INTRODUCTION TO PURCHASING

AND SUPPLY CHAIN MANAGEMENT

DR. MURALI KRISHNAMURTHY

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 Background
• Historically, the management of materials and component
parts has been the most neglected element in the production
process.
• In the past businesses emphasized minimizing the cost of
capital and labor.
• The focus on labor was logical because the industrial
revolution had generated many labor-intensive
manufacturers.
• Producing large standardized batches represented the norm
for some manufacturers.

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 Setting the Stage

• As a functional area within a firm, purchasing and supply

management grappled with the stigma of being labeled a
clerical function.

• However, in the past 30 years, purchasing has made many

strides toward shedding this label and has emerged as a
viable professional career path.

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 Setting the Stage for Change

• Businesses have had to change radically in response to

burgeoning technologies

• The reality is that technology is rapidly displacing labor.

• During the next decade, the supply management function is

likely to contribute to profits more than any other function
in the company.

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 PURCHASING
Purchasing refers to a business or organization
attempting to acquire goods or services to
accomplish the goals of the enterprise.
All production firms have the need of supplies of
materials and services from external sources.
Purchasing function may include the purchase of
raw material, spare parts.
The chief function of the Purchasing manager is to
satisfy the materials and supplies related to
requirements of other depts. This is done in
accordance with the mission, purpose, goals &
objectives of the firm.

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The key issues involved in purchasing are:-

Quantity

Quality

Time

Place

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OBJECTIVES OF PURCHASING
 Purchase of satisfactory material.
 Proper negotiations with suppliers.
 Co-ordination with other departments.
 Timely deliveries.
 Continuous and regular supply.
 Minimized wastages.
 Quality
 To control the qty. of material
 Information about new material and processes, which
can reduce the cost of production and improve the
performance of the product.
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Definitions
• “Make-or-Buy decisions compare the cost of
producing a component or providing the service
internally with the cost of purchasing the
component or service from an external supplier”

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Outsourcing
• Outsourcing:-
• “Outsourcing is a strategic decision to give a task or
activity to an independent contractor who
determines how best to do the task or activity”.

• (it is a) management strategy by which an

organisation outsources major non-core functions
to specialised, efficient service providers”

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Subcontracting
Outsourcing is a strategic long term decision,
Subcontracting is a tactical, short term approach.
• “Outsourcing is nothing but delegating a particular
business activity/function to another
individual/entity. Sub-contracting is sharing a part
of the business activity with another. ”

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Tactical Make-Buy Decisions
• Some common reasons for make-buy decisions at
this level follow:-
• Delivery failure or poor service by existing source
• To allow the client organization to focus on its core
business
• To access skills and technologies
• To provide flexibility
• Pressure to reduce costs

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Operational Make-Buy Decisions
• - a simple and probably logical rule of thumb when
considering whether to make-or-buy is to carryout
a comparison of cost of making ourselves with
buying in.

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Purchasing vs. Fabrication-Past

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Outsourcing vs Insourcing
• Out - Sourcing is when a company "A" makes an
agreement with a company "B" about giving them
some part of the work to do.

For example BMW outsourced with "Bose Sound

System" in a way that BOSE does all the music for the
BMW cars.

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Insourcing:-
• “In-Sourcing is so similar to Out-sourcing, with the
difference that it is under clients' sight. “
• for example TOSHIBA insourced with UPS (unit parcel
service) in a way that UPS now is in control of the supply
chain for toshiba. if your laptop at home needs repair, UPS
will pick it up and fix it at the TOSHIBA/UPS REPAIR CENTER
and deliver it back to you.
Therefore the difference: BOSE was in charge of doing
sound systems in BMW (Clients didn't see any of that work)
Whereas UPS s in charge of delivering products for TOSHIBA
(Clients were almost managers in that work)

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Why Outsourcing?
• Resource intensive activities – high labour/ capital costs.

• Subject to specialist areas

• Subject to dynamic market conditions for which it is costly

to recruit & retain staff

• Subject to rapid changes in technology with high investment

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Examples of outsourced services
• Car park management • Library
• Cleaning • Medical/ Welfare
• Catering • Pest control
• Building maintenance • Ground maintenance
• Security • Computers &
• Transport management information technology
• Waste disposal

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Types of Outsourcing
• Body shop outsourcing – a means of meeting short
term requirement, shortage of in house skills to
meet temporary demand.

• Project management outsourcing – for all parts of a

particular project, new IT project, training
requirement

• Total outsourcing – supplier given full responsibility

for selected function, catering, security

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Some benefits of Outsourcing
• Gain access to world • Free management time
class capabilities • Reduce staff costs
• Improve organisational • Increased flexibility
focus
• Cost certainty
• Make capital funds
available • Improved service levels
• Reduced capital
requirement
• Reduced risk

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Some problems with outsourcing
• Long term commitment • Quality of service
• Communication with • High staff turnover
suppliers • Poor project
• Dependence on management
suppliers • Lack of control over
• Additional training larger suppliers
• Reduction in flexibility
• Coordinating different
suppliers
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Measuring outsourcing performance
• Typically consider measuring:-
• Response time
• Performance reports
• Satisfactory performance statement
• Penalties for non performance

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 Project Procurement Management
Processes
• “Project Procurement Management includes the processes
necessary to purchase or acquire products, services, or results
needed from outside the project team. The organization can be
either the buyer or seller of the products, services, or results of a
project”.
• Procurement planning: determining what to procure and when
• Solicitation planning: documenting product requirements and
identifying potential sources
• Solicitation: obtaining quotations, bids, offers, or proposals as
appropriate
• Source selection: choosing from among potential vendors
• Contract administration: managing the relationship with the
vendor
• Contract close-out: completion and settlement of the contract

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Figure 2-1. Project Procurement
Management Processes and Key Outputs

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 Procurement Planning Tools and Techniques

• Make-or-buy analysis: determining whether a

particular product or service should be made or
performed inside the organization or purchased from
someone else. Often involves financial analysis
• Experts, both internal and external, can provide
valuable inputs in procurement decisions

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Purchasing vs. Fabrication-Present

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 Purchasing Managers, Buyers, and
Purchasing Agents
• Seek to obtain the highest-quality merchandise at the lowest
possible purchase cost for their employers.

• Purchasers buy goods and services for use by their business

organization.

• Buyers typically buy items for resale.

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 Purchasers and Buyers:
• determine the best value,

• choose the appropriate suppliers

• negotiate the best price, and

• award contracts that ensure that the correct amount

of the product or service is received at the
appropriate time.

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 Purchasers and Buyers
• Purchasing managers, buyers, and agents must become
experts on the services, materials, and products they
purchase.

• Purchasing managers, buyers, and purchasing agents evaluate

suppliers on the basis of price, quality, service support,
availability, reliability, and selection.

• Once all of the necessary information on suppliers is

gathered, orders are placed and contracts are awarded to
those suppliers who meet the purchaser’s needs.

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 Factors That Influence

•• Changing economic and political environments,

emerging technology versus labor, and the changing
nature of purchasing and supply chain management
as a discipline— must influence the role of
purchasing and supply management .

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 Process Definitions and Functions
• The purchasing process is an interacting
structure of people, equipment, methods,
and controls that is designed to accomplish
the following primary functions:
2. Handle the repetitive work routines of the
purchasing department and the receiving
department
3. Support the decision needs of those who
manage the purchasing and receiving
departments
4. Assist in the preparation of internal and
external reports

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Internal Perspective of
Purchasing Process

1. Purchase
requisition
sent from
inventory
control
department to
purchasing
department

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Internal Perspective of
Purchasing Process

2. Purchase
requisitions
from various
other
departments
sent to
purchasing
department

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Internal Perspective of
Purchasing Process

3. Purchase
order sent to
vendor

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Internal Perspective of
Purchasing Process
4. Purchase
order
notification
sent to various
other
departments
or to inventory
management
process
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Internal Perspective of
Purchasing Process

5. Purchase
order
notification
sent to
receiving
department

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Internal Perspective of
Purchasing Process

6. Purchase
order
notification
sent to
accounts
payable
process

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Internal Perspective of
Purchasing Process

7. Good and
services
received from
vendor

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Internal Perspective of
Purchasing Process

8. Receiving
notification
sent to
accounts
payable and
general ledger
processes

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Internal Perspective of
Purchasing Process

9. Receiving
notification
sent to
purchasing
department

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 Goal Conflicts and Ambiguities in the
Organization
• Individual managers’ goals may not be in congruence with
organizational objectives
– Purchasing may buy large quantities of inventory for quantity discounts
and to reduce ordering costs
– This may drive up costs of receiving, inspecting, and carrying inventory
• Ambiguity often exists in defining goals and success in meeting
goals.
– A purchasing goals might be to select a vendor who will provide the best
quality at the lowest price by the promised delivery date
– Realistically, one vendor probably will not satisfy all three conditions
• Prioritization of goals is necessary in choosing the best solution
given the various conflicts and constraints placed on the
process
– Trade-offs are made in prioritizing among the goals that conflict
– If the market is sensitive to satisfying customer needs, the company may
pay higher prices to ensure that it is procuring the best quality goods and
obtaining them when needed
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Organization’s Supply Chain

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 Purchasing and the Supply Chain
• The supply chain is the system of adding value
beginning with acquiring raw materials
(purchasing) and ending with product field
support
• Organizations attempt to achieve maximum value
added in all the supply chain activities
• Internet purchases are driving down purchasing
costs
• Supply chain management (SCM) software
assists with demand planning, one of the most
important areas of supply chain management

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 2 categories of SCM Software
• Supply chain planning software
• Accumulates data about orders from retail customers,
sales from retail outlets, and data about manufacturing
and delivery capability to assist in planning for each of the
SCM steps.
• Supply chain execution software
• Automates the SCM steps.
• ERP software is assigned to this category as it receives
customer orders, routes orders to an appropriate
warehouse, and executes the invoice for the sale.
• Many of the connections between players in the supply
chain are B2B automated interfaces.
• For example, the sourcing step may be implemented
through an automatic order sent to a supplier via the
Internet.

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 Benefits of Managing the Supply Chain
• Lower costs to the customer
• Higher availability of product
• Higher response to customer request for product
customization and other specifications
• Reduced inventories along the supply chain
• Improved relationships between buyers and sellers
• Smooth workloads due to planned goods arrivals and
departures, leading to reduced overtime costs
• Reduced item costs as a result of planned purchases
through contracts and other arrangements
• Increased customer orders due to improved customer
responsiveness
• Reduced product defects through specifying quality during
planning and sharing defect information with suppliers
during execution

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 Things that can go wrong in SCM initiatives
• Data not collected or not shared across functional
boundaries
• Lack of sharing of information between supply chain
partners
• Inaccurate data in the supply chain negatively affects the
entire chain.
• Over-reliance on demand forecasting that may be
inaccurate
– Good demand forecasting requires an intelligent combination of
software tools and human experience
• Competing objectives can lead to unrealistic forecasts.
– Marketing may want a high target to ensure a successful product
– This may be unrealistic
– Therefore promotion and production budgets will be inaccurate
– Sales, on the other hand, will be evaluated on its ability to meet
sales quotas and wants a lower demand forecast.

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Mitigating problems with SCM Initiatives
Technology Summary 12.2
• Types of Collaboration in the Supply Chain
– CRP: Continuous Replenishment also called:
• VMI Vendor Managed Inventory
• SMI Supplier Managed Inventory
– Co-managed Inventory
• A form of CRP
– CFAR: Collaborative Forecasting and
Replenishment (precursor to CPFR)
– CPFR: Collaborative Planning Forecasting and
Replenishment

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 Mitigating problems with SCM
Initiatives
Technology Summary 12.3: CPFR Process

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Purchasing Process—
Context Diagram

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 Inventory Reorder Methods
• Reorder point analysis
– each item is assigned a reorder point based on its
sales rate
• Economic order quantity
– order quantity based on costs of ordering and
carrying inventory
• ABC analysis a technique for ranking items in
a group based on the output of the items
– ABC analysis can be used to categorize inventory
items according to their importance

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Purchasing Process—Level 0 Diagram

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 Data Stores Used in the
Purchasing Process
• Inventory master data
– A record of each item stocked or regularly ordered
• Vendor master data
– Stores information about approved vendors
including vendor performance
• Purchase requisition data
– Data on all purchase requisitions
• Purchase order master data
– Open PO information including status of items on
order
• Purchase receipts data
– Lists items received 5
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Purchasing Process Systems Flow
Chart

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Purchasing Process Systems Flow Chart, Cont’d.

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 Fraud and the Purchasing Function
• Many frauds involve manipulation of purchasing
because it involves the payment of cash
– The typical cases included in this category of process
exploitation are instances in which:
• An employee (e.g., a buyer, purchasing manager, or other
person) places purchase orders with a particular vendor in
exchange for a kickback, secret commission, or other form of
inducement from the vendor.
• An employee has a conflict of interest between his
responsibilities to his employer and his financial interest—direct
or indirect—in a company with whom the employer does
business.

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Purchasing Control Matrix

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Control Matrix, Cont’d.

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 The Supply Management Process

• In most firms, functional managers within each area make

independent decisions using similar techniques.

• The objective is to provide high-quality customer service

while minimizing the cost of producing the service.

• Purpose of supply management is to support the

transformation of raw materials and component parts into
shipped or inventory goods.

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 Purchasing Dollar Responsibility

• The cost of acquiring, storing, and moving materials is an

increasingly large portion of the cost of goods sold.

• Consider the dollar responsibility of one General Motors’

materials management groups:
1.Parts and (materials) = 10 times direct labor dollars
2.Supply management expenditures = $100 billion
3.Transportation bill = $3 billion
4.Purchasing buys 97 percent of all component parts.

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 Ratios Of Materials
Related Costs
•• The following are ratios of materials-related costs
that are typically cited in fabrication–assembly
industries, for example, consumer durable goods.
– Cost of purchase = 80 percent of sales
– Cost of marketing (sales) = 10 percent of sales
– Cost of transportation = 10 percent of sales
– These ratios are increasing for various reasons: material
shortages, increased use of synthetic materials, inflation,
and thoroughly complex high-value products.

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 Ratios Of Materials
Related Costs
• These ratios are increasing for various reasons:
– Material shortages
– Increased use of synthetic materials
– Inflation
– Complex high-value products.
– Where else is the potential for cost reduction and
competitive advantage so great?

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 Potential For Profit
• All supply management activities have potential for cost
reduction and hence increased profit.

• Many opportunities exist to reduce the cost of purchases.

• If the firm’s sales remained the same, the effect on profit,

given the 2 percent reduction of material cost, would look like
that in Figure 1.4.

• For each $1 reduction of material cost, there is a $1 increase

in profit. The ratio is 1:1.

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 Potential For Profit

• What increase in sales would be necessary to increase profit

by $10,000 if material costs were not reduced?

Let x be the required sales; then 0.5x is the cost of materials and 0.2x is
labor cost.
Sales = Variable cost + Fixed cost ± Profit
x = 0.5x + 0.2x + 250 + (10+50)
x = $1,033,333

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 Integrated Supply Management (ISM)
• Achieving integration is a challenge.
• The decisions of a production-inventory control (PIC) manager
may maximize utilization of production equipment, yet poorly
serve the requirements of the marketing manager.
• The decision of the purchasing manager affects not only the
purchasing function, but other materials functions.
• It is the objective of ISM to manage the related
considerations. Purchasing should consider the
nonpurchasing consequences of its decisions.

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Integrated Supply Management (ISM)
• Example
The significance of average inventory is that inventory
cost is a function of average inventory.

Inventory is an asset. Working capital is tied up in

material rather than an alternative asset.

Opportunity costs as well as costs of storing, insuring,

and handling are incurred when inventory exists.

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 Annual Inventory – Ordering
Transportation Costs
• How can the best decision be made—one that provides the
desired customer service at minimum cost?

• The customers are manufacturing, sales, distribution, the final

consumer, and, of course, purchasing, which is the supplier’s
customer.

• The costs of satisfactory customer service are only partly

identifiable and quantifiable.

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 Annual Inventory – Ordering
Transportation Costs
• The opportunity costs of poor customer
service is also incomplete. Yet decisions must
be made while recognizing that system wide
decision criteria are
1.Multiple
2.Complex
3.Conflicting

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 A Developing Discipline
• Supply management is a developing discipline and an
area of management specialization.

• Measures of customer service are usually expressed in

terms of the availability of material.

• Did the plant ship on time? Was the product on the shelf
when the customer entered the shop?

• While important, availability is only one dimension of

customer service.
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 A Developing Discipline.

• As these areas develop, purchasing and distribution cost

accounting will become part of the accounting-information
system. Standard costs to create the time and place utilities
will be calculable.

• Budgeting for materials management activities will have the

detail and reliability of budgeting in manufacturing.

• When supply management costs become more visible, their

control becomes more feasible

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 Organizing for Purchasing
• Supply coordination involves both structure and design
of the organization.

• In any purchasing organization, two major problems

must first be considered.
1. The first issue has to do with where the purchasing function
should be located in the organization.

2. The second issue is, what level of authority should the

purchasing function have? Given the evolution of outsourcing,
the purchasing function is expected to gain authority in the
corporate hierarchy

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 CENTRALIZED VERSUS
DECENTRALIZED PURCHASING

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 Advantages of Centralized Purchasing

• Centralized purchasing results in lower costs because of the

availability of purchase quantity discounts.

• If all material uses are coordinated into one major purchase,

the supplier will work harder to service the buying firm.

• Large dollar purchase quantities equals buying power.

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 Advantages of Centralized Purchasing
• Centralized purchasing promotes the effective use of
purchasing professionals because it allows the materials
manager more authority and credibility.

• Each buyer can easily become an expert on associated buys

(commodities and non-commodities) Expertise will be
developed when there is a critical mass.

• Toyota, Dell, Wal-Mart, and IBM all use centralized

purchasing and have in-house expertise ranging from engine
parts to rental cars to office equipment to pharmaceuticals

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 Advantages of Centralized Purchasing

• Centralized purchasing enables the buying firm to do a better

job monitoring various changes throughout the industry.

• Centralized purchasing also lends itself to periodic (1) reviews

of purchasing activities, (2) evaluation of suppliers, and
(3) the development of purchasing training programs.

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Disadvantages of Centralized
Purchasing
• High engineering involvement in procurement decision
making

• High need to coordinate purchased parts with production

schedules

• High need to buy from local community.

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 The Future Organization Concept
• The future outlook is that the majority of significant dollar-
valued purchases will continue to be centralized.

• This trend also will be the result of increased computer-based

management information systems.
– As firms become lean, centralized purchasing will become a major
focus. Long-term agreements will be more frequently negotiated to
stabilize prices.

• Honda of America is an excellent example of a firm that uses

centralized procurement as a competitive weapon.
Approximately 75 percent of the sales dollar for each
automobile manufactured in Marysville, Ohio, is purchased
from Japanese firms.

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 Reporting Assignment
• The status of the purchasing professional in an organization is determined
by the capacity structure. In the majority of the Fortune 500 firms, the
purchasing professional reports directly to the manufacturing vice
president.

• The purchasing organizational structure also should be different for

service-based firms.

• A Center for Advanced Purchasing (CAPs) study found that in 16 percent

of the firms surveyed, purchasing managers reported directly to the
president.

• In smaller firms, more than one-third of the purchasing professionals

report to the V.P. of manufacturing. What’s more, in firms with sales
between 5.1 and 10 billion dollars, 61 percent report to either the
president or executive V.P.

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 The Supply Management Concept

• To summarize The supply management concept is a

formal organizational concept that is involved with the
flow of materials through a manufacturing firm.

• The functional areas affected include

(1) purchasing,
(2) inventory control,
(3) traffic,
(4) production control, and
(5) stores

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 Careers in Purchasing
and Supply Management
• This is the best time for the next generation of
managers to pursue a career in purchasing supply

• Supply professionals must possess a comprehensive

skill set

• The average salary for a supply management

professional is $92,165.

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