MM Chapter 3

CHAPTER PURCHASING
THREE MANAGEMENT
Course Instructor: Desalegn S

06/01/2024 1
(MBA)
3.1. Definition Purchasing
• Purchasing in its narrow sense, refer merely to the act of buying
an item at a price.
• A broader meaning of purchasing makes it a managerial activity
that goes beyond the simple act of buying and includes the
planning and policy activities, research and development, service
selection etc.
• Therefore, Purchasing is the procurement of raw materials,
supplies, machines, tools, and services required for equipment,
maintenance and operation of a manufacturing plant.
06/01/2024 Course Instructor: Desalegn S (MBA) 2

3.2. Purchasing objectives
• The principal objective common to all types of purchasing
activities is to obtain the greatest value from each monetary
value the purchasing organization spends.
• Effective purchasing helps the organization to save money and
contribute to the organizational profitability.
• The fundamental objectives of purchasing are:
– To maintain standards of quality in materials
– To procure required materials and services at the lowest
cost consistent with the quality and service required.
Con….
– To maintain continuity of supply
– To ensure minimum investment in materials inventory,

consistent with safety and economic advantage
– To avoid duplication, waste and obsolescence with respect
to materials
– To search the market continually for materials
– To develop and maintain good supplier (vender) relations
– To maintain proper records

3.3. Purchasing Policies
• Polices are guidelines in making operating
decisions that channel actions toward
achievement of the objectives.
• They can be used by auditors who check
purchasing adherence to organizational policies.
• The following are major policy examples:

Con….
1. Centralized/Decentralized Purchasing Policy
a. Centralized purchasing:- Centralization exists when the entire
purchasing function is made the responsibility of a single unit.
• This unit is held accountable by top management for the proper
performance of purchasing activities.
• If it functions properly, centralized purchasing has the following
benefits:
– Uniform policies and procedures at all levels and companywide
uniform quality standards
– Minimize duplication of effort in purchasing
Con….
– Volume discounts from bulk purchases of the same and similar
materials.
– Transportation savings by consolidating orders and delivery
schedules.
– Develops purchasing specialists
– More effective inventory control is possible because of companywide
knowledge of stock levels, materials usage, lead-time and prices.
– Minimized ordering costs
– Fixed responsibility of purchasing to a single department facilitating
management control.
Course Instructor: Desalegn S (MBA)

06/01/2024 7
)
Con….
b. Decentralized Purchasing: Under decentralized
purchasing structures the majority of purchasing decisions
are made at the plant or operating unit level.
• The reasons are:
– The plant or operational manager, who is responsible
for the profitable operation, should have jurisdiction
over purchasing because the cost of purchasing may
affect the cost and efficiency of production.
Course Instructor: Desalegn S (MBA)

06/01/2024 8
Con….
– Each plant or operational level may have some unique
requirements and differences in operating conditions that
affect materials needs.
– When the public relations aspect of purchasing locally
may be significant. Good will can be fostered by
purchasing from nearby sources or through local
distributors
– Plant purchasing operations can provide quicker and
more efficient services in meeting user needs.
Con….
2. Policies affecting external relationships and image: - Good
supplier relations contribute to the formation of good public
image. The business organization may need to establish policies
that promote good relationships with suppliers to receive good
treatment and service.
3. Policies on pricing and supply sources:- Such types of policies
include policies on Competitive bidding and the use of negotiation
and the size of souring firms, local firms, international firms,
distributors and manufacturers, selection criteria, etc.

Con….
4. Policies on purchase orders and contracts: – these policies are
concerned with :
– identifying persons authorized to sign purchaser orders and
contracts
– specifying the monetary amounts that a person is authorized to
sing.
5. Policies on internal relationships:- Policies should define the
scope and responsibilities of the purchasing function. These are
related to lines of authority, channels of procedures and
department's relationships.
Con….
• Policy on rush orders:- Rush orders are made under emergency
situations. These orders should be received only when the user
departments have justifiable reason to make the request because rush
orders cost more than if they were handled through the normal
purchasing system. Rush orders result from poor planning by user
departments.
• Policy on small orders:- Small orders are permanent problems in every
organization. They are costly to the buyer and the seller alike. The
following methods can minimize the small order problems.
– Centralized stores system
– Blanket order system
3.4. Purchasing Procedures
• To facilitate the implementation of policies, operating procedures
should be developed.
• A procedure guides an individual how to perform a specific action.
• The following are major examples of purchasing procedures:
1. Recognition and determination of the need
• The need for a purchase typically originates in the user

departments or in the inventory control section.
• The purchasing department is usually notified of the need by one of

the two basic methods:
Con….
• Purchase requisition - The purchase requisition determines the
date, description of material, unit of measurement, quantity required,
date required, estimated unit cost, signature of the requesting
unit/person and an authorized signature
• Materials requirement planning schedule - Materials requirement
planning schedule determines the specific materials required for a
specific production or (activity) scheduled during a specific time
period.
• It eliminates the necessity of preparing numerous purchase
requisitions.
Con….
2. Definition and description of the need
• There should be clear, complete and appropriate definition and
description of materials.
• This task is a joint responsibility of the user and the buyer.
3. Determination and analysis of possible source
• The buyer assesses and investigates the market to identify potential
source of supply.
• The degree of investigation depends on whether the goods/services
are routine items or newCourse

06/01/2024
or Instructor:
high-value items.
Desalegn S (MBA) 15
Con….
4. Determination of prices and terms
• The successful supplier is one, which provides the lower price
consistent with the quality required and other terms, and
conditions that favor the buyer.
5. Preparing and placement of purchase order
• Once a supplier has been selected, the purchasing department
prepares and issues a serially numbered purchase order.
• In most cases, the purchase order becomes a legal contract
document.

Con….
• For this reason, the buyer should take great care in preparing and
wording the order.
• Quality specifications must be described precisely.
• Quality requirements, price and delivery and shipping requirements
must be specified accurately.
• Conditions of acceptance (e.g. Sample inspection) should be stated or
referenced on the order.
• In short, the order should include all data required to ensure a
satisfactory contract, and it should be worded in a manner, which
leaves little room for misinterpretation, by either party.
Con….
6. Getting acknowledgement of the order
• In most cases, the purchase order constitutes a legal offer to
buy.
• It needs acceptance of the seller.
• The seller's acceptance to the order can take through
performance or formal notification that the offer is accepted.
• Acknowledgement of the order helps to understand whether
or not the seller is able to meet the desired delivery date.

Con….
7. Follow–up and/or expediting the order
• The purchasing department's responsibility continues until the material is
received and accepted.
• The buyer should determine specific dates of follow-up checks.
• Fax, E-mail or telephone can be used for this purpose.
8. Receipt and inspection of goods
• The receiving clerk verifies the packing list against the purchase order.
• After the shipment is inspected for quantity and for general condition of the
material, the receiving clerk issues a receiving report.
• Before shipments are accepted, technical inspection is necessary

Con….
9. The invoice audit and completion of the order
• To ensure proper payment for the materials actually received, review
of the purchase order, the receiving report and the invoice is
necessary.
• By checking the receiving report against the purchase order, the
purchaser determines whether the quantity and type of material
required was received.
• Then by comparing the invoice with the purchase order and receiving
report, the firm verifies that the supplier’s bill is priced correctly and
that it covers the proper quantity of acceptable material.
Con….
• Finally, by verifying the arithmetic accuracy of the invoice, the
correctness of the total invoice figure is determined.
• Once the invoice is audited, records are closed, All documents and
correspondence relevant to the order are consolidated and the
completed order is then filed in the closed order file.
• The completed order consists of the purchase requisition, copy of
the purchase order, the acknowledgement, the receiving report, the
inspection report and any notes or correspondence pertaining to the
order and the record of all activities encompassing the total
purchasing cycle.
Con….
10. Maintaining purchasing 11. Reporting of delivered
records materials
• The following basic records • Information on delivered
are essential for the effective materials should be
operation of most purchasing communicated to
units. various concerned
– A record of open orders parties specifically:
– Record of closed orders – to the purchasing,
– Purchase log – accounts,
– Commodity record – inspection and
– Supplier record – using departments
– Contract record
3.5. Supplier Selection
• A good supplier is an invaluable resource to the organization
requiring its product or service.
• Such suppliers make a direct contribution to a firm’s success.
• They can assist their customers with product development,

value analysis, and timely delivery of the desired level of quality.
• Good buyer-seller relations facilitate the buyer’s efforts to gain

superior performance, extra service, cooperation on cost
reduction programs, etc.
3.5.1. Sources of supplier information
• Supplier purchasing information files of past and present
suppliers: - This file includes name of the supplier, list of materials
available from each supplier, the supplier’s delivery history, the
supplier’s quality record, the supplier’s overall desirability.
• Supplier catalogs (list of items and their prices):- Commonly
used source of supplier information.
• Trade registers and directories:- Contain information on the
addresses, number of branches, and affiliations of all leading
manufacturers.

Con….
• Trade journals: - Advertisements in trade journals are often a
buyer’s first contact with potential suppliers and their products.
• Trade exhibits: - Exhibits provide good opportunity for buyers to
see various new products and modifications of old products and an
opportunity to compare currently similar products of different
manufacturers.
• Sales personnel: - These people can often suggest new applications
for their products, which will eliminate the search for new suppliers.
Since they contact with many firms, they learn about many products
and services
3.5.2. Evaluating suppliers
1. Qualitative evaluation analysis
Technical ability  After-sales service
Manufacturing capability  Convenience

Reliability  Plant visit and appraisal
Financial condition  Third party certification

 Other considerations
Price

2. Quantitative Methods of Vender Evaluation
• The real test of vender selection is the test of experience or
satisfactory vender performance.
• Rating systems generally involve quality, price and delivery.
• Quality is the most important, though sometimes price can be given
equal weight.
• Formula for rating suppliers may vary depending on the item being
purchased, the quality required, and competition within the supplying
industry.
• The quantitative vender evaluation methods are divided into two
weighted point method and cost ratio method.
Weighted – point–method
• The weighted point method is designed to provide a comparative
evaluation of vendor performance when an item is procured from
two or more sources.
• The method is based upon the principles that – evaluation of
vender performance must include all major - purchasing factors:
quality, price, delivery, etc.
• The first step is thus, to assign appropriate weights to each adding
up to a total weighting factor of 100 points.
• The assignment of these weights is a matter of judgment learned
from experience.
Con….
• The ratings are multiplied by their respective weighting factors and
the results are added to give numerical incoming material rating for
each vendor for a given item.
• Perfect deliveries, on schedule time, at the lowest net price earn
rating of 100 points.
• Any rejection lapses in delivery, or prices higher than the lowest
quotation reduces the rating.
• At the sometime there is an objective basis for determining the extent
to which superior quality and service offset higher prices in overall
value and satisfaction, or vice versa.
An example of analysis of the weighted method is given below:
• Weights show rank order performance of each factor; for

instance, in this example, quality is the most important.

Let us compare two vendors:

Con….
• In this instance, vendor ‘A’ is judged to be the
more satisfactory source (92.7 score) and the
buyer is warranted in placing the bulk of the
business with ‘A’ in spite of A's substantially
higher price.

3.6. Make-Or-Buy Decisions
• Make-or-buy decisions significantly affect a firm's ability to
utilize its resources in an optimal manner.
• These decisions involve both economic and non-economic
considerations.
• Economically, an item is produced in-house if the in–house
products' value is high enough to cover all the variable costs of
production plus make some contribution to fixed costs.
• In considering what to make and what to buy, then, the decision
should consider and exploit the firm’s core competencies.

3.6.1. Factors influencing make-or-Buy Decisions
• The following are considerations, which favor making:
– Cost considerations
– Productive use of excess plant capacity to help absorb fixed
overhead
– Need to put direct control over production and /or quality
– Design secrecy required
– Unreliable suppliers
– Desire to maintain a stable workforce (in period of declining
sales)
Con….
• The following are considerations, which favor buying:
– Suppliers’ research specialized know-how
– Cost considerations
– Small-volume requirements
– Limited production facilities
– Multiple source policy
• followed for the explicit purpose of having available a reliable
and experienced second source of supply.
• This is basically important when a firm is not able to meet its
internal production schedule.
Quantitative analysis of make–or–buy decision
Example:
• The Evergreen Garden Tractor Company has extra capacity that can
be used to produce gears that the company has been buying for Birr
10 each.
• If Evergreen makes the gears, it will incur materials costs of Birr 3
per unit, labour costs of Birr 4 per unit, and variable overhead costs
of Birr 1 per unit.
• The annual fixed cost associated with the unused capacity is Birr
8,000. Demand over the next year is estimated at 4000 units.
• Would it be profitable for the company to make the gears?
Making the gears is advantageous because it can be done for 32,000 in
variable costs versus the 40,000 cost of purchasing the gears.
The 40,000 total cost to make the gears covers both fixed and variable
costs, whereas the 40,000 purchase cost does not help to cover any
fixed cost. Yet, the fixed cost must be covered.
3.7. Types of purchasing
• Once the potential suppliers are identified, a decision must be made
to determine whether to use competitive bidding or negotiation (or
a combination of the two) as the basis for source selection.
1. Competitive Bidding
• When competitive bidding is used, requests for bids are sent to
limited number of suppliers or all interested bidders are invited.
• Requests for bids ask suppliers to quote the price at which they will
perform in accordance with the terms and conditions of the
contract, should they be successful bidder.

Con….
• Competitive bidding is an efficient method of source selection
and pricing if the following requirements are satisfied.
– The monetary value of the specific purchase must be large
enough to justify the expense to the buyer and the seller.
– The specifications of the item or service to be purchased must
be explicitly clear to both buyer and seller and the seller must
know or be able to estimate accurately the cost of producing
the item or rendering the service.
– The market must consist an adequate number of suppliers.

Con….
– The supplier must be technically qualified and actively
want the contract; and, therefore, be willing to price
competitively to get it.
– The time available must be sufficient for using this
method of pricing. Suppliers competing for large
contracts must be allowed adequate time to evaluate
bids and to perform the necessary cost analysis before
they can calculateCourse

06/01/2024
their best price.
Instructor: Desalegn S (MBA) 40
Con….
• Conditions in which bidding is not required
– When it is impossible to estimate costs with a high degree of
certainty
– When price is not the only important variable. For example,
quality, schedule and service may be negotiable variables of
equal importance
– When the purchasing firm anticipates the need to make
changes in the specification or some other aspect of the
purchase contract
a. Open bid
• Under the open bid, all interested and eligible suppliers (bidders)
are invited through different media as appropriate, to quote the
prices and other terms and conditions of the purchase of a material
or service.
b. Closed/restricted bid
• In this type of bid, limited/selected suppliers are invited to tender
and more appropriate for complex, important contracts, where the
ability of the chosen supplier/s to perform the contract is of primary
importance.
1. Preparing list of items to be purchased
2. Preparing bid specifications
3. Informing potential suppliers
– Sending quotations to suppliers directly
– Advertisement for bid
– Receiving suppliers' quotations directly or through
tender box

1. Checking the presence of all participants
2. Parties to be present
• Purchasing unit representative
• Potential suppliers
• Suppliers' representatives
• Auction (bid) committee members
3. Showing that the tender box is sealed

4. Opening the box or the sealed envelopes
5. Reading the price quotations clearly
6. Declaring the winner immediately or at later time
Reading Assignment!!!
 Read the Following topics From Your handout.

– Invitation to tender
– Instruction to bidders
– Specifications
– Price
– Delivery time

• Purchasing by negotiation is the art of arriving at common
understanding through bargaining on the essentials of a
contract such as quality, quantity price, specifications,
delivery and other terms.
• When competitive bidding is not desirable negotiation used
to select suppliers.
• Besides, negotiated purchase is preferable to competitive
bidding when:
Con….
– The negotiation process provides more chance to a
complete understanding of all issues of the procurement.
– Quality, delivery schedule and services are given equal or
greater weight with prices.
– There is a sole supplier.
– Where the supply is of patented good or service and has no
substitute.
– Parts are available only with the producer or supplier of the
machinery or equipment purchased.
Con….
• When preparing for negotiation the purchaser has to establish its own
bargaining position, and to the extent possible and anticipate the
supplier’s position.
• The buyer’s strength may be affected by:
– The extent of competition-amount of competition in the field
– Adequacy of knowledge of cost/price methods and structures of
the supplier.
– Extent of preparation for negotiation
– Time available for negotiation
– Volume of purchase
Con….
The Suppliers' strength may be affected by:

– Desire for the contract - how much suppliers are
attracted to the contract.
– Certainty of getting the contract - how sure they
are that they will get the contract.
– Time available for negotiation - how much time
there is to reach an agreement.

a. Initiate and develop a proposed plan to conduct the
negotiation.
– Definition of the negotiation objective, An agenda,
Clear identification of all issues involved, Designation of
the team leader, Details on the key items in–house
analyses and Requests for qualified specialists for
evaluation of specific areas
b. Document and submit the proposed negotiation plan,
through supervision, to the individual authorized to approve
the contractual agreement.
 They must be clear and rapid thinkers.
 They must be able to communicate effectively
 They must possess the ability to analyze the statement of others
 They must be impersonal - must approach a problem from the
basis of the company objective rather than from personal
inclinations.
 They must be patient.
 They must be able to consider other persons’ ideas objectively.
 They must have a good knowledge of human nature

• International sourcing requires additional efforts when compared
with domestic sourcing because dealing with unknown companies
in foreign markets presents many difficulties and obstacles.
• Some of the potential problems buyers encounter when purchasing
offshore are given below:
– Political issues
– Currency problems
– Payment terms and conditions
– Shipping Terms and Packaging
– Packaging
• This is an attempt to see any material or any component can be
substituted or eliminated so as to achieve the proper function at a
lower cost.
• Value analysis is concerned with scrutiny of the design function
and cost of any product, material or service with the object of
reducing cost by modification of design material specification,
more efficient process, change in source of supply or possibly the
elimination of an item or its incorporation in to a related item
without sacrificing reliability and quality.

Con….
• The two basic conceptual tools in the operation of value analysis are:
1. Design analysis of the required material

• This can be examined by:
– Can any part be eliminated without impairing the operation of the
other unit?
– Can the design of the part be simplified to reduce its basic cost?
– Can design of the parts be changed to permit the use of simplified
and less costly production method?
– Can less expensive, but equally satisfactory materials be used in the
part?
Con….
2. Cost analysis of the required material
• To get actual selling price of a suppler:

– Construct estimated elemental cost for labor, material,
manufacturing overhead and general overhead.
– Total these cost, to arrive at approximate actual costs of
producing for an efficient producer.
– Make-up reasonable profit and arrive at selling price.

• Select the material that is right for value analysis.
• Gather information about the material which

includes, drawings, costs, scrap rate etc.
• Define the prime functions; prime function of a
material can be defined using two words; verb
and noun.
• Estimate the present cost of each function.
Con….
• Generate alternatives, using brain storming-insist
people to give new ideas.
• Evaluate alternatives interms of cost, feasibility,
undesirable consequence, etc…
• Present proposals.
• IF approval is secured implement the plan; translate

the approved proposal to engineering change order.

06/01/2024 Course Instructor: Gezu G. (MBA) 58

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CHAPTER PURCHASING

Course Instructor: Desalegn S

06/01/2024 Course Instructor: Desalegn S (MBA) 2

– To ensure minimum investment in materials inventory,

– To develop and maintain good supplier (vender) relations

– To maintain proper records

06/01/2024 Course Instructor: Desalegn S (MBA) 5

Course Instructor: Desalegn S (MBA)

Course Instructor: Desalegn S (MBA)

supplier relations contribute to the formation of good public

image. The business organization may need to establish policies

that promote good relationships with suppliers to receive good

treatment and service.

3. Policies on pricing and supply sources:- Such types of policies

include policies on Competitive bidding and the use of negotiation

and the size of souring firms, local firms, international firms,

distributors and manufacturers, selection criteria, etc.

• A procedure guides an individual how to perform a specific action.

• The following are major examples of purchasing procedures:

1. Recognition and determination of the need

• The need for a purchase typically originates in the user

• The purchasing department is usually notified of the need by one of

• There should be clear, complete and appropriate definition and

• This task is a joint responsibility of the user and the buyer.

3. Determination and analysis of possible source

• The buyer assesses and investigates the market to identify potential

• The degree of investigation depends on whether the goods/services

are routine items or newCourse

06/01/2024 Course Instructor: Desalegn S (MBA) 16

06/01/2024 Course Instructor: Desalegn S (MBA) 18

• The purchasing department's responsibility continues until the material is

received and accepted.

• The buyer should determine specific dates of follow-up checks.

• Fax, E-mail or telephone can be used for this purpose.

8. Receipt and inspection of goods

material, the receiving clerk issues a receiving report.

• Before shipments are accepted, technical inspection is necessary

• Such suppliers make a direct contribution to a firm’s success.

• They can assist their customers with product development,

• Good buyer-seller relations facilitate the buyer’s efforts to gain

06/01/2024 Course Instructor: Desalegn S (MBA) 24

Technical ability  After-sales service

Manufacturing capability  Convenience

Financial condition  Third party certification

06/01/2024 Course Instructor: Desalegn S (MBA) 26

• Weights show rank order performance of each factor; for

06/01/2024 Course Instructor: Desalegn S (MBA) 30

06/01/2024 Course Instructor: Desalegn S (MBA) 31

06/01/2024 Course Instructor: Desalegn S (MBA) 32

06/01/2024 Course Instructor: Desalegn S (MBA) 33

06/01/2024 Course Instructor: Desalegn S (MBA) 38

06/01/2024 Course Instructor: Desalegn S (MBA) 39

want the contract; and, therefore, be willing to price

competitively to get it.

– The time available must be sufficient for using this

method of pricing. Suppliers competing for large

contracts must be allowed adequate time to evaluate

bids and to perform the necessary cost analysis before

they can calculateCourse

– When it is impossible to estimate costs with a high degree of

– When price is not the only important variable. For example,

quality, schedule and service may be negotiable variables of

– When the purchasing firm anticipates the need to make

changes in the specification or some other aspect of the