectives. Than the plans will be discussed with the stakeholders. After this the contracting
starts (Chapter 2).
Getting Better Results from Suppliers
Each of these steps will lead to significant benefits and savings:
- Put the best possible legal contract in place
o Thorough analysis of current contract agreements with existing suppliers.
- Select the best possible supplier
o Builds on the previous one. Having a sound legal contract in place, the question now
arises as to whether the contracted partner is the best the company could get. Focus
on analyzing the supply market and sounding out international competition.
Objective is to get a competitive bid from a large number of new suppliers.
- Get the best possible solution from the best possible supplier
o Focus on continuous improvement within the supplier relationship. Concrete
objectives and targets on price reduction, quality improvement, lead time reduction
and improvement of customer service are settled
Main objective is to develop and optimize operational relationship with the best-in-class supplier and
to integrate it into the new product development processes and projects.

The Myth of Partnership

A major objective underlying in co-operation is to achieve significant improvements in:
- Logistics
- Quality
- Product and SC cost
- Product development
Chapter 14: Purchasing, Corporate Social Responsibility

and Integrity
Learning objective
- The importance of corporate social responsibility to large international companies
- Purchasing and supply’s contribution to ‘people, planet profit’
- How corporate responsible purchasing can be embedded in a company’s culture
- The importance of integrity codes within purchasing
- How companies can act responsibly in their relationship with their suppliers.
Introduction
Products are produced by so-called contract manufacturers, to European standards. Doing business
successfully in these countries require careful preparation. Local laws on how to protect the

environment and social security are not widely developed. Child labor, long labor hours and terrible
work conditions are frequently encountered in these countries.
Towards a Sustainable Environment: ‘People, Planet, Profit’

The idea of CSR/sustainability is to develop
business solutions in such a way that
requirements of the current world populations
are met without doing harm to the needs of
future generations.
Sustainable profitability can only be achieved if
the company is able to balance the interests of
customers, employees, society, the
environment and its shareholders. This idea
was expressed by Carroll (1991)( in his famous
sustainability pyramid).
In order to measure progress in the sustainable

domain, large companies report on indicators
that are derived from the Dow Jones Sustainability Index and the Global Reporting Initiative.
Sustainable Purchasing: Towards Sustainable Supply Chains

Philips introduced a sustainability audit, as where companies had to report their self-assessment and
then Philips audited them with their own experts. Variances were discussed and supplier were
invited to come up with an action plan. Suppliers that did not match the CSR requirements were
dropped out.
How to Drive CSR in Supply Chain Relationships

- Most major companies today have CSR integrated in their mission statement and business
strategies. However, initiatives in CSR seem to be sector specific. For retailers more
emphasize product safety and environmental friendliness. While Shell focus more on carbon
footprint.
- When driving CSR in their SC relationships, some activities, tools and techniques are more
popular than other. Most large companies today have specific Supplier Sustainability Codes
of Conduct in place. These need to support the General Code of Conduct and Business Values
of the corporation. These are signed by the supplier, but the procurement should actually
check it.
- Most popular norms and standards are the United Nations Global Compact Principles
(UNGCP), the Global Reporting Initiative (GRI) and the Dow Jones Sustainability Index (DJSI).
Many companies also report to use the ISO 14001.
- To improve supplier sustainability, companies may engage in different sets of actives. One
set of activities is to train supply chain and sourcing staff in sustainability auditing and
capability developing programs.
- Of course, SC and sourcing managers need to report on the results that were obtained from
their supplier sustainability programs (KPI).

Trust, Business Integrity and Ethics

As companies become more dependent on each other, trust and integrity are an important subject
for supply chain research.
- Trust is an critical dimension of supplier-buyer relationship performance. Trust is the
confidence a party has that the other party will behave co-operatively, in a consistent,
predictable and honest manner. In general, trust as a construct consists of fairness, reliability
and goodwill. Trust is perceived as a multilevel construct that can exist at a personal,
organizational, institutional or international level.
- Inter-organizational trust is based on experience, interaction and common history with an
exchange partner.
- In general, three types of trust can be identified: contractual trust (delivering the promised
good or service); competence trust (the ability of the actor to fulfil the expectations) and
goodwill trust (the commitment to do more that formally expected). Goodwill is normal long-
term relationship
- Having skilled labor force is a necessary but not a sufficient condition for building trust in B2B
relationships. In order to be able to generate trustworthiness, companies also need to have
strict ethical principles and procedures. This is why knowledge management has got more
interest.
To increase uniformity in behavior towards the business community, a number of large companies
have become explicit on their policies with regard to ‘business integrity’ explaining their company’s
business values and regulations on matters such as conflict of interest.
Chapter 15: Supplier Management: Cost Approaches

and Techniques
Learning Objective:
- How prices are set by suppliers
- How to use the learning curve technique as a basis for price negotiations
- Supplier evaluation and vendor rating techniques
- How to evaluate the financial position of suppliers
- What it takes to develop suppliers

Introduction
Decisions relating to purchasing price determine the cost price of a company’s product or services-
offering product to a high degree. The importance of purchasing as a function increases if rises in
materials prices cannot be automatically passed on to the customer. Price is therefore one of the
most important elements in the purchasing decision. Cost analysis techniques provide tolls to check
whether price increases announced by the supplier are justified.
How is the Purchasing Price Determined?

The price ultimately paid for materials and services is the result of environmental factors, both
internal and external.
External factors are those factors that may affect the short-term and long-term availability of product
in a given market and they can be divided into economic, socio-political, and technological
development. They relate to factors which are outside the supplier’s control.
The price of a product can be influenced by external factors in two ways, due to direct changes in
cost structure of a particular product or, indirectly, due to changes in market structure and shifts in
supply/demand relationship.
The classification reflects three different pricing models:

- Cost-based pricing: the supplier offering price is derived directly from his cost price; what
most systems boil down to is that a particular profit margin is added to all costs, including the
costs of sales (marking-up pricing)
- Market-based pricing: the price of the product is determined on the market, and is generated
exclusively by market
circumstances, such as demand,
supply, stock positions, the
economic situation and political
factors.
- Competitive bidding: the price of
the product is influenced y
market factors as well as cost
factors. This situation is the most
common.
The following table reflects the

relationship between the pricing methods and the various purchasing product groups:

Pricing Methods
Fixing the selling price is no simple matter. The supplier has to take into account many factors, a few
of which are listed below:
- The expected demand for its product
- The number of competitors in the market
- The expected development of the cost price per product unit
- The customer’s order volume
- The importance of the customer to the supplier
- The value of the product to the customer
All of these factors affect the selling or purchasing price. In practice, the following pricing metods can
be distinguished:
- Mark-up pricing: a fixed percentage mark-up to the cost price. This does not take
competitors into account, nor it acknowledge developments in the demand of product.
- Target-return pricing: the price is determined based on the amount of profit that should be
realized. Based on the fixed and variable cost and the expected selling price, the required
sales volume is calculated. (calculate BEP, then based on profit that is to be made, the
required extra volume is determined.
- Perceived value pricing: general rule in marketing is that you do not base your selling price
on the cost price of the product, but rather on what the market can bear. Often used for
well-known brand articles and industrial products
- Value pricing: the company tries to win customers by charging them fairly low prices for high-
quality offerings.
- Going rate pricing: the firm bases its rice largely on competitors price. The firm might charge
the same amount more, or less, than major competitors. Market leader sets the price.
- Auction type pricing: reverse auctions etc.
One special characteristics of pricing policies for industrial products is the discount policy which is
applied. Some authors differentiate between the following discount practices:
- Payment discount - Geographical discount
- Quantity discounts - Seasonal discount
- Volume bonus - Promotional discount

Wwhen conducting an analysis of the supplier’s cost structure buyers should create detailed
knowledge about:
1. The supplier’s materials cost 4. Transportation and distribution cost
2. Direct labor cost 5. Indirect cost and so on.
3. Energy consumption and CO2
emission rights,
As a general rule, the higher the share of the fixed costs in the cost price of the end product, the
greater the supplier’s price elasticity.
The Learning Curve

The learning curve is an important instrument in the development of purchasing strategies. The
learning effect is general results from the following factors:
- Reduced supervision as experience with production of a particular product grows
- Increased profits, from improved efficiency through streamlining the production process
- Reduced defects and line reject rates during the production process
- Increased batch size
- Improved production equipment and process
control
The basic principle of the learning curve is that ‘each
time the cumulative production volume of a particular
item doubles, the average time required to produce that
items is approximately x percent of the initial required
time’. An 80 percent learning curve means that if the
cumulative number of produced goods in doubled, only
80 percent of the original amount of hours is needed for
producing one unit.
The knowledge is clearly of vital importance to the buyer. Anticipating the supplier’s learning
experience, he can negotiate price reductions in the future. The learning curve is preferably used in
the following situations:
- Wen it concerns customized components, manufactured by a supplier to the customer’s
specification
- When large amounts of money are involved (so that the costs which must be incurred to
apply the technology in question can be recovered
- When the buyer cannot request competitive quotations, which leads the buyer to single
sourcing
- When direct labor costs make up an important part of the cost price of the product be
produced.
Supplier Assessment
Level of assessment
The growing role of suppliers in the company’s business chain increases the need for objective
assessment of supplier performance. The buyer must also want to determine whether a suppler is
sufficiently equipped to live up to the company’s longer-term requirements and needs.

There are four supplier assessment levels:

- Product level: focus on establishing and improving suppliers product quality
- Process level; quality of product strongly relates to the supplier’s manufacturing process
- Quality assurance system level; checking the way in which procedures regarding quality
inspection are developed, kept up-to-date and refined.
- Company level: auditors not only focus on quality aspects, but also on financial aspects.
Supplier assessment methods

Supplier assessment methods used to assess supplier performance may vary from company to
company. Two types may be differentiated. Subjective methods (personal judgement) and objective
methods (quantify supplier performance). The following tools and techniques can be used:
- Spreadsheets: used to systematically compare and assess quotations obtained from suppliers
- Qualitative assessment: used with whom close business relationships exist. They rate quality
control, engineering, manufacturing, production planning and purchasing.
- Vendor rating: limited to quantitative data only. Measuring aspects of price, quality and
delivery reliability per supplier through a limited number of well-chosen KPIs.
- Supplier audit: entails that the supplier is periodically visited by specialists from the customer
- Cost modelling: very detailed approach. Specialists at buying company estimate the
supplier’s unit cost by means of show calculation, based on the production technology, which
currently is being used by the supplier.
Laseter (1998) did provide an interesting framework that may hep buyers identify the most
important cost drivers for their commodities:
Financial assessment
The financial assessment of suppliers is
carried out on the basis of annual financial
reports.
Supplier Development
Supplier assessment and developing cost models are aimed at improving the performance of
suppliers in their relationship with the buying organization.
In order to develop differentiated supplier strategies, companies have segmented their suppliers into
distinct supplier segments.

- Suppliers best choice: for such a customer, suppliers are prepared to invest in the
relationship resulting in a better product and service, allowing the customer company to
make a difference in its end-user and customer markets, irrespective of the business cycle. In
doing so, several actions are required:
1. Purchasing professionals need to provide their suppliers consistently with honest
and clear feedback on their performance.
2. It will be needed to check how satisfied a supplier is with its relationship with the
customer company. This is why a limited number of ompanies have started to
conduct periodic supplier satisfaction suverys.
For a purchasing professional to develop its suppliers to a high level, the following three types of
action:
- Supplier suggestion program: the buyer actively solicits
ideas for improvement from suppliers. May relate to
new product design, current product design, operational
processes, quality assurance etc.
- Supplier development: aims to engage with the suppliers
on the business long-period price-reduction business
model with the objective to create value for both the
customers as the suppliers
- Supplier satisfaction survey: developing a close,
collaborative relationship between business partners
requires that expectations between al stakeholders
involved are made explicit.

Powered by TCPDF (www.tcpdf.org)

Purchasing and Supply Management Stting 1

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Purchasing and Supply Management Stting 1

Uploaded by

Copyright:

Available Formats

Purchasing and Supply Chain

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Chapter 1: The Role of Purchasing in the Value Chain

The Role of Purchasing in the Value Chain

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

- Support activities (indirect purchasing): laboratory equipment, lease-cars, office equipment,

Importance of Purchasing to Business

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Classification of Purchasing Goods

Challenges and changes in Purchasing context

Chapter 2: Industrial Buying Behavior: Decision-Making

Organizational Buying Behavior: Basic Characteristics

Characteristics of industrial markets:

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

- Large order quantities and large amounts of money involved

Models of Industrial Buying Behavior

Variables that affect the buying process

Decision-making unit (DMU) / Buying center:

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

- Aligned with business needs (technical specifications/supplier selection)

The Specification Phase

Supplier selection Phase

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

4. Selection of the supplier (long/short bidders list)

Negotiation and contracting

Follow-Up and Evaluation of the Buying Process

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Electronic auctions are divided between:

Major Bottlenecks and Problems

Chapter 3: The Purchasing Management Process

Primary Tasks and Responsibilities

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Professionalizing Purchasing: A Few Principles

Integrated, cross-functional approach

Purchasing Management Process

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

3. Determining purchasing and supply

Purchasing and supply (market) research

Purchasing and supply objectives, strategy and planning

Implementation of purchasing policy

Control and evaluation

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

How Purchasing and Supply Management Develops Over Time

Based on this, the follow purchasing development model is introduced

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Stage 1 ‘Transaction orientation: serve the factory’

Stage 2 ‘Commercial orientation: lowest unit price’

Stage 3 ‘Co-ordinated purchasing’

Stage 4 ‘Internal integration: cross-functional purchasing’

Stage 5 ‘External integration: supply-chain management’

Stage 6 ‘Value Chain orientation’

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Chapter 4: Buying Business Services

The Increasing Importance of Services

Differences between Goods and Services

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Towards a Classification of Services

The Pre-Contractual Stage

Specifying: defining the scope of work for service providers

Selecting service providers

Gedownload door: tiboluyts | tiboluyts@hotmail.com Wil jij €76 per

Contracting for services