Course: MBASubject: Production & Operation

ManagementUnit:2.6

Purchase Management

Purchase Management

•Businesses need to get the best possible products or materials for the price.

•Making smart spending decisions can result in better values for customers and larger profits for the business.

Planning Purchase

• Purchasing decisions mean the difference between success and failure for the entrepreneur.

• purchasing also known as procurement, the buying of all the materials needed by the organization

Factors: Purchasing’s Position

• History

• Type of industry

• Total value of goods and services

• Other

– Founding philosophy

– Type of purchased materials

– Ability to influence company performance

Organizing the Purchasing Function

• Specialization within purchasing

– Sourcing and negotiating

– Purchasing research

– Operational support and order follow-up

– Administration and support

Sourcing and Negotiating

• Identifies potential suppliers

• Negotiates with selected suppliers

• Performs the buying of goods and services

– By specific items

– By commodity family

– By service categories

Purchasing Research

• Developing long-term material forecasts

• Conducting value analysis programs

• Assessing supplier capabilities

• Analyzing supplier cost structures

Operational Support and Follow-up

• Supporting day-to-day operations including expediting

• Preparation and transfer of material releases

• Strategic vs. tactical purchasing

Administration and Support

• Developing policies and procedures

• Administering and maintaining the purchasing information system and database

• Determining required staffing levels

• Developing departmental plans

• Organizing training and development

• Developing measurement systems

Purchasing Department Activities

• Buying• Expediting• Inventory control• Transportation• Managing countertrade arrangements• Insourcing -outsourcing• Value analysis• Purchasing research• Material forecasting• Supply management• Other

Other Department Activities

• Receiving and warehousing

• Managing travel expenses

• Production planning and control

• Commodity futures trading

• Global transportation and materials management

• Economic forecasting

• Subcontracting

Strategic Activities

• Manage relationships with critical suppliers

• Develop electronic purchasing systems

• Implement companywide best practices

• Negotiate companywide supply contracts

• Manage critical commodities

Operational Activities

• Manage transactions with suppliers

• Use e-systems to source standard and direct items in electronic catalogs

• Source unique items

• Generate and forward material releases

• Provide supplier performance feedback

Placement of Purchasing Authority

• Centralized

• Decentralized

• Hybrid combination

Size of Purchasing Staff

• Type of company

• Nature or complexity of products and services produced

• Physical number of items procured

• Scope of purchasing responsibility

– Strategic sourcing

– Market research and analysis

– Extent of involvement in services

Factors Influencing Authority

• Organizational business strategy

– Responsiveness vs. efficiency

• Total purchase dollar expenditures

– Cost savings required

– Geographic dispersion

• Overall philosophy of management

Strategic vs. Operational Sourcing

StrategicSourcing Activities

• Manage relationships with critical suppliers• Develop electronic purchasing systems• Implement companywide best practices• Negotiate companywide supply contract• Manage critical commodities

OperationalActivities

• Manage transactions with suppliers• Use e-systems to obtain standard or indirect items

through catalogs• Source items that are unique to the operating unit• Generate and forward material releases• Provide supplier performance feedback

Advantages of Centralization

• Consolidate purchase volumes

• Reduced duplication of purchasing effort

• Ability to coordinate plans and strategies

• Ability to coordinate and manage companywide purchasing systems

• Developing expertise

• Managing companywide change

Advantages of Decentralization

• Speed and responsiveness

• Understanding unique operational requirements

• Product development support

• Ownership

Product Development Support

• Utilize early supplier involvement

• Evaluate long-term material requirements

• Develop strategic plans

• Determine if substitute materials are available

• Anticipate product requirements

Hybrid Purchasing Structures

• Lead buying division

• Regional buying groups

• Global buying committees

• Corporate purchasing councils

• Corporate steering committees

Make or Buy Decision

Make or Buy

• Make-or-Buy decision (also called the outsourcing decision) is a judgment made by management whether to make a component internally or buy it from the market.

• While making the decision, both qualitative and quantitative factors must be considered.

• Examples of the qualitative factors in make-or-buy decision are: control over quality of the component, reliability of suppliers, impact of the decision on suppliers and customers, etc.

• The quantitative factors are actually the incremental costs resulting from making or buying the component. For example: incremental production cost per unit, purchase cost per unit, production capacity available to manufacture the component, etc.

example• The estimated costs of producing 6,000 units of a component are:

• The same component can be purchased from market at a price of $29 per unit. If the component is purchased from market, 25% of the fixed factory overhead will be saved.

• Should the component be purchased from the market?

Per Unit Total

Direct Material $10 $60,000

Direct Labor 8 48,000

Applied Variable Factory Overhead

9 54,000

Applied Fixed Factory Overhead

12 72,000

$1.5 per direct labor dollar

$39 $234,000

Solution

Per Unit Total

Make Buy Make Buy

Purchase Price $29 $174,000

Direct Material $10 $60,000

Direct Labor 8 48,000

Variable Overhead 9 54,000

Relevant Fixed Overhead

3 18,000

Total Relevant Costs

$30 $29 $180,000 $174,000

Difference in Favor of Buying

$1 $6,000

Insourcing vs. Outsourcing

• Insourcing – producing goods or services within an organization

• Outsourcing – purchasing goods or services from outside vendors

• Also called the “Make or Buy” decision

• Decision Rule: Select the that option will provide the firm with the lowest cost, and therefore the highest profit.

Qualitative Factors

• Non-quantitative factors may be extremely important in an evaluation process, yet do not show up directly in calculations:

– Quality Requirements

– Reputation of Outsourcer

– Employee Morale

– Logistical Considerations – distance from plant, etc

Opportunity Costs

• Opportunity Cost is the contribution to operating income that is foregone by not using a limited resource in it’s next-best alternative use– “How much profit did the firm ‘lose out on’ by not selecting this

alternative?”

• Special type of Opportunity Cost: Holding Cost for Inventory. Funds tied up in inventory are not available for investment elsewhere

Product-Mix Decisions

• The decisions made by a company about which products to sell and in what quantities

• Decision Rule (with a constraint): choose the product that produces the highest contribution margin per unit of the constraining resource

Adding or Dropping Customers

• Decision Rule: Does adding or dropping a customer add operating income to the firm?

– Yes – add or don’t drop

– No – drop or don’t add

• Decision is based on profitability of the customer, not how much revenue a customer generates

Managing Purchases

• Key Factors That Affect Purchasing

Selecting the right quality

Buying the right quantity

Timing your purchases

Choosing the right vendors

Getting the right price

Receiving and following up on purchases

Choosing the Right Vendors

• Considerations in Vendor Selection

DistanceService

Reliability

Getting the Right Price

Contact several vendors to find the best price.

A purchase discount, such as a trade discount, can affect prices.

• trade discount: a discount from the list price of an item allowed by a manufacturer or wholesaler to a merchant

Getting the Right Price

• An entrepreneur/ firm may be able to take advantage of a quantity discount or a cash discount.

• quantity discount a discount that a vendor gives to a buyer who places large orders

• cash discount an amount deducted from the selling price for payment within a specified time period

Getting the Right Price Dating Terms

Early paymentAdvance dating

Extra datingEnd-of-month (EOM) dating

Receipt-of-goods (ROG)

dating

Getting the Right Price

• Until you establish a good working relationship, your new vendor may request secured funds.

• secured funds a form of guaranteed payment, such as a credit card, a cashier’s check, a wire transfer, or cash

Receiving and Following Up on Purchases

• When you receive a shipment from a vendor, it should be accompanied by an invoice, indicating size, cost, selling price, and other similar information.

• invoice an itemized statement of money owed for goods shipped or services rendered

Key Terms

• financing cost• opportunity cost• storage cost• insurance cost• shrinkage cost• obsolescence cost• warehousing• lead time• usage rate• safety stock

Reference

• http://accountingexplained.com/managerial/relevant-costing/make-or-buy-decision

• www.csus.edu