Purchase

Managem
ent
Submitted By:
Brij Mohan Gupta..…037
Shweta Bhandari…....005
Varsha Tushir………034
Neha Singh…………004
Anuj Sagar……….....014
Deepak Tyagi….…...028
 PURCHASE MANAGEMENT

Purchase Management is a function of materials management in a company. Their basic

function is procuring the inputs for production function. This function encompasses
suppliers in the market external to the organization and several internal to the
organization.

Till recently, the purchasing process simply involved placing an order with the supplier who
offered the lowest price. Nowadays, increase in competition and market demand and scarcity
of resources have forced organizations to reexamine their purchasing activities. The
purchasing department functions have expanded considerably and include activities such as
verifying the credentials of suppliers, inspecting the quality of the material to be purchased,
ensuring the timely delivery of the material, etc.

While the value of purchased items varies from industry to industry, it adds up to more than
fifty percent of sales in all industries. Purchase management is regarded as a significant
activity in many organizations because of the high cost involved in carrying out purchasing
activities, increasing quality benchmarks, and increasing global competition. Purchase
departments buy raw materials, parts, machinery, and services used by production systems.
The objective of purchase management is to procure the right equipment, materials, supplies
and services in the right quantity, of the right quality, from the right suppliers, at the right
time, at the lowest price.

IMPORTANCE OF PURCHASE MANAGEMENT

Purchase management is considered to be very important function of materials management

in a company. Its importance is felt even outside the formal scope of materials management.
As the purchase decisions commit a very large portion of financial resource of the company
purchase function is said to be highly important. Purchase personnel deal with large number
of external agencies while performing their functions. Hence they represent company’s
reputation in the outside world. As they negotiate and finalize deals worth lot of money for
the company their integrity is of utmost importance for the organization.
OBJECTIVES OR GOALS OF PURCHASING

Primary objective or goal of purchasing function is making inputs available to the conversion
process at minimum cost to the final output of the company. Thus focus is on system output
rather than on micro level objectives.

The inputs to be made available are raw materials, semi finished items, bought out items etc.
There are certain parameters to be monitored for fulfilling the system objectives. We can call
them goals of purchasing. These goals are popularly known as 5R’s of purchase namely, right
price, right quantity, right quality, right place and right time. In simple terms, if the above
5Rs are achieved primary objective is fulfilled:-

• Right Price: Right price is determined by costing the production process of the
supplier. Right price is determined by allowing reasonable profit for the supplier and
insisting and helping to reduce cost. Tender system should be used to identify lowest
responsible bidder rather than lowest bidder. Principles normally used to ensure right
price are cost structure and learning curve.

• Right Quantity: Right quantity of purchase is the one that ensures no excess and no
shortage. High priority items are subjected to EOQ analysis to determine the right
quantity for purchase. This ensures overall minimum cost for inventory.

• Right Quality: In an item purchased should ensure adhering to mutually accepted

standard by supplier and customer at the time of finalizing the purchase order. The
accepted standard may be a drawing, a sample, a grade or a universal standard like DIN,
IS, BS etc.

• Right Place: is the one where the item is going to enter the value stream. If the item is
not available here, when needed, it is in short supply for the process.

• Right Time: is as decided by production schedule for meeting customer’s

requirements.

ORGANISING PURCHASING

The effectiveness of purchasing activities can be enhanced by proper organization and

coordination of the activities. There are two types of purchasing system:-
 • Centralized purchasing system

• Decentralized Purchasing system

i. Centralized purchasing system: In a centralized purchasing system, all purchasing

activities of an organization are carried out by a separate department. A centralized
system is effective when an organization has a number of production sites within the
same site which requires the material with same or similar specifications. In such cases,
a centralized system allows pooling of all the requirements so that benefit of bulk
purchasing can be realized. The centralization also leads to consistency in buying
policies and uniformity in maintaining purchasing records.

ii. Decentralized Purchasing System: In a decentralized purchasing system, the heads of

different departments purchase the needed materials according to their specific
requirements. This method gives each department the flexibility to alter its purchasing
policies on the basis of specific requirements.

However, most organizations do not totally depend on any one system: instead, they use a
combination of both the systems.

FUNCTIONS OF PURCHASING DEPARTMENT

The purchase department is one of the key players in achieving the strategic objectives of a
firm. Functions of purchasing department or often categorized as the responsibilities of
Purchasing Manager are:-

• Vendor Development: The primary responsibility of a purchase manager is to search

for and identify a list of possible suppliers. He should ensure that sources of supplies
are reliable and stable.

• Selection of Suppliers: The purchase manager should examine the cost of the material
and other aspects. And selection should be made after analyzing all the relevant
issues.

• Contract Negotiations and Communication Interface: Once a vendor is selected, the

purchasing manager should negotiate and establishes the terms and conditions of
contract to be drawn between the two parties.
 • Value Analysis: The purchasing manager conducts value analysis that aims at
achieving cost effectiveness and maintaining the required level of quality.

PURCHASE SYSTEMS

In an organization all activities are carried out according to systems and procedures for
reducing variations and errors arising out of individuality. This makes performing the
function simple and less prone to errors. Purchase organization also consists of such systems
established for smooth running of purchasing function. These systems are pre purchase
system, ordering system, post purchase system.

1. Pre Purchase System: This system lays down how purchase activity is initiated. Various
activities controlled by this system are requisitioning, selection of suppliers and obtaining
& evaluating quotations.

• Requisitions: Requisition for an item may be made by anyone in the organization.

Pre purchase system prescribes separate requisition form for capital equipment as
this purchase activity is controlled by a separate system. Requisition for an item
shall be made in a standard format. This format ensures that indenting person
furnishes all relevant information like quantity, specifications, etc. and gets the
purchase authorized by competent authority in the organization. Thereby making
purchase activity easier and less time consuming. This system shall identify the
hierarchical level competent to authorize the purchase depending on the nature
and value of the item.

• Traveling requisitions: In an inventory system where an item is made a

stock item to be perpetually maintained at a minimum level, purchase activity is
triggered by stores function based on ROL. The requisition is a permanent
document with specification, authorization and quantity required permanently
marked on it. The traveling requisition returns to indenting department after
purchase is initiated.

• Inquiries: Pre-purchasing system prescribes standard formats for making

inquiries in the market for supply of a particular product. These are standard forms
boldly declaring that they are not explicit or implicit purchase orders.
2. Ordering System: Purchase order is the most important element in ordering system.
Purchase manager releases the purchase order after selecting the supplier and finalizing
the price and other conditions of sale. Once the purchase order is raised and accepted it
becomes a legal document.

Contents of the purchase order are:-

Purchase order reference number

Description of materials and specifications
Quantity required and delivery schedule
Price and discounts
Shipping instructions
Location where the material is to be shipped
Signature of the authorized officer
Detailed terms and conditions:-
Several numbers of copies made to be forwarded to various recipients. Many companies color
code the copies making the color destination specific.
Original and a copy is sent to the supplier for acknowledgment of the original order. This
acknowledgment is acceptance of terms and conditions of purchase order.
One copy is sent to the receiving department for making necessary receiving arrangement
One copy is sent to the indenting department for information.
One copy is sent to finance department for organizing payment to the supplier.
Post Purchase System: This system includes follow up procedures, receipt and checking
invoices.
• Follow up procedures: Follow up is an expensive activity for an organization. Hence
this should be minimized and made more effective. A sound procedure for follow
up is required to eliminate duplication and ineffectiveness. After conducting FSN
analysis follow up frequency should be fixed for follow up according to FSN status
so that follow up doesn’t become wasteful. Follow up responsibility is assigned to
buyers responsible for areas in which suppliers are situated.

• Receipt: Receipt system should ensure that defects in receipt process are eliminated
proactively. A systematic record of all receipts, carrier details and descriptions is
maintained. This record is in chronological sequence of arrival of supplies. The
system ensures that inspection of consignments received is arranged in time and
 payment to suppliers for accepted consignments is organized. In many organizations
a receipt section handles this activity centrally.

• Invoice checking: supplier sends his invoice to customer’s finance department for
payment for the goods supplied. Invoice checking system ensures that the invoice is
checked against the PO terms, receipt details, quantity received, inspection reports
[accepted quantity and rejected quantity], losses, damages etc. this system helps
materials management to coordinate with finance department for payment to
suppliers.

IMPORTANCE OF SOURCE

Source is the place from where we procure our inputs. These inputs may be in the form of
raw materials, out sourced components or semi finished items. Manufacturing companies
outsource large number of items as they slim down processes.
Following reasons are considered to be making source an important element in materials
management:-
Source of market intelligence: source is a window through which the buyer organization
looks at the world outside. Source provides access to the real time information about the
phenomenon. Information about current trends and industrial climate is obtained from
the sources.
Crucial for product quality: buyer organizations depend on out sourced components for
producing the product which central to the objectives business. Reliance on capabilities
of supplier to meet tough quality standards is very high in current business environment.
Member in the value chain: supply source is an important element in the value chain. Any
cost added to the value chain reaches the end user as price. Hence effectiveness and
efficiency of the source becomes vital to business.
Import substitution, cost reduction, value improvement: as indigenization of sub assemblies,
components and spare parts is necessary to reduce the cost of product in competition,
buyer organizations turn to supply sources to develop these items. Several trials and
corrections may be required to finalize the substitute. In house capacity is generally not
available for this kind of trials. A resourceful supplier is very useful in this process.
Same logic holds good in other exercises for cost reduction and value improvement. It is
quite logical that entire process is not outsourced but isolated developmental activities
are invariably done. It is common knowledge that many small scale companies do not
have full-fledged tool rooms but rely on sources for all tool room activities.

PURCHASING POLICIES

The major principles on which purchasing policies should be based are a sound orientation,
reflect a cross –functional approach and be directed at improving the company’s bottom line.

i. Business orientation

Developing a purchasing and supply strategy requires a thorough understanding of the

company’s business policies. The following questions are important to determine how
purchasing and supply strategies will need to support the company in meeting its goals and
objectives:-

- What end-user market is the company targeting and what are the major developments
going on in those markets?

- What competition is the company suffering from and what leeway does the company
has in setting its own pricing policies?

- To what extent can material’s price increases can be passed onto the last customer or
is it impossible?

- What changes are happening in the company’s product, production and information
technologies?

- What investments will be made by the company in terms of new products and
technology?

- What products will be taken out of the market for the years to come?

ii. Integrated, cross-functional approach

Purchasing decisions cannot be made in isolation, and should not be aimed at optimization of
purchasing performance only. Purchasing decisions should be made taking into account the
effects of these decisions on other primary activities like:-

- Production planning

- Materials management

- Transportation

Therefore purchasing decisions need to be based on balancing total cost of ownership. When
buying for instance, a new packaging line it is important to consider not only the initial
investment, but also the costs which will be incurred in the future for buying accessories,
spare parts and services. This example itself illustrates the complexity of its type of purchases
and the different kind of decisions that need to be made.
 Careful decision making in those circumstances, therefore requires a cross functional and
team based approach among all the business disciplines affected by it. This can only be done
when top managers are involved. The purchasing and supply manager will lead the
developing of such views and visions.

iii. Bottom-line orientation

The purchasing should provide a healthy commercial opposition vis-à-vis its internal
customers. Through their activities the buyers should make their company more and more
cost aware. They should consistently look for improving the price/value ratio of the goods
and services bought by the company. To accomplish this, purchasing should be able to
suggest alternatives to existing product designs, materials or components to be used and
alternative suppliers. Experience with companies in which purchasing is recognized as a
bottom-line driven activity shows this function contributes to a permanent reduction in cost
price of the end product, whilst stimulating innovation from the suppliers at the same time.

IMPLEMENTATION OF PURCHASE POLICY

Important areas to consider when implementing supply and purchase policy are supply,
product and supplier quality, materials costs and prices, supplier policy and communication
policy

i. Supply

Supply is aimed at the optimization of both the ordering process and the incoming materials
flow.

Purchasing order processing entails handling of:-

- Purchasing requisitions

- Order processing and expediting

 - Development of efficient, computer –supported order routines

Materials and supply planning relates to:-

- Issuing materials delivery schedules to suppliers

- Reducing supplier lead times

- Troubleshooting in case of delivery problems

- Reducing (pipeline) inventories

- Monitoring supplier delivery performance

ii. Product and supplier quality

Central to this aspect are the materials specifications. Two important subjects of concern here
are purchasing early involvement in design and product development and improving product
and supply quality performance. Activities which may contribute to both areas are:-

• Standardization of materials-by striving for standardisation or simplification of

product- specifications, the buyer may reduce product variety resulting in both cost
reduction and supplier dependence at the same time;

• A purchasing policy focussed on the life cycle of the end products- there is not much
point in investigating material quality improvements used in products which will be
eliminated shortly;

• Specific quality improvements- negotiating targets on improving reject rates, reducing

incoming inspection, and negotiating quality agreements;

• Agreeing on and gradually extending permanent warranty conditions that are to be

provided by the supplier;

• Initiating special programmes in the field of value analysis to simplify product design
and/or reduce product costs;
iii. Materials cost policy

The objective of cost policy is twofold:-

- First to obtain control of materials cost and prices in such a way that suppliers are
unable to pass on unjustified price increases to the company.

- Second, to systematically reduce the supplier’s materials cost through joint, well
prepared action plans.

In order to be successful in both aspects a thorough knowledge of the supplier’s pricing

policies and cost structure is required. Understanding and knowledge of the market structures
and of their susceptibility of the price paid to market and cost factors is necessary. It should
be decided for what products to build detailed cost models, for what models to monitor
underlying cost factors, and for what products to develop detailed materials budget estimates.

iv. Supplier policy

The supplier policy is focused on the systematic management of the company’s supplier base.

- Decisions need to be made for what commodities to pursue a multiple sourcing

strategy or to go for single sourcing or a partnership relationship.

- Suppliers who perform best should be rewarded with more business in the future.

- Targets and possible projects for future co-operation should be determined carefully.

- Relationships with suppliers who consistently fail to meet the company’s expectations
should be terminated.

However such decisions need to be made based on detailed data on how the supplier
performed in the past and be implemented carefully.

v. Communication policy

The company’s purchasing policies need to be communicated both internally and to

suppliers. Companies use the Intranet for the former and many employ their own Purchasing
Websites in order to communicate their future materials requirements and ways of working to
their suppliers.

The next step is that preferred suppliers have access to the customer’s Intranet through which
internal users can order directly from them through their electronic catalogues.
VALUE ANALYSIS

The purchasing manager conducts value analysis that aims mainly at achieving cost
effectiveness and maintaining the required level of quality. Value analysis is an organized
effort that studies in detail the ‘value’ of material. Value Analysis reviews the design changes
with the objective of eliminating high cost materials and the materials that are technically
obsolete and reducing the number of parts. After analyzing the functions and cost of material,
the purchasing manager evaluates the possibilities of using the material.

Value Analysis evaluates the materials by seeking answers to the following questions:-

- What is the function of the item?

- Is it possible to run the system without the item?

- Can the item be substituted with a standard part?

- How much does the item cost?

- How much does the substitute, if any, cost?

- Can the functions performed by two or three materials be clubbed together and be
replaced by any other material?

Value Analysis involves the coordinated efforts of the engineering, production and the
purchasing personnel and helps in reviewing purchase activities to ensure that expenditures
result in the receipt of appropriate value.

The step by step procedure of Value Analysis is given below:-

- Examine all the products/materials that are being reordered and identify each
product/material that needs an improvement.

- Gather all possible information about the designs, costs and so forth of the product.

- Form a team that includes experts from various functional areas that are related to the
functions performed by the material.
- Generate alternatives by generating new ides and evaluate different ways of
accomplishing the task.

- Evaluate the alternatives on criteria like cost and feasibility and eliminate the non
feasible alternatives.

- Refine the feasible alternatives and select the optimal one.

MAKE-OR-BUY DECISIONS

The make-or-buy decision is the act of making a strategic choice between producing an item
internally (in-house) or buying it externally (from an outside supplier). The buy side of the
decision also is referred to as outsourcing. Make-or-buy decisions usually arise when a firm
that has developed a product or part—or significantly modified a product or part—is having
trouble with current suppliers, or has diminishing capacity or changing demand.

Make-or-buy analysis is conducted at the strategic and operational level. Obviously, the
strategic level is the more long-range of the two. Variables considered at the strategic level
include analysis of the future, as well as the current environment. Issues like government
regulation, competing firms, and market trends all have a strategic impact on the make-or-
buy decision. Of course, firms should make items that reinforce or are in-line with their core
competencies. These are areas in which the firm is strongest and which give the firm a
competitive advantage.

Considerations that favor making a part in-house:-

• Cost considerations (less expensive to make the part)

• Desire to integrate plant operations
• Productive use of excess plant capacity to help absorb fixed overhead (using existing
idle capacity)
• Need to exert direct control over production and/or quality
• Better quality control
• Design secrecy is required to protect proprietary technology
• Unreliable suppliers
• No competent suppliers
• Desire to maintain a stable workforce (in periods of declining sales)
• Quantity too small to interest a supplier
• Control of lead time, transportation, and warehousing costs
• Greater assurance of continual supply
• Provision of a second source
• Political, social or environmental reasons (union pressure)
• Emotion (e.g., pride)
Factors that may influence firms to buy a part externally include:-

• Lack of expertise
• Suppliers' research and specialized know-how exceeds that of the buyer
• cost considerations (less expensive to buy the item)
• Small-volume requirements
• Limited production facilities or insufficient capacity
• Desire to maintain a multiple-source policy
• Indirect managerial control considerations
• Procurement and inventory considerations
• Brand preference
• Item not essential to the firm's strategy

LEAN MANAGEMENT

It is a philosophy concerning how to run a manufacturing organization, which entails all

aspects of the business system in general, and design, manufacturing and supply management
in particular. Fundamental to lean management is that it transfers the maximum number of
tasks and responsibilities to those workers actually adding value to the product and it has in
place a system for detecting the defects that quickly traces every problem.

Important features of lean management are:-

• Teamwork among line workers, who are trained in a variety of skills to conduct
different jobs within their working group. These not only relate to manufacturing
tasks; workers are also trained to do simple machine repairs, quality checks ,
housekeeping and material ordering.

• Simple, but comprehensive information display systems that make it possible for
everyone in the plant to respond quickly to problems and understand the plant’s
overall situation.

• Total commitment to quality improvement5 on the shop floor. Workers are

encouraged to think and act positively on how to improve the effectiveness of their
work, whereas their supervisors need to provide active support to bring these ideas to
fruition.
LEAN MANAGEMENT AND PURCHASE SYSTEM

The average supply base is much smaller in lean management system .Suppliers are usually
involved in new product development in a very early stage. Supplier along with engineers
from the manufacturer may work full time at each other premises when solving technical
problems and/or working out improvements .

Suppliers are confronted with well defined targets in terms of quality improvement, lead time
reduction and cost reduction and are, by means of a simple grading and performance system,
fully informed as to whether they meet contractual obligations.

JIT AND PURCHASING SYSTEM

The principle of just-in-time (JIT) means that all materials and products become available at
the very moment when they are needed in the production process, not sooner and not later,
but exactly on time and in exactly the right quantity .It implies that nothing is produced if
there is no demand. The production process is in fact ‘pulled’ by customer orders. When no
customer orders have been received, manufacturing activities will come to an end and the
spare time is used to do minor repairs/maintenance, housekeeping and/or prepare for
materials planning.

A second characteristic of JIT principle is related to quality awareness, smaller batch sizes
which make it necessary to detect quality defects at an early stage.

The JIT concept cannot be limited to production only. It must be supported and implemented
in every functional area in the organization .Applied to purchasing JIT is a philosophy that
aims to make the required materials and products available at exactly the time they are
needed, so that value is added only to the product which is to be manufactured , and indirect
costs are avoided . JIT has a major impact on both the quality and quantity of the materials to
be purchased.

The JIT approach is characterized by regular but flexible supply .ordered materials are
delivered frequently in different quantities. To facilitate this, the supplier is informed of the
production planning and the related purchasing requirements on a daily, weekly and monthly
basis through delivery schedules which are available on-line. In this way

Conditions are renegotiated with the supplier. Targets for productivity improvement and cost
reduction, as required by the producer, are also part of these negotiations.
As far as quality is concerned, the guiding principle is zero defects. Imposing quality targets
upon suppliers may represent large savings to the producer, both in terms of a reduction of
the numbers of incoming quality inspections and a reduction of buffer stock. In this way the
supplier is educated towards a better quality performance.

VENDOR MANAGEMENT

Vendor Management is the management and control, by an entity, of those third parties that
supply goods and/ or services to that entity. It is the discipline of establishing service, quality,
cost, and satisfaction goals and selecting and managing third party companies to consistently
meet these goals:-

• Establishing Goals- Just as employees need clearly established goals, operations need
clearly defined performance parameters. When selecting or managing vendors,
vendor managers must optimize their opportunity to achieve these goals by using third
parties companies.
• Selecting Vendors- The fine art of vendor management is essential to optimizing
operational results. Different vendors have different strengths and weaknesses, and it
is the vendor manager’s responsibility to match the right company with the desired
performance characteristics. Failure to consider this comprehensively could lead to
complete failure.
• Managing Vendors- On a daily basis, vendor managers must monitor performance,
provide feedback, champion new projects, define or approve/disapprove change
control processes, and develop vendors. There’s a tremendous amount of detail to
this aspect of the discipline, and we’ve covered this in many posts here.
• Consistently Meet Goals- Operations must perform within statistically acceptable
upper and lower control bounds. Everything the vendor manager does should focus
on meeting goals, from providing forecasts to defining requirements, from ensuring
vendors have adequate staff to ensuring the staff have completed all required training.

VENDOR RELATIONS

An important objective in purchase management is that of maintaining good relations with

vendors. A good vendor is an asset of the company; and, therefore, just as customer goodwill
is considered important, a good relationship with the vendor should be treated likewise. A
vendor who supplies the proper quality material in proper amounts in proper time is not very
easy to find. Moreover, there are many situations where materials are required in hurry. There
are situations where materials are in shortage in the supply market. In all such situations,
good relationships with the vendors pay dividends. This may entail: personal relationship,
professional relationship:-

- By helping the vendor in times of stress and strain with financial aid, by providing
management skills if necessary, and,

- Maintaining a healthy professional relationship by fair negotiation, fair evaluation

and fair compensation.

The modern management theory and world class manufacturing call for a long-term, almost a
lifetime, association with the vendors. This also means that there will be fewer vendors but
these will be dedicated vendors- almost a part of organizational family.

Until the present and even now, the Indian industry has not given/is not giving much
importance to vendor relations. The emphasis, if any, has been on vendor selection and on
monitoring the performance of the vendor through a vendor rating system. Vendor is the
entity that is, generally, taken for granted. This attitude is: All said and done, the vendors for
the company may change over a period of time. They may change to another business; some
of them may not give the desired performance in quality, delivery and price, and therefore,
one should always expect a drop-out rate in the vendors list of the company.

SELECTION OF VENDORS

1. The production capabilities of the vendor

(a) Capacity to manufacture the required product in desired quantities.

(b) Possibility of future expansion in capacity.

(c) The understanding or the knowledge of the vendor regarding the buying company
and its need.

2. The financial soundness of the company

(a) The vendor company’s capital structure.

(b) Whether it belongs to a larger group of companies; whether it is a Private Limited

or a Public Limited company.
 (c) The profitability record of the company in the past.

(d) Expansion plans of the company in the future.

3. Technical capabilities

(a) Whether the available machines are capable of the required quality of materials?
What are the future plans of the vendor?

(b) Whether there are enough technical skills available with the vendor?

(c) Whether there is proper research, design and development facility available with
the vendor?

(d) What is the record of the vendor in filling the orders of other buying companies in
the same business?

(e) What has been the consistency in the quality produced by the vendor?

(f) Whether the vendor has appropriate storage and warehouse facilities to retain the
quality of the product produced?

(g) Whether proper quality control procedures are being followed in the vendor
company?

4. Other considerations

(a) What are the working conditions in the vendor company?

(b) How are the industrial relations in the vendor company?

(c) Whether there is any possibility of disruption of the supply of materials in terms
of quantity and/or quality due to human relations problem in the vendor company?

VENDORS MANAGED INVENTORIES

Vendor Managed Inventory (VMI) is a supply chain practice where the inventory is
monitored, planned and managed by the vendor on behalf of the consuming organization,
based on the expected demand and on previously agreed minimum and maximum inventory
levels. In its simplest form, Vendor Managed Inventory is the process where the vendor
assumes the task of generating purchase orders to replenish a customer’s inventory. VMI is a
term that is used to describe many types of supply chain initiatives.
Traditionally, success in supply chain management derives from understanding and managing
the trade off between inventory cost and the service level.

The Vendor Managed Inventory Approach

VMI reduces stock-outs and reduces inventory in the supply chain. Some features of VMI
include:-

• Shortening of the supply chain

• Centralized forecasting
• Frequent communication of inventory, stock-outs, and planned promotions. Electronic
Data Interchange (EDI) linkages facilitate this communication.
• No manufacturer promotions
• Trucks are filled in a prioritized order. For example, items that are expected to stock
out have top priority, then items that are furthest below targeted stock levels, then
advance shipments of promotional items (promotions allowed only in transition
phase), and finally, items that are least above targeted stock levels.
• Relationship with downstream distribution channels
• Result: Inventory reduction and stock-out reduction

VMI is based on the belief that supplying parties are in a better position to manage inventory
as they have better knowledge of the goods production capacities and lead times. Also it is
based on the belief that allowing vendors to manage inventory reduces the number of layers
in the supply chain, increasing stock visibility and reducing overall inventory levels. To
enable VMI, sales data must be provided to the vendor via Electronic Data Interchange
(EDI), other electronic means, or via traditional human agents at outlets.

Origin of Vendor Managed Inventory

VMI started in the retail business and grew out of Efficient Consumer Response (ECR),
where consumer satisfaction or rather consumer expectation of stock availability is an
important way to have a competitive edge over others. Wal-Mart is one of the successful
pioneers of this supply chain strategy.
VMI is now gradually progressing towards strategic-partnership based forms. These
influences the way companies plan their inventory, evolving to Collaborative Planning,
Forecasting and Replenishment (CPFR).

Usage of Vendor Managed Inventory

• Error sensitive industries. Example: Pharmaceutical Sector.

• Multiple outlets, fast-moving consumer goods. Example: Wal-Mart.
• Perishable goods. Example: K Mart.
• Valuable and unpredictable components. Example: PC manufacturing.
• Strong competition (small margins). Example: Automotive.

Steps in Vendor Managed Inventory

VMI should be achieved in a number of phases:-

1. Communicate expectations of all parties.

2. Retailer/distributor must commit to sharing precise information.
3. Vendor must ensure reliable transmission, receipt, and use of information.
4. Agreement on ordering policy, risk and reward sharing.
5. Commit time and resources.
6. Extensive testing.
7. Implementation and evaluation. Adjust.
8. Appreciate vendors that manage the inventory well. Example: promotion to Category
Captain, profit sharing schemes, etc.

Strengths of Vendor Managed Inventory

• Supply Chain level

o Lower inventory levels at total supply chain level.
o Less overhead.
o Increased sales.
o Reduces human data entry errors.
• Vendors
o Better insight in customer demand (better resource usage, reduced raw and
finished goods inventories).
 o Improved, more direct communication with customers.
o Improved market analysis.
o Increased sales via lower out of stock rates.
o Opportunity to provide category management and other value-added services.
• Suppliers
o Reduced replenishment times and lower inventory costs.
o Increased sales through reduced stock outs.
o Less redundancy.
o Build strategic strengths through establishing strong supply chain
relationships.
o Vendor assistance with category management.
• End-users
o Increased service level.
o Reduced stock outs

Limitations of Vendor Managed Inventory

• Success of VMI initiative depends on the strength of relationship between the vendors
and retailers.
• Increased dependency between the parties and increased switching costs.
• Lack of trust to exchange data can result in the ineffective implementation in one or
more of the following forms:
o Inventory invisibility.
o Inventory imbalance.
• Costs of technology and changing organization.
• Extensive data- and EDI testing is needed.
• Loss of necessary shelf space at the selling party may result in less attention by
buyers, compared to competitors that are not into VMI yet.
• Special promotions or events need to be communicated beforehand to avoid
replenishment planning mistakes (loss of flexibility).
• Increased vulnerability for non-foreseeable risks such as employee strikes, hurricanes,
etc. due to lower inventory levels.
• Most of the benefits are for the end client and for the selling party, while the vendor
does much of the work.
Assumptions of Vendor Managed Inventory

VMI is usually successful for industries and organizations with the following characteristics:

• Multiple outlets, because this increases the benefits compared to traditional inventory
management.
• Severe consequences in case of human errors (Pharmaceutical).
• Industries with steady and high volumes (Retail, Consumer Products).
• Industries with high-value inventory and a high level of demand unpredictability
(High Tech).
• Management with strong leadership capability to form strategic long term
partnerships (Automotive).

VMI Implementation Challenges

VMI can be made to work, but the problem is not just one of logistics. VMI often encounters
resistance from the sales force and distributors. At issue are roles and skills, trust, and power
shifts. Some of the sales force concerns are:

• Loss of control
• Effect on compensation - incentive bonuses may depend on how much is sold, but
sales force has less influence under VMI.
• Possible loss of job
• Scepticism that it will function well - technical problems
• Concern that reduced inventory will result in less shelf space and therefore loss of
market share. This concern can be addressed by filling the shelf space with other
stock keeping units from the same vendor.

VENDOR RATING

Vendor rating is the result of a formal vendor evaluation system. Vendors or suppliers are
given standing, status, or title according to their attainment of some level of performance,
such as delivery, lead time, quality, price, or some combination of variables. The motivation
for the establishment of such a rating system is part of the effort of manufacturers and service
firms to ensure that the desired characteristics of a purchased product or service is built in and
not determined later by some after-the-fact indicator. The vendor rating may take the form of
a hierarchical ranking from poor to excellent and whatever rankings the firm chooses to insert
in between the two. For some firms, the vendor rating may come in the form of some sort of
award system or as some variation of certification. Much of this attention to vender rating is a
direct result of the widespread implementation of the just-in-time concept in the United States
and its focus

CRITERIA FOR EVALUATION

Vendor performance is usually evaluated in the areas of pricing, quality, delivery, and
service. Each area has a number of factors that some firms deem critical to successful vendor
performance.

Pricing factors include the following:-

• Competitive pricing: The prices paid should be comparable to those of vendors

providing similar product and services. Quote requests should compare favorably to
other vendors.
• Price stability- Prices should be reasonably stable over time.
• Price accuracy: There should be a low number of variances from purchase-order prices
on invoiced received.
• Advance notice of price changes: The vendor should provide adequate advance notice
of price changes.
• Sensitive to costs: The vendor should demonstrate respect for the customer firm's
bottom line and show an understanding of its needs. Possible cost savings could be
suggested. The vendor should also exhibit knowledge of the market and share this
insight with the buying firm.
• Billing: Are vendor invoices are accurate? The average length of time to receive credit
memos should be reasonable. Estimates should not vary significantly from the final
invoice. Effective vendor bills are timely and easy to read and understand.

Quality factors include:-

• Compliance with purchase order: The vendor should comply with terms and
conditions as stated in the purchase order. Does the vendor show an understanding of
the customer firm's expectations?
 • Conformity to specifications: The product or service must conform to the specifications
identified in the request for proposal and purchase order. Does the product perform as
expected?
• Reliability: Is the rate of product failure within reasonable limits?
• Reliability of repairs: Is all repair and rework acceptable?
• Durability: Is the time until replacement is necessary reasonable?
• Support: Is quality support available from the vendor? Immediate response to and
resolution of the problem is desirable.
• Warranty: The length and provisions of warranty protection offered should be
reasonable. Are warranty problems resolved in a timely manner?
• State-of-the-art product/service: Does the vendor offer products and services that are
consistent with the industry state-of-the-art? The vendor should consistently refresh
product life by adding enhancements. It should also work with the buying firm in new
product development.

Delivery factors include the following:-

• Time: Does the vendor deliver products and services on time; is the actual receipt date
on or close to the promised date? Does the promised date correspond to the vendor's
published lead times? Also, are requests for information, proposals, and quotes swiftly
answered?
• Quantity: Does the vendor deliver the correct items or services in the contracted
quantity?
• Lead time: Is the average time for delivery comparable to that of other vendors for
similar products and services?
• Packaging: Packaging should be sturdy, suitable, properly marked, and undamaged.
Pallets should be the proper size with no overhang.
• Documentation: Does the vendor furnish proper documents (packing slips, invoices,
technical manual, etc.) with correct material codes and proper purchase order
numbers?
• Emergency delivery: Does the vendor demonstrate extra effort to meet requirements
when an emergency delivery is requested?

Finally, these are service factors to consider:-

 • Good vendor representatives have sincere desire to serve. Vendor reps display
courteous and professional approach, and handle complaints effectively. The vendor
should also provide up-to-date catalogs, price information, and technical information.
Does the vendor act as the buying firm's advocate within the supplying firm?
• Inside sales. Inside sales should display knowledge of buying firms needs. It should
also be helpful with customer inquiries involving order confirmation, shipping
schedules, shipping discrepancies, and invoice errors.
• Technical support. Does the vendor provide technical support for maintenance, repair,
and installation situations? Does it provide technical instructions, documentation,
general information? Are support personnel courteous, professional, and
knowledgeable? The vendor should provide training on the effective use of its
products or services.
• Emergency support. Does the vendor provide emergency support for repair or
replacement of a failed product.
• Problem resolution. The vendor should respond in a timely manner to resolve
problems. An excellent vendor provides follow-up on status of problem correction.

A more comprehensive approach is needed for suppliers that are critical to the success of the
firm's strategy or competitive advantage. For firms that fall into the latter category
performance may need to be measured by the following 7 C's.

1. Competency-managerial, technical, administrative, and professional competence of

the supplying firm.
2. Capacity-supplier's ability to meet physical, intellectual and financial requirements.
3. Commitment-supplier's willingness to commit physical, intellectual and financial
resources.
4. Control-effective management control and information systems.
5. Cash resources-financial resources and stability of the supplier. Profit, ROI, ROE,
asset-turnover ratio.
6. Cost-total acquisition cost, not just price.
7. Consistency-supplier's ability to exhibit quality and reliability over time.

BENEFITS

Benefits of vendor rating systems include:-

 • Helping minimize subjectivity in judgment and make it possible to consider all
relevant criteria in assessing suppliers.
• Providing feedback from all areas in one package.
• Facilitating better communication with vendors.
• Providing overall control of the vendor base.
• Requiring specific action to correct identified performance weaknesses.
• Establishing continuous review standards for vendors, thus ensuring continuous
improvement of vendor performance.
• Building vendor partnerships, especially with suppliers having strategic links.
• Developing a performance-based culture.

Vendor ratings systems provide a process for measuring those factors that add value to the
buying firm through value addition or decreased cost. The process will continually evolve
and the criteria will change to meet current issues and concerns.

RECENT TRENDS AND DEVELOPMENT IN PURCHASING

Many companies are now confronted with diminishing growth opportunities, which results in
a situation where an increase in turnover can only be realized at the expense of the
competition and only with a great deal of effort. This leads to increased pressure on sales
prices and consequently on cost prices and margins, which causes two developments.

- On the one hand it has resulted in shifts of power between purchasing and selling
parties in many markets. Due to the fact that in many cases the market has changed
from seller’s market to buyer’s market, the role of the buyer is now more dominant
than a number of years ago.

- On the other hand the increasing pressure on sales prices and margins has resulted in
an increased pressure on direct materials-related costs. Because the purchasing prices
determine the sales prices in the industrial sector to a large extent, the company will
be constantly on the look-out for opportunities to keep these prices as low as possible.

As a result of both developments, the purchasing and supply strategies of industrial

companies have undergone major changes.

Several examples of these changes are presented below:-

 i. Co-ordination of purchasing requirements: In companies with several manufacturing
plants, important purchasing advantages can be realized by combining policy is seen to
emerge in many European companies of this type, even across national borders.
Traditionally this was already common for raw materials; at present however, a similar
approach is used for the purchase of computer hardware and software, capital goods and
components. Good examples of companies with an active policy concerning purchasing
co-ordination are, apart from the automotive and computer industry, Shell, Philips
electronics and Alcatel.

ii. Integration of purchasing in logistics: Automation enables companies to improve

materials planning and supply systems. It furthermore may significantly improve the
productivity within the materials area. An integrated approach of materials management
requires close cooperation between the production planning, inventory control, quality
inspection and purchasing. To achieve succesful automation, system standardization is a
prerequisite. Purchasing cannot be allowed to follow its own course. To ensure effective
integration of the different materials related areas. Purchasing increasingly is integrated
into supply chain management.

iii. Integration of purchasing in engineering and production planning: In practice,

supplier selection is determined to a large degree by the technical specifications. Once
established, this specification is often very difficult to change. From a commercial point
of view it is undesirable that specifications are defined towards a particular supplier; in
that case purchasing often ends up with a monopolist, which seriously hampers
negotiating. To prevent this it is desirable to include purchasing in the development
process at an early stage. The goal is to make optimal use of purchasing knowledge of
products and markets for the benefit of the product design.

iv. Make or Buy: Practice shows that several production activities can be done cheaper and
faster by specialized suppliers. Moreover, companies may take greater demands in
terms of quality on external suppliers than on their own. This is why in some industrial
branches, the purchasing to sales ratio has been steadily rising. For some companies
these have resulted in detailed make or buy studies. Purchasing should always be
closely involved in this type of study, because they are the logical source of market
information.
v. Reciprocity agreements and compensation obligations: Companies operation on
international markets is often obliges to compensate their sales turnover by counter
purchase obligations. The recent opening up of the eastern European block has counter
trade an actual issue. Buying from these countries may even open up interesting sales
opportunities. Purchasing become involved in fulfilling such obligations

vi. Total quality control and just-in-time production: In several companies a growing
interest in quality improvement and increased productivity can be observed. The
activities of the European foundation for Quality Management, initiated by the
presidents of 14 European industries on 5 September 1988, illustrate the first; several
EEC programmes, aimed at logistics, the second. There is a growing awareness in the
international business scene that, if Europe wishes to remain competitive on a world
scale in several sectors, Improvements must be made in both the level of costs and the
level of quality of the end products.

E-PURCHASING AND E-PROCUREMENT

The Internet and e-commerce is drastically changing the way purchasing is done. Internet use
in buying has led to the terms "e-purchasing" or "e-procurement." Certainly, communication
needed in competitive bidding, purchase order placement, order tracking, and follow-up are
enhanced by the speed and ease afforded by establishing online systems. In addition,
negotiation may be enhanced and reverse auctions facilitated. Reverse auctions allow buying
firms to specify a requirement and receive bids from suppliers, with the lowest bid winning.

E-procurement is considered one of the characteristics of a world-class purchasing

organization. The use of e-procurement technologies in some firms has resulted in reduced
prices for goods and services, shortened order-processing and fulfillment cycles, reduced
administrative burdens and costs, improved control over off-contract spending, and better
inventory control. It allows firms to expand into trading networks and virtual corporations.

Criteria for e-purchasing include:

• Supporting complete requirements of production (direct) and non-production

(indirect) purchasing through a single, internet-based, self-service system.
• Delivering a flexible catalog strategy.
• Providing tools for extensive reporting and analysis.
 • Supporting strategic sourcing.
• Enhancing supply-chain collaboration and coordination with partners.

ETHICS IN BUYING

Since the purchasing department deals with large sums of money purchasing personnel may
in some cases may take part in unethical and illegal activities such as manipulating
quotations, fixing prices, favoring up specific supplier and so on.

Most organisations develop a set of rules and guidelines to ensure that their purchasing
manager conduct business in ethical manner. Some of these rules are:-

- The organization’s interest should be kept in mind while purchasing.

- No undue favor should be taken from or given to suppliers.
- All purchasing activities should be conducted honestly and truthfully.
- All purchasing commitments should be completed on time.

Organisation can reduce the temptation to adopt unethical practices by compensating

employees suitably.
Bibliography

• Operations Management By S.N. Charry

• Purchase and Supply Management by Arjan J Van Welee
• Operation Management by ICFAI Business School
• Operation Management by K. Ashwathapa
• Purchase Management by L.C. Jhamb
• Wikipedia