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Purchasing

Chapter 7

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Purchasing
the process of buying Requires input from:
Marketing Engineering Manufacturing Manufacturing Planning and Control
what materials to order when to order them
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Purchasing and Profit Leverage


On average 50% of sales dollars
raw materials components supplies

Tremendous potential to increase profits

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Income Statement
Sales Cost of Goods Sold Purchases Other expenses Profit Before Tax $100
$50 40

90 $ 10

assume a profit before tax of 10%


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Income Statement (sales increase)


Sales Cost of Goods Sold Purchases Other expenses Profit Before Tax $110
$55 44

99 $ 11

to increase profits by $1; sales must increase by 10%


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Income Statement (reduced purchase cost)


Sales Cost of Goods Sold Purchases Other expenses Profit Before Tax $100
$49 40

89 $ 11

to increase profits by $1; decrease costs by 2%


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Sales / Purchasing Leverage


A 10% increase in sales is the same impact on profits as A 2% decrease in the purchase cost
Leverage effect is 5:1

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Objectives of Purchasing
Obtain goods and services:
of the required quantity and quality at the lowest possible cost at the best possible service and delivery while maintaining and developing suppliers

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Purchasing Functions
Determining purchasing specifications
right quality right quantity right time (delivery) right place (delivery)

Selecting supplier
right source
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Purchasing Functions (continued)


Negotiating terms and conditions
right price

Issuing and administering purchase orders

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Purchasing Cycle
1. Receive and analyse purchase requisitions
2. Select suppliers, issue quotations 3. Determine the right price 4. Issue purchase orders 5. Followup to assure correct delivery 6. Receive and accept the goods 7. Approve invoice for payment
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Receiving and Analyzing Requisitions


From planners (MRP system) and all other users Purchasing will:
Identify originator, account number, approvals Check material specifications Verify quantity and unit of measure Verify delivery date and place Ensure all supplemental information
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Selecting Suppliers
Often from a list of approved suppliers For small items:
internet catalogues trade journals

For large items, issue a request for quotation


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Requesting Quotations
Written inquiries sent to enough suppliers
to ensure competitive and reliable quotes are received

Quotes are analyzed


price compliance to specification technical suitability often with the involvement of the originator
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Determining the Right Price


Usually the lowest May involve negotiations
Responsibility of the Purchasing Department

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Issuing a Purchase Order


Legal document Forms a contract with the supplier upon acceptance Copies to:
Supplier Originator Accounting Receiving Purchasing file
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Follow-up and Delivery


Ensure on-time delivery Negotiate any changes Take corrective action:
expedite as required find alternative sources of supply work with suppliers to resolve problems reschedule production?
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Receiving and Accepting Goods


Receiving inspects goods for correct quantity and any damage Accepts goods and generates a receiving report
send to quality for further inspection hold goods damaged in transit

Copies to Accounting, Purchasing


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Approving Invoice for Payment


Agreement with: Original Purchase Order Receiving Report Invoice
price including discounts quantity

Send approval to Accounts Payable


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Establishing Specifications
Purchasing can help to make the best buy
Quantity requirements Price Requirements Functional Requirements

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Quantity Requirements
Small volume
find a standard item

Large items
design for economies of scale reduce cost satisfy functional needs
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Price Requirements
Relates to the use of the item
Relates to the selling price of the finished product

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Functional Specifications
What the item is expected to do
Set by the end user
performance expectations aesthetic expectations

Example: functional specifications for a car


run reliably? make you look cool? safety?
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Functional Specifications and Quality


Quality and product planning
to meet the expectations of the marketplace

Quality and product design


determining the specifications

Quality and manufacturing


meeting the specifications

Quality and use


satisfying customer expectations
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Functional Specification Description


1. Brand 2. Physical and chemical specifications Material and method of manufacturing Performance 3. Engineering drawings 4. Miscellaneous methods
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Description by Brand
Items are patented Special supplier expertise Small quantity
not worth the effort of developing specifications

Preferred by
customers the buyer
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Description by Brand
Reputation of the supplier
guarantees / warranties

Limits competition
higher price easy to inspect

Specify by brand or equivalent


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Description by Specification
Physical and chemical specifications
buyer defined

Material and method of manufacture


environmental or food issues

Performance specifications
state what the item is supposed to do uses supplier expertise
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Specifications
Too loose
may not give the desired performance

Too detailed
costly to develop may limit competition

Should allow for multiple sources Can be difficult to do i.e. colors Best to use suppliers standard products
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Sources of Specifications
Buyer specifications
expensive and time consuming

Standard specifications
set by government and nongovernmental agencies SAE 10W30 motor oil Underwriters Laboratories (UL) ASME steel standards
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Standard Specifications
Widely known and accepted Lower in price Adaptable to customers needs
Market grades
describe many aspects of a product eggs: Grade A small, medium or large
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Engineering Drawings
Detailed description of parts
finishes tolerances materials used no other way to describe the item

Expensive to produce Can be used for inspection


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Miscellaneous Specifications
Samples used for colors / patterns Combination of methods
e.g. curtains
drawing of the window dimensions fire or safety rating type of material to use samples of pattern desired
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Selecting Suppliers
The right supplier:
can supply the quality needed has the capacity to deliver the quantity need and on time (JIT deliveries?) makes a profit, but at a good price contributes to the improvement of your product

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Factors in Selecting Suppliers


Technical ability Manufacturing capability Reliability After-sales service Location Other considerations Price
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Technical Ability
Do they have the technical capability? Is there a program of product development and improvement? Can they assist in improving your product? Their products become part of your product

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Manufacturing Capability
Can they consistently meet the specifications and quality desired?
quality control programs competent personnel

Do they have good manufacturing planning and control systems?


to supply information on delivery
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Reliability
Reputable Stable Financially strong
Were in this together

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

After-Sales Service
Service organization Supply of spare parts Technical support

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supplier Location
Location may effect delivery time Local inventories May be required for after-sales service
will your customers require service?

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Other Considerations
Credit terms Willingness to hold inventory JIT Information technology Reciprocal business

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Price
Not always the lowest May include other services

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supplier Selection
On-going relationship Mutual benefit Supplier can depend on future business Buyer can be:
assured supply of quality products technical support product improvements / problem solving
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Identifying Suppliers
Internet Catalogues Salespeople Trade magazines Trade directories Salespeople of the buyers firm
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Supplier Selection Weighted-Point Plan


Factors
Weights Rating Ranking

Things that must be considered as part of what we will be buying The relative importance of each of the factors How well each supplier compares on each factor The weight times the rating
2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

Weighted-Point Plan
1. 2. 3. 4. Select the factors Assign a weight to each factor Rate the suppliers for each factor Rank each supplier
multiply the weight by the rate for each factor

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Weighted-Point Plan

Figure 7.1 Supplier rating


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Price Determination
Direct influence on companys profit 50% of cost of goods sold (CoGS) Package of:
function quantity service price

you only get what you pay for


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Basis for Pricing


Fair price
competitive gives seller a profit allows buyer to make a profit

Upper limit
established by buyers

Lower limit
established by sellers
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Analyzing Costs
Fixed Costs
costs incurred no matter the volume of sales
equipment, insurance, overhead

Variable Costs
costs which vary with the volume produced
direct labor, direct materials

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Analyzing Costs
Total cost = fixed cost + (var cost/unit)(volume)
Unit cost = total cost volume = fixed cost + variable cost per unit volume

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Break Even Point


The volume of sales where total revenue equals total costs A seller must have sufficient volume to make a profit Knowing the sellers break even point is useful in negotiations
increased volume may lower price paid
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Break Even Point -example


Fixed Cost = $5,000 Variable Cost = $6.50 / unit Selling Price = $15 per unit Average Cost = $5,000 1000 + $6.50 = $11.50 per unit To find the Break Even Point Let X = Number of Units $15X = $5,000 + $6.50X $8.50X = $5,000 X = 588.2 units The volume must exceed 588.2 units to make a profit
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Price Negotiation
Buyer needs knowledge of sellers costs Buyer must have sufficient clout Should benefit both supplier and buyer Savings must justify the time and effort required

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Negotiations - Type of Product


Commodities
price is determined by the market concern for future contracts

Standard products
price set by catalogue listings little room for negotiation

Small value items


try to reduce ordering costs or increase volume

Made-to-order items (negotiation possible)


quotations from a number of sources
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Impact of MRP on Purchasing


Purchasing - two categories of activity: Procurement
establishing specifications, selecting suppliers, determining price, negotiations

Supplier scheduling and follow-up


same as production activity control execute the master schedule and the MRP ensure good use of resources, minimize WIP, provided the desired level of customer service
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Buyer / Planner Concept


Production activity control
controls the flow of work through the plant schedules need for components

Purchasing
coordinates the flow of goods from suppliers

Plans are going to change!


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Buyer / Planner Concept


Responsibility of planning and buying Works with the Master Scheduler and other Planner / Buyers Handles fewer components Smoother flow of information
knowledge of factory needs matches material requirements with supplier capabilities
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Planner / Buyer Responsibilities


Determining material requirements Developing schedules Issuing shop orders Issuing material releases to suppliers Establishing delivery priorities Controlling orders in the factory and to suppliers Handling all the activities associated with the buying and the production scheduling Maintaining close contact with suppliers
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Contract Buying
Long term contract with a supplier for small volume items
Authorize releases against the contract when goods are needed

Supplier may be given a copy of the material requirements plan Requires close coordination Works best with Buyer / Planner concept
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supplier Responsiveness and Reliability


Material requirements often change Suppliers must be able to react to change Flexibility
in volume in products needed

Reliable
in delivery promises
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Contract Buying
Assures supplier of a certain amount of business Suppliers are more responsive to buyers needs
Assures buyer that capacity will be available when needed Buyer can delay actual ordering
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Close Relationship with Suppliers


The need to understand each others capabilities and constraints Cooperation and team work Very frequent communications Between the buyer/planner and the suppliers production planner

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Electronic Data Interchange (EDI)


Electronic exchange of information between customers and suppliers
purchase orders invoices material requirements plans

Reduces time involved Avoids costly paper work


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Vendor Managed Inventory


Supplier maintains an inventory of certain items at the customers plant Customer only pays for the inventory when it is actually used Usually for standard, small value items
fasteners electrical components
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

The Internet
Internet
open public access to posted information valuable source of supplier and product information

Intranet
internal to company personnel only

Extranet
between participating companies
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supply Chain Management Organizational Implications


Total cost focus
not just price includes transportation, storage, handling value stream mapping mutual value analysis with suppliers

Arnold, Chapman, & Clive: Intro Materials Management, 6th ed.

2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supply Chain Management Organizational Implications


Mutually advantageous supplier negotiations Information sharing
costs schedules inventory levels

Measurement systems
all aspects of the supply chain

Growth in electronic business (Internet)


Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.

Supply Chain Management Savings


More effective product specifications Leveraging through volume discounts and supplier consolidation Lower costs through long-term contracts and efficient communications Lower payment costs
credit cards electronic commerce blanket orders
Arnold, Chapman, & Clive: Intro Materials Management, 6th ed. 2008 Pearson Education, Upper Saddle River, NJ 07458. All Rights Reserved.