Unit 2

• General procurement procedures

o Definition, description, and transmission of the need
o Supplier qualification and selection and order preparation
Order follow-up
o Receipt and inspection
o Invoice audit and order completion
• Purchasing records
o Open orders; closed orders; purchase log
o Commodity record
Supplier record
o Contract and tool records
• Handling rush orders
• Handling small orders
o Blanket orders; systems contracting
o Contracting/MRP systems
Telephone/fax orders; electronic
systems Petty cash and C.O.O.
systems
o Purchase credit card system
o Consignment and supplier delivery systems
• Evolving ordering arrangements
o Long term contracts—definite delivery; indefinite delivery
o National agreements

A procedure outlines in detail the specific actions to be taken to accomplish a given task, within the
guidelines of any applicable policies. In short, it establishes the way of doing things.
Procurement procedures, and the documents they utilize, serve two fundamental purposes within a
firm:
1 They provide the framework and the direction for accomplishing the supply and materials
management activities effectively and efficiently.
2 They provide the means for processing information inputs from outside the department to
produce output communications needed by individuals in other departments to do their jobs in a
coordinated and timely manner. (Figure 4-1 identifies the numerous departments that are affected by
procurement procedures.)
The purpose of this chapter is to identify and discuss the basic operating procedures, documents, and
records that integrate the specialized activities of those chapters into a complete operational
purchasing cycle.
In operation, these basic procedures can be implemented manually, by means of a computer-based
system, or most commonly by a combination of the two.
PURCHASING CYCLE
A purchasing department buys many different types of materials and services, and the procedures used
in completing a total transaction normally vary among the different types of purchases.
However, a general cycle of activities in purchasing most operating materials and supplies is fairly
standardised. The following steps constitute the typical purchasing cycle.
(i) Recognition of the need.
(ii) Definition and description of the need.
(iii) Investigation, qualification and selection of a suitable source for the supply (often a source may
have to be developed).
(iv) Determination of price and availability of materials.
(v) Preparation and issue of purchase order.
(vi) Supplier's acceptance of the purchase order (i.e., order acknowledgment).
(vii) Follow-up of the purchase order to ensure timely delivery of the material (includes expediting
and de-expediting).
(viii) Receiving and inspecting the material supplied.
(ix) Checking the invoice and approving payment of bills.
(x) Closing the orders.
The above activities involved in the purchasing cycle are illustrated in Exhibit 9.3.
The activities involved in the purchasing cycle are briefly discussed in the following paragraphs.

i) Recognition of the need: The need for a purchase typically originates in one of a, firm’s
operating departments (i.e., user department or indenting department) or in its inventory control
section. The purchasing department is usually notified of the need by means of (i) a standard purchase
requisition issued by the user department or (ii) a material requirement planning (MRP) schedule
issued by the inventory control section or stores department or materials planning and control section.
If the need is one-time purchase, then an engineering bill of materials is sometimes used.
(ii) Description of the need: Regardless of how the need is transmitted to the purchase department by
the industry or user department, material requirements must be defined clearly and described in detail
with part name, part number, coding, specifications, quantities required etc. The purchase requisition
must include all necessary information about the material to be purchased, in a form that can be readily
checked and verified
iii)Supplier selection: As soon as a need has been established and precisely described, the buyer
begins an investigation of the market to identify potential sources of supply. In case of routine items
(repetitively bought) for which supplier relationships have already been developed, little additional
investigation may be required to select a good source of supply. But for the purchase of a new or a
high-value item a thorough investigation of potential suppliers may be necessary.
The buyer may refer to the approved supplier's list or register maintained in the purchase department to
select a few suppliers to whom enquiries are to be sent for getting the quotations. Sometimes it
becomes necessary to advertise in the newspapers inviting tenders from suppliers.
After qualifying a preliminary group of potential sources, the buyer may employ the techniques of
competitive bidding or negotiation or both. When competitive bidding is used, the buyer initiates the
procedure by requesting quotations from a reasonable number of firms with whom the buying group is
willing to do business.
Whatever is the method, it is essential that a right source must be selected. A right supplier is one who
delivers materials of the correct specifications on the stipulated delivery dates. The qualifications of a right
supplier are : (a) ethical in behaviour, (b) stands by the promises, (c) regards for cordial buyer-
seller relationships, (d) progressive in business, (e) seeks technological advancements in improving quality
of his products, (f) charges reasonable prices, (g) can be relied upon, (h) honest and fair in his dealings all
the times, (i) has adequate plant facilities and know-how
Before selecting a right source, the buyer has to decide which to have: a single source or multiple
sources, both having their own advantages and disadvantages.
The factors in source selection are : (a) reliability, (b) technical abilities, (c) after sales service
availability, (d) buying convenience, (e) past experience, (f) location, (g) financial position, (h) labour
relations, (i) reciprocal relations.
(iv) Determination of price and availability: After selecting the potential sources of supply, the next step
is to secure the price for the items to be purchased. This can be done in three ways : (a) For standard
items, vendor's catalogues and price lists are available. For such items, the buyers need only check current
listings to obtain the price, (b) Negotiating with potential suppliers for establishing the price and (c)
Inviting tenders or quotations from the potential suppliers.
(v) Preparation and issue 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. Hence, the buyer should take great care in preparing and wording the
purchase order. Quality specifications must be described precisely. Quantity requirements, price and
delivery and shipping requirements must be specified accurately. The purchase order may also include
terms and conditions designed to give legal protection to the buyer on such matters as contract acceptance,
delivery performance and contract termination, shipment rejections, assignment and subcontracting
of the order, patent rights and infringements, warranties, compliance with legal regulations, and invoicing
and payment procedures etc. Usually these terms and conditions are printed on the back of the firm's
purchase order form.
(vi) Order acknowledgment by the supplier: In most cases, the original copy of the purchase order which
is sent to the supplier constitutes a legal "offer" to buy. No purchase "contract" exists, however, until the
supplier accepts the buyer's offer. Hence, it is necessary for the buyer to obtain the order
acknowledgment from the supplier in a copy of the purchase order sent to the supplier.
The purpose of order acknowledgment is twofold: (a) The supplier can complete the order
acknowledgment and return the same to the buyer, acknowledging acceptance of the order, (b) The
supplier can indicate whether or not he or she is able to meet the desired delivery date. If the supplier ships
the ordered item immediately, it is not necessary to send the order acknowledgment.
(vii) Follow up and expediting: The purchasing department's responsibility for an order does not terminate
with making of a satisfactory contract with seller by placing a purchase order. Purchasing bears full
responsibility for an order until the material is received and accepted. Even though a supplier intends to
meet a required delivery date, many problems may arise to prevent the supplier from making his/her delivery
commitments. When there is a possibility that the supplier may not stay on schedule, important orders
with critical delivery dates should be actively followed-up by the buyer. At times such orders are placed,
the buyer may have to determine specific dates for follow-up checks to be made.
Follow up is usually done through a fax or a telephone call for critical orders. Routine follow-up for the less
critical orders is usually accomplished by mailing a preprinted enquiry to the supplier.
(viii) Receipt and inspection: When a supplier ships materials, a packing slip which itemises and
describes the contents of the shipment is kept along with the items shipped. The receiving clerk or
stores person uses this packing slip along with his/her copy of purchase order to verify that the correct
material has been received.
After the consignment of materials received has been inspected for quantity and general condition of the
material, the receiving clerk issues a receiving report.
Before shipments can be accepted, technical inspection may be necessary for some materials, A copy of
the receiving report may be sent to the inwards goods inspection section. The inspectors carry out the
necessary technical inspection and record their remarks and quantity of materials which are accepted
as well as those which are rejected. Copies of this report known as inspection cum receiving report (ICRR)
will be sent to purchase department, stores department, supplier and "bills payable" section of accounts
department for necessary action.
(ix) Checking the invoice and approval for payment: Once the inspection is completed and if all the
quantities ordered are supplied and accepted, then the purchase executive checks the inspection cum
receiving report received by him/her with the copy of the purchase order and verifies the bill sent by the
supplier for payment. If the bill is priced correctly and if no rejections occur in the quantity supplied,
the bills are passed by the purchase executive and sent to "bills payable" section of the accounts
department for payment to the supplier.
(x) Closing the purchase order: If the supplier supplies materials in quantities as specified in the
purchase order and if no rejection occurs, then the order can be closed. Closing the order entails a
consolidation of all documents and correspondence relevant to the order, the completed order is then filed
in the closed order file as a part of historical record. In cases where the supplier supplies partial quantities
or some of the items supplied are rejected, the supplier is asked to expedite supply of balance quantities or
rejection replacements and after the order quantities are completely received and accepted, the purchase
order is treated as closed. The supplier may be paid for the partial supplies or for the accepted quantities
which are less than the ordered Quantities as per the terms of the purchase order. In cases where the
supplier refuses to supply the balance quantities or rejection replacements, the purchase order may be
short closed to the extent of accepted quantities and payments made accordingly and the purchase
order is amended to this effect.

GENERAL PROCUREMENT PROCEDURES

A purchasing department buys many different types of materials and services, and the procedures used in
completing a total transaction normally vary among the different types of purchases. However, the general
cycle of activities in purchasing most operating materials and supplies is fairly standardized. The
following steps constitute the typical purchasing cycle:
• Recognize, define, and describe the need
• Transmit the need
• Investigate, qualify, and select the supplier
• Prepare and issue the purchase order
• Follow up the order (including expediting and de-expediting)
• Receive and inspect the material (except in the case of some JIT systems and some partnering
agreements)
• Audit the invoice
• Close the order

Figure 4-1 outlines these steps in operational form. More important, it details the minimum flow
of communications required for a system to function smoothly and efficiently. These
communications may be electronic messages or paper documents, depending on the type of system
used. The precise form the electronic message or the documents take varies widely from one
company to another The important point to note, however, is that a properly controlled purchase
requires extensive communication with numerous work groups. Procurement procedures constitute
the framework within which this task is accomplished.

Recognition, Definition, Description, and Transmission of the Need

The need for a purchase typically originates in one of a firm's operating departments or in its inventory
control section. The purchasing department is usually notified of the need by one of two basic
methods: (l)a standard purchase requisition or (2) a material requirements planning (MRP) schedule. If
the need is a one-time purchase, then an engineering bill of materials is sometimes used.
Standard Purchase Requisition - The purchase requisition is an internal document, in contrast with

the purchase order which is basically an external document. Most companies use a standard, serially
numbered purchase requisition form for requests originating in the operating departments. The user
generally makes a minimum of two copies. One copy is sent to purchasing; the other is retained in the
using department's file. Some companies use as many as nine copies of the requisition for
communication with other interested departments. Purchase requisition formats vary widely because
each company designs its format to simplify its own particular communication problems. The essential
information which every requisition should contain, however, includes a description of the material,
quantity, and date required; estimated unit cost; operating account to be charged; the date; and an
authorized signature. A typical purchase requisition is shown in Figure 4-2.
Today some progressive firms load into the company's mainframe computer, or its local area network,
information and prices for the more commonly used materials. Users can then scan the items through
their computer terminals and requisition those desired electronically. The electronic requisition goes
directly to the appropriate buyer in purchasing—and the purchasing cycle is under way.

FIGURE 4-2
Atypical purchase requisition form. (Courtesy of Storage Technology Corporation.)
In those firms that maintain their inventory records on a computer, most utilize a programmed
inventory monitoring system that identifies the items whose inventory level has reached the reorder point.
When the computer detects this condition, it automatically prints an inventory replenishment requisition
that goes to purchasing for action. This computer-generated requisition replaces what used to be called a
"traveling requisition" when the inventory system was operated manually.
Material Requirements Planning Schedule - When a design engineer completes the design of a part or
an assembly, he or she makes a list of all the materials (and quantity of each) required to
manufacture the item. This list is called an engineering bill of materials. In firms using computerized
production and inventory planning systems, such as an MRP system, the engineering bill of materials is
first reconfigured into a structured multilevel bill of materials. This structured bill of materials for each
item being manufactured can then be used in determining specific material requirements for a given
production schedule during a specific time period. The computer program utilizes the reconfigured
"bills" along with the production schedules for all items as input—and calculates as output the precise
time-phased requirements for each material that will be used in the manufacturing process. This schedule
is then sent to purchasing for direct use in obtaining the required materials. It obviously eliminates the
necessity of preparing numerous purchase requisitions— and it is ideally suited for use in a multiproduct
intermittent manufacturing operation.
Engineering Bill of Materials - In firms that do custom manufacturing work, or for various reasons are
involved in unique one-time projects, a similar but less sophisticated approach can be used. When purchase
of the required materials is a one-time affair, the engineering bill of materials, along with the production
schedule, can be sent directly to purchasing as notification of the production department's need for
materials. Total requirements are then obtained by the buyer simply by manually extending the bill of
materials for the production quantity scheduled. Thus, communications are simplified and the need for
purchase requisitions is eliminated.
Definition and Description of the Need - Regardless of the form of transmission used, material
requirements must be defined effectively, and the most appropriate methods of description should be
selected for the situation at hand. The point to be understood here is that clear, complete, appropriate
definition and description is a joint responsibility of the user and the buyer. One of the reasons why every
purchase authorization document should be approved by designated departmental supervisors is to ensure
that it is initially reviewed by qualified individuals and subsequently comes to purchasing in correct form.
The buyer's responsibility is then threefold. First, he or she checks the document for accuracy and
completeness, including internal data such as the account to which the purchase will be charged. Second,
the buyer determines that the need has been adequately defined. Finally, he or she must ensure that the
appropriate method of description has been used to guarantee a satisfactory purchase for the user and,
at the same time, provide all possible latitude in the selection of a supplier.
The Stock Check - With the exception of requisitions that originate in the inventory control section, when
purchase requests arrive in the purchasing department, they are checked to see if the requested item is
carried in stock. In many cases, a buyer can tell simply by looking at the requisition whether it involves a
stock material. If adequate stock is on hand, no purchase is necessary.
Some companies route all requisitions for tools, supplies, and production- type materials to inventory
control before they are sent to purchasing. If a sizable percentage of a firm's requisitions involve
stores-type items, this procedure expedites the supply process and reduces clerical work in the
purchasing department. It also apprises inventory control of the non-stock items that are being ordered
repetitively and, therefore, might advantageously be carried in stock.
Supplier Selection and Preparation of the Purchase Order
As soon as a need has been established and precisely described the buyer begins an investigation of the
market to identify potential sources of supply. In the case of routine items for which supplier
relationships have already been developed, little additional investigation may be required to select a good
source. The purchase of a new or a high-value item, on the other hand, may require a lengthy investigation
of potential suppliers. If the item to be purchased is complex or highly technical, the firm may utilize a
cross-functional sourcing team, first to qualify potential suppliers—and perhaps eventually to make a
team decision about the most desirable supplier.
After qualifying a preliminary group of potential sources, the buyer may employ the techniques of
competitive bidding or negotiation, or both. When competitive bidding is used, the buyer initiates the
procedure by requesting quotations from a reasonable number of firms with whom the buying group is
willing to do business. Although "request for quotation" forms vary widely among firms, typically they
contain the same basic information that will subsequently be included on the purchase order. Figure 4-
3 provides an illustration.
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. For this reason, the
buyer should take great care in preparing and wording the order. Quality specifications must be described
precisely. If engineering drawings or other related documents are to be considered an integral part
of the order, they should be incorporated clearly by reference. Quantity requirements, price, and delivery
and shipping requirements must be specified accurately. In the event that statistical process control or
sampling inspection is to be used, conditions of acceptance should be stated or referenced on the order.
Similarly, any other important factor affecting the acceptability of the product should be stated precisely.
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.
In addition to those provisions that are unique to each contract, most firms also include as a part of every
contract a series of terms and conditions that are standard for all orders (typically called "boilerplate").
These terms and conditions are designed to give legal protection to the buyer on such matters as contract
acceptance, delivery performance and contract termination, shipment rejections, assignment and
subcontracting of the order, patent rights and infringements, warranties, compliance with legal
regulations, and invoicing and payment procedures. Each company develops its terms and conditions of
purchase in accordance with its own unique needs. Consequently, much variation exists among firms. The
terms and conditions which are printed on the back of one firm's purchase order form are reproduced in
Figure 4-4
Most companies prepare their purchase orders on multipart snap-out forms similar to the one shown in
Figure 4 5. These multipart forms provide enough copies of the order to satisfy both internal and
external communication needs. Although one preparation completes all copies, the various copies of the
form
FIGURE 4-3
A typical request for quotation form (Courtesy of Storage Technology Corporation.)
Terms and conditions
The following terms and conditions and any specifications, drawings, and additional terms and
conditions which may be incorporated by reference or appended hereto are part of this purchase order
By accepting the order or any part thereof, the Seller agrees to and accepts all terms and conditions
1 The cash discount period available to Buyer shall commence on the date of the receipt of the
merchandise or on the date of receipt of the invoice, whichever may be the later.
2 In the event of Seller's failure to deliver as and when specified, Buyer reserves the right to cancel
this order or any part thereof without prejudice to its other rights, and Seller agrees that Buyer may
return part or all of any shipment so made and may charge Seller with any loss or expense sustained as
a result of such failure to deliver.
3 In the event of any article sold and delivered hereunder shall be covered by any patent, copyright,
or application therefore, Seller will indemnify and save harmless Buyer from any and all loss, cost, or
expense on account of any and all claims, suits, or judgments on account of the use or sale of such
article in violation of rights under such patent, copyright, or application.
4 Seller guarantees that the design and performance of all items being purchased conform with the
requirements of applicable insurance and government health and safety regulations, including
regulations administered by OSHA and EPA.
5 Seller agrees not to use the name of Buyer or to quote the opinion of any of Buyer's employees in
any advertising without obtaining the prior written consent of Buyer.
6 Buyer may at any time insist upon strict compliance with these terms and conditions
notwithstanding any previous custom, practice, or course of dealing to the contrary.
7 Seller agrees to indemnify, defend, and hold harmless Buyer, its trustees, officers, agents, and
employees, of, from, and against any and all claims and demands which may arise in any way out of
the furnishing of goods or services hereunder, including, without limitation, claims and demands
arising from injury to or death of personnel of Buyer or for damage to the property of Buyer, except
those arising by reason of the negligent or willful act of Buyer, its officers, agents, or employees.
8 It is the policy of the Buyer to give favorable consideration to those suppliers who do not
discriminate against any employee or applicant for employment because of race, creed, color, or
national origin.
FIGURE 4-4
Terms and conditions of purchase appearing on the back of a typical purchase order.

may be printed with slightly different formats as the use of each demands. Seven is the minimum
number of copies most commonly required. The typical distribution procedure is as follows:
• Copy 1 and copy 2 (the acknowledgment copy) are sent to the supplier.
• Copy 3 informs the accounting department of the purchase. It is used by accounting in
checking and issuing payment for the seller's invoice.
• Copy 4 advises the receiving department that it can expect to receive shipment of the order on
a particular date. Receiving uses its copy to identify and check the incoming shipment.
• Copy 5 informs the user of the details of the order so he or she can plan the work and budget
accordingly.
• Copy 6 remains in the purchasing department open-order file and is often used for purposes
of order follow-up and expediting. (See pages 71-72.)

• Copy 7 becomes the buyer's working document and is filed in purchasing's open-order file.
Some firms organize their personnel into a larger number of specialized work groups and therefore
require more copies of the order to complete the communications system. In any event, all parties
involved in the transaction should receive a copy of the order. This communication has two objectives:
(1) to permit planning and efficient conduct of the individual activities and (2) to integrate the efforts of
the individual groups into a smoothly functioning supply operation.
After an order has been issued, changes in company requirements frequently require a change in the
contract. In such cases, the buyer issues a change order, following the same procedures as were
followed for the original order. When accepted by the supplier, the change order either supplements or
replaces the original order.
Acknowledgment and Follow-Up of the Order
In most cases, the original copy of the purchase order which is sent to the supplier constitutes a legal
"offer" to buy. No purchase "contract" exists, however, until the seller "accepts" the buyer's offer. The
seller's acceptance can take one of two forms: (1) performance of the contract or (2) formal notification
that the offer is accepted.
The purpose of sending the supplier an acknowledgment form along with the purchase order is
twofold. First, it is a form that can be completed conveniently and returned to the buyer,
acknowledging acceptance of the order. At the same time, the supplier can indicate whether or not it is
able to meet the desired delivery date. If a supplier ships the ordered item immediately from stock, it
frequently disregards the acknowledgment form.
If shipment is not made immediately, an acceptance should be sent to the buyer. Although the
acknowledgment form usually serves this purpose, some sellers prefer to use their own forms, which
state their terms and conditions of sale. In either event, the buyer should check the acceptance closely to
see that the supplier has not taken exception to any provisions of the order. If the seller's acceptance terms
are different from those on the buyer's order, the law holds that they will automatically be
incorporated in the contract unless they materially alter the intent of the offer, or unless the buyer files a
written objection to their inclusion. In cases where the seller's and the buyer's terms are in direct
conflict, the law omits such terms from the contract, leaving settlement of the differences to private
negotiation or legal adjudication. In view of the posture adopted by the courts on this matter, it is
amply clear that a buyer must review suppliers' order acceptances with great care.
The purchasing department's responsibility for an order does not terminate with the making of a
satisfactory contract. Purchasing bears full responsibility for an order until the material is received and
accepted.
Even though a supplier intends to meet a required delivery date many problems can arise to prevent it
from doing so. When there is a reasonable chance that the supplier may not stay on schedule, important
orders with critical delivery dates should receive active follow-up attention. At the time such orders are
placed, the buyer should determine specific dates on which follow- up checks are to be made.
Regardless of the specific system used, follow-up communication with the supplier usually takes one of
two forms. A fax or a telephone call is typically used for most critical orders. Routine follow-up for the
less critical orders is usually accomplished by mailing or faxing a preprinted inquiry to the sup- plier.
In some firms, follow-up procedures are conducted by the buyer handling the order. In others,
follow-up activities are conducted by a separate expediting group.
Although relatively few in number, some firms maintain a force of follow- up personnel in the field.
Such firms typically purchase a great deal of critical material or major equipment on very tight
delivery schedules. To ensure that all material is available when needed, these firms track critical
purchases by having traveling follow-up representatives personally visit suppliers' plants. In some
situations these field personnel have the additional responsibility of attempting to speed up (expedite) or
even delay (de-expedite) delivery as the buyer's timing requirements undergo unexpected changes.
Receipt and Inspection
The next step in the traditional purchasing cycle is receipt and inspection of the order. When a supplier
ships material, it includes in the shipping container a packing slip which itemizes and describes the
contents of the shipment. The receiving clerk uses this packing slip in conjunction with his or her copy of
the purchase order to verify that the correct material has been received.6
After a shipment has been inspected for quantity and for general condition of the material, the
receiving clerk issues a receiving report. In some cases, the report is prepared on separate receiving
department forms. However, the trend in most companies today is to reduce the clerical work by using an
online computer-based system, coupled with bar code order identification, or by preparing a
receiving report form during the same typing or printing operation that prepares the purchase order. In the
latter situation, a receiving report form is included in the snap-out purchase order form. A typical form
is shown in Figure 4-6. To complete the report, the receiving clerk merely records the identification and
receiving figures in the appropriate spaces included on the form.
FIGURE 4-6
A receiving report form, reflecting a purchase order format different from that shown in Figure 4-5.
(Courtesy of Stanford University.)
Copies of the receiving report are typically distributed as follows:

• Copy 1 is used by the purchasing department in closing out its working file of the order.

• Copy 2 is used by the accounting department in reviewing the order for payment.
• Copy 3 is sent to the user as notification that the material has arrived, or as a delivery copy if
immediate delivery is made. (If another notification system is used, this copy can be omitted.)

• Copy 4 is retained in the receiving department's operating record file.

Before some shipments can be accepted, technical inspection is necessary. (A discussion of these
procedures is found in Chapter 24.) In some companies, distribution of the receiving report is withheld
until the technical inspection report has been prepared. In other companies, distribution of ihe
receiving report precedes distribution of the inspection report. Some firms send an inspection report to
every department that gets a receiving report, so their records of actual receipts will be complete.
Other companies provide copies only to purchasing, accounting, and inspection.
Three developments in recent years have modified the traditional receiving policy in some firms. The
use of certified suppliers in some JIT and some partnering purchasing arrangements has led to the
elimination of the receiving inspection function for such purchases. Instead, incoming shipments are
routed directly to the point of use, bypassing receiving. In such cases, the buying organization relies
completely on the quality control and operating accuracy of the supplying firm. The third development
is the advent of the purchase credit card. In many firms that use company credit cards for small
purchases, the purchased item does not go through receiving because of its relatively low value.
The Invoice Audit and Completion of the Order
Occasionally, a supplier's billing department makes an error in preparing an invoice, or its shipping
department makes an incorrect or incomplete shipment. To ensure that the purchaser makes proper
payment for the materials actually received, sound accounting practice dictates that some type of
review procedure precede payment to the supplier.
A typical procedure involves a simultaneous review of the purchase order, the receiving report, and the
invoice. By checking the receiving report against the purchase order, the purchaser determines
whether the quantity and type of material ordered was in fact 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. Finally, by verifying the arithmetic
accuracy of the invoice, the correctness of the total invoice figure is determined.
Auditing invoices is a repetitive, time-consuming task that should be handled as efficiently as possible.
It should also be conducted soon after receipt of the invoice to permit the accounting department to
make prompt payment and obtain any applicable cash discounts. prompt payment also supports the
firm's efforts to establish and maintain good supplier relations. Because of the labor cost involved in
auditing invoices, many companies do not verify the accuracy of low-dollar-value invoices.
Invoice auditing is technically an accounting function. And when possible, it is prudent to separate the
responsibility for authorizing payment for an order from the responsibility for placing the order.
Theoretically, the purchasing department's job is completed when the material covered by a purchase
order has been received in the plant and is ready for use. In practice, however, some firms assign the
invoice auditing responsibility to accounting, while others assign it to purchasing.
In the purchase of complex or technical materials, operationally it makes sense to assign the auditing
task to the buyer who handled the order. This individual is familiar with the materials and their
technical nomenclature, with prices and contract provisions, and with all ensuing negotiations.
Invoices for such orders often are difficult to interpret and evaluate without a detailed knowledge of
these things. Auditing invoices for the purchase of most standard materials, on the other hand, is a
routine task that should be assigned to appropriate accounting personnel. A majority of most firms'
orders fall in this category.
Figure 4-1 indicates that the purchasing department closes its purchase order file before the invoice is
audited. This is usually the case if accounting audits the invoice. When purchasing audits the invoice,
its records are closed after the audit. Closing the order simply entails a consolidation of all documents
and correspondence relevant to the order; the completed order is then filed in the closed-order file. In
most firms, a completed order consists of the purchase requisition, the open-order file copy of the
purchase order, the acknowledgment, the receiving report, the inspection report, and any notes or
correspondence pertaining to the order. The completed order file thus constitutes a historical record of
all activities encompassing the total purchasing cycle.
PURCHASING DEPARTMENT RECORDS
The files of a purchasing department contain an endless flow of operating data. Despite its huge
volume, much of this information can be useless in daily operations unless it is organized in a manner
which makes it readily accessible. Although the unique needs of each purchasing department dictate
the specific structure of its records system, the following basic records are essential for the effective
operation of most purchasing departments:
• A record of open orders • Supplier record
• A record of closed orders • Contract record
• Purchase log • Special tool record
• Commodity record
Record of Open Orders
All buyers need immediate access to information concerning the status of their outstanding orders. The
record system can be maintained on a computer, in hard-copy form, or as a combination of the two.
Because reference to these orders most frequently requires identification by the supplier's name, the
record system customarily is indexed alphabetically by suppliers' names. Within each supplier's
subfile, orders are arranged in ascending numerical sequence.
Although practice varies widely, each order record commonly contains the purchase requisition, the
working copy of the order, the returned acknowledgment information, follow-up data, and all notes
and correspondence that pertain to the order. Some companies also include competitive bids in the
order file. Others prefer to keep bids in a separate price file or with the commodity record. When the
bid is not included in the order file, the order record must contain a cross-indexing reference.
Some firms also maintain a separate numerical file or log of purchase requisitions. Such a file makes it
easy to locate a purchase order needed to answer questions from a requisitioner who can identify the
order only by requisition number. In such situations, it is essential to note the purchase order number
on the requisition.
Record of Closed Orders
The closed-order file provides a historical record of all completed purchases. It frequently serves as a
useful reference when questions arise concerning past orders and when certain historical data are
needed to guide future decisions. Specific inclusions of the file were discussed previously.
It is difficult to generalize about the length of time such records should be kept. While government
contract records should be kept indefinitely, most firms retain their other closed orders from three to
seven years. Normally, any order files kept longer than this should be retained only on a highly
selective basis. In a large firm, records retention is costly. Therefore, if commodity and supplier
records are properly maintained, only unique and high-value orders are generally worth keeping
longer than the four-year period required for legal purposes.7
Purchase Log
Every purchasing department should maintain an ongoing record, in numerical sequence, of all
purchase orders issued. The record need not be elaborate, but it should contain the purchase order
number, the status of the order, the supplier's name, a brief description of the material purchased, and
the total value of the order. Such a record summarizes the commitments for which the purchasing
executive is responsible. In the event that the working copy of an order is lost, basic data concerning
the purchase can be found in the log. The log further serves as a convenient record from which
summary administrative data can be extracted concerning such matters as the number of small orders,
rush orders, and total orders issued; the volume of purchases from various suppliers; the value of
outstanding commitments; and so forth.
The purchase logs of some firms consist of a sequential list of purchase orders recorded in a journal or
in the computer data base. Other firms accomplish the same objective simply by filing, in numerical
sequence, the follow-up copy or an additional copy of the order.
Commodity Record
The file of commodity records constitutes a vast reservoir of materials data that makes efficient "mass
production purchasing" possible. A commodity record card or computer file should be maintained for
each major material and service that is purchased repetitively. Typically included in the record is a
complete description of the material or service, with full reference to necessary engineering drawings
and specifications which might be filed elsewhere. Also included should be a list of approved suppliers
and their price schedules. Competitive quotations may be included in the file, although it is more com-
mon to summarize bid data in the record, note a cross reference to the original quotation, and place all
quotations in a separate file.
The preceding data provide a buyer with the basic information initially required in a repetitive
purchase investigation. In making the purchase decision, the buyer supplements this information with
numerous qualitative considerations concerning individual suppliers, such as their current work loads,
internal problems, quality performance, and so on. Some companies, however, also include in the
record a complete purchase history for the item. For every purchase, the purchase order number,
purchase quantity, price, delivery performance, and quality performance are recorded. In deciding
how much detailed information to keep in its commodity record, each firm must weigh the value of the
information against the cost of transcribing it.
Supplier Record
To provide quick access to information about suppliers, most companies centralize such information
in a single record file. A separate card or computer record is maintained for each major supplier. In this
record is recorded the address, telephone number, and the names of personnel to contact on specific
matters of inquiry. Selling terms and routing instructions for shipping purposes also usually are
included. Although the practice varies, many firms additionally summarize in this record the supplier's
delivery and quality performance, as well as the annual volume of materials purchased from the sup-
plier.
in a matter of seconds, these records enable a buyer to obtain a wealth of summary information about
any important supplier.
Contract Record
Today most firms are purchasing an increasing number of items on a long- term contractual basis. In
such cases, it is usually convenient to consolidate all contracts in a separate file. In addition to
providing immediate access to all contract documents, this file also apprises all buying personnel of
the materials that are purchased in this manner. If the number of contracts is large, it is desirable also to
list them in summary form to provide a bird's-eye view of all contract purchases and their expiration
dates.
Special Tool Record
Many companies have no need for this record. However, such a record is essential to those firms that
purchase many items requiring special tooling for their manufacture. On some orders the purchaser
buys the required dies, jigs, fixtures, and patterns; on others the supplier owns them. By maintaining a
record of special tools, the buyer can summarize for quick reference the special tools owned, the age
and location of each, and the essential mounting and operating characteristics of each.
RUSH ORDERS
Every department executive tries to develop an orderly and systematic pattern of operation that
efficiently utilizes the resources of that department. In a well- run purchasing department, systematic
analysis and processing of most orders is completed in two to four days after the purchase request is
received.
How should purchasing handle the emergency needs that inevitably arise in any business operation?
Clearly, a special procedure for processing rush requisitions is needed. The key elements of such a
procedure are discussed in the following paragraphs.
Even in the case of emergencies, it is unwise to accept oral requisitions—in person or over the
telephone. Too much chance for erroneous interpretation of the requirement exists. The requisitioner
should state the need in writing and, preferably, deliver it to the buyer in person. For purposes of
identification, emergency requisitions can be printed on paper of a different color, or they can be
identified with a visible emergency sticker. Typically the buyer should process these requisitions
immediately and telephone emergency orders to the supplier. In no case, however, should an order be
placed without assigning it a purchase order number. For most purchases, a confirming purchase order
subsequently should be mailed to the supplier. In cases where the emergency is less urgent, the buyer
may process such requisitions at appointed times twice daily (say, at 10:30 a.m. and 2:30 p.m.).
Purchasing's basic responsibility is to the departments it serves—its internal customers. Yet
purchasing should not permit users to take unfair advantage of its emergency service Only justifiable
requests should receive this service.
Rush orders always cost more than if they were handled through the normal purchasing system. Higher
prices frequently are paid because rush purchases are not investigated as thoroughly as those handled
in the normal routine, and premium-cost transportation typically is used. Furthermore, the interruption
of a buyer's scheduled work by the emergency request invariably produces inefficiency in normal
purchasing department activity.
Consequently, steps should be taken to discourage all rush orders that arise because of poor planning
in the using departments. In practice, three approaches have proved successful. The first involves a
concerted effort to coordinate the activities of the using group or production scheduling and
purchasing. Some companies require that realistic order points for inventory materials be established
jointly by production scheduling and purchasing. In other firms operating on a job-order basis,
purchasing is required to issue periodic lead time reports to users for all major classes of materials. A
second approach, designed to reduce unjustifiable requests, requires the requisitioner to obtain
approval from a general management executive for all emergency requisitions. A modification of this
approach requires an after-the-fact review of all rush orders by top management. Still another
approach assesses the requisitioning department a predetermined service charge for each emergency
requisition processed.
THE SMALL-ORDER PROBLEM
Small orders are a perennial problem in every organization—and a serious problem in some.
Examination of a typical company's purchase order file reveals that a sizable percentage (sometimes
up to 80 percent) of its purchases involve an expenditure of less than $250. In total, however, these
purchases constitute a small percentage (seldom more than 10 percent) of the firm's annual dollar
expenditures.
For example, 75 percent of Conoco's purchase orders are for expenditures of less than $500, and 50
percent are for less than $100. The Intel Corporation found that its purchasing department spent 66
percent of its time managing 1.7 percent of the firm's expenditures.9
Clearly, no manager wants to devote more buying and clerical effort to the expenditure of less than 10
percent of his or her funds than to the expenditure of the other 90 percent. Yet this frequently is what
happens. The very nature of business requires the purchase of many low-value items. Nevertheless,
small orders are costly to buyer and seller alike. It costs a seller only a few cents more to process a
$1,000 order than it does to process a $10 order. The following sections discuss various methods a
purchasing manager can use to minimize the small-order problem.
Centralized Stores System

A stores system is the first approach typically used to reduce the volume of small-order purchasing
activity. When experience shows that the same supply items are ordered in small quantities time after
time, the logical solution is to order these items in larger quantities and place them in a centralized
inventory for withdrawal as needed. An analysis of repetitively used production materials leads to the
same action for the multitude of low-value items. If usage of an item is reasonably stable, an optimum
order quantity can be computed using a basic economic order quantity approach. There is, of course, a
limit to the number of items and the financial investment a firm can place in inventory.
Blanket Order System
A stores system solves the small-order problem only for items that are used repetitively A blanket
order system helps solve the problem for the thousands of items a firm cannot carry in inventory, as
well as some that it does carry.
Briefly, the general procedure used for this type of purchase is as follows. On the basis of an analysis
of past purchases, the buyer determines which materials should be handled in this manner. After
bidding or negotiation, the buyer selects a supplier for each item, or family of items, and issues a
blanket order to each supplier. The order includes a description of each item, a unit price for each item
when possible, and the other customary contract provisions. However, no specific order quantities are
noted. The blanket order typically indicates only an estimated usage during the period of coverage
(usually one to three years). It also states that all requirements are to be delivered upon receipt of a
release from the buyer or other authorized person. On receiving a requisition for one of the materials,
the buyer merely sends a brief release form to the supplier. On the release form are noted the blanket
order number, the item number, and the quantity to be delivered. Receiving reports are filed with the
original order, and at the end of the month are checked against the supplier's monthly invoice. At the
end of the period, the order may be renewed or placed with another firm, depending on the supplier's
performance record.
Many companies develop their own unique modifications of the basic procedure. For example, instead
of advising suppliers of order releases by means of a written form, some companies simply issue
releases to local suppliers by telephone or fax. By noting such releases on the order, the buyer still
retains adequate control. Some firms are experimenting with the use of electronic data interchange
releases.
In the event that material is needed immediately (and the supplier is nearby), some firms allow the
using department to pick up the material without notifying the purchasing department. The employee
obtaining the material simply endorses and enters the proper accounting charge on the sales receipt, a
copy of which is sent to the buyer. This document then serves as the receiving report. This procedure is
particularly applicable to the frequent purchase of various repair parts, when specific needs are not
known until the faulty equipment is dismantled. It also works well for purchasing special processing
services, such as heat-treating and plating, when the service is required quickly but cannot be planned
in advance. This variation of the basic blanket order procedure can easily be abused and possibly can
lead to petty fraud. It is therefore important to entrust its use only to responsible operating personnel
and periodically to review the endorsed sales receipts.
The blanket order system offers six important benefits:
1 It requires many fewer purchase orders and reduces clerical work in purchasing, accounting,
and receiving.
2 It releases buyers from routine work, giving them more time to concentrate on major
problems.
3 It permits volume pricing by consolidating and grouping requirements.
4 It can improve the flow of feedback information, because of the grouping of materials and
suppliers.
5 Because some suppliers will stock material for prompt delivery, this system may reduce the
buyer's lead times and inventory levels.
6 It develops longer-term and improved buyer-supplier relationships.
To function effectively in the long run, however, any blanket order system must provide adequate
internal control. Absence of the control element encourages petty fraud and poor supplier
performance. The elements essential to effective control are:
1 A numbered purchase order, including proper internal accounting charge notations
2 A record of authorized delivery releases
3 Bona fide evidence of receipt of the material
Despite the fact that blanket order systems offer both the buying and the supplying organizations a
number of important benefits, historically they have been used by fewer firms than might be expected.
A recent study conducted by Purchasing magazine found that approximately 25 percent of the firms
surveyed used a blanket order type of contracting system extensively for their small purchase needs.
Increased usage was forecast in view of growing demands for more effective utilization of industrial
resources.11
Systems Contracting
At this point a few words need to be said about systems contracting. Though frequently used as a basic
purchasing strategy, as well as an approach for minimizing the small-order problem, systems
contracting, in reality, is simply an extension and more sophisticated development of the blanket order
purchasing concept. Some firms call it "stockless" purchasing.
As its name implies, systems contracting involves the development of a corporate wide agreement,
often a one-to-five year requirements contract, with a supplier to purchase a large group or "family" of
related materials. The items to be purchased are usually described in detail in a "catalog" that becomes
part of the contract. Estimated usage usually is included, along with a fixed price for each item and an
agreement by the supplier to carry a stock of each item adequate to meet the buyer's needs. Various
types of supplies and commonly used operating items, typically purchased from distributors, are the
materials most often covered by these types of agreements.1
In addition to the benefits of blanket order purchasing, a major objective of systems contracting is to
minimize both the buyer's and the supplier's administrative costs associated with the purchases. The
operating procedures of the two firms are integrated to the extent practical. For example, users in the
buyer's various operating locations usually send their purchase requisitions directly to the supplier
holding the contract for the item. The requisition thus serves as the purchase order. The supplier then
simply maintains a list of such shipments on a "tally sheet," identifying each by the requisition number
(or a supplier-assigned number), and periodically (monthly or semi-monthly) submits the tally sheet to
the buyer for payment in lieu of an invoice.
These types of integrated procedures and shortcuts typically develop a closer relationship between the
two firms and reduce paperwork and associated costs markedly. The buyer's inventories and carrying
costs obviously decline as well.
Term Contracting System Coupled with MRP
On page 65 the engineering bill of materials was discussed as a device for communicating production
material needs to the purchasing department. Some firms that use an MRP computer-based scheduling
system have carried this concept one step further, moving closer to achievement of a " paperless"
purchasing operation.
The engineering bill of materials first is converted into a "structured, " or tiered, bill of materials that
can be used for production planning purposes. The logic of an MRP system then converts these bills of
materials into aggregate requirements schedules for each part used in the products being manufac-
tured. Using these precise MRP schedule requirements, some firms utilize a two-step approach to
eliminate both the purchase requisition and the purchase order. First, the buyer establishes a long-term
contract (one year or longer) with a supplier for each part. Second, material needs are transmitted
directly to suppliers simply by sending them updated copies of the weekly (or monthly) material
requirements schedule. The MRP schedule thus serves as both the purchase requisition and the
purchase4 order (or release). Suppliers simply deliver to the schedule. At the Boston Gear Works, for
example, this approach works smoothly, involving purchasing personnel only on a manage- ment-
by-exception basis after the initial purchase contracts are developed.
Telephone/Fax Order System
Most companies now use a telephone or fax ordering system to reduce the paperwork associated with
small-order purchasing. Under this system, when the purchasing department receives a requisition, it
does not prepare a formal purchase order. Instead, the order is placed by telephone or fax, and the req-
uisition is used in the receiving procedure.
Although many variations of this system are in use, it is important that the requisition form be
designed to provide all data necessary for internal communications and control. One company uses a
six-part form which includes all data normally included on a conventional purchase order. When the
order is placed, one copy of the requisition is sent to the requisitioner, one goes to accounting, one
remains in purchasing, and three copies are sent to receiving. When the material arrives, all receiving
data are noted on the latter copies. One of these copies is sent to accounting, one is sent to purchasing,
and the final copy either goes to the requisitioner or remains in a permanent receiving file.
One large firm in the electrical industry reportedly places most of its small orders by telephone—this
translates to approximately 60 percent of all orders placed during the year. The system goes one step
further in the elimination of paperwork; the firm's suppliers send no invoices for telephone purchases.
A firm price is determined during the initial telephone conversation and is recorded on the requisition.
When the material is received as ordered, the accounting department issues payment on the basis of the
purchase requisition.
Electronic Ordering Systems
A number of electronic communication systems currently are available to transmit material purchase
requests without writing orders or talking on the telephone. The hardware in a commonly used system
consists of a magnetic card reader connected to a telephone in the purchaser's office and an inter-
preting unit connected to a telephone in the supplier's office. With this system, the buyer simply places a
purchase requisition, in magnetic card form, in the card reader and dials the supplier's telephone
number The requisition data are then transmitted over telephone lines to the supplier's interpreting unit
Another approach in this evolving process utilizes a computer terminal as the input device at the
buyer's site. The terminal is tied to a telephone line through a modem The data signal is then
communicated via the telephone line to a printer or other receiving device at the supplier's site
Such electronic systems will have limited use for general purchasing activity until a buyer's major
suppliers acquire the necessary equipment and operating systems. Rapid growth in usage, however, is
occurring among industrial supply firms. In situations where buyers find their use feasible, such
systems can expedite the purchasing process, reduce paperwork, and simplify internal accounting and
control. They are particularly applicable to the purchase of repetitively used items whose recurring
orders can be placed using the same card or input source. Clearly, the use of an electronic ordering
system requires a blanket order or similar contractual arrangement with the supplier.
The next step in the evolutionary development of this concept—computers talking to computers—is
now a reality in a growing number of firms across the country. The topic of electronic data interchange
(EDI) is discussed in the next chapter.
Petty Cash and C.O.D.
Most firms today use a petty cash fund for making small one-time purchases. For this purpose, many
firms define "small" as under $100. It is often less expensive for an individual user (or a purchasing
delivery employee) to buy minor items personally and pay for them from a petty cash fund than it is to
buy them through the conventional purchasing system. Any inefficiencies that may arise because of a
lack of buying skill are more than compensated for by the administrative savings resulting from not
placing a purchase order.
Some firms also find it economical to make small one-time purchases on a C.O.D. basis. Material can
be ordered by telephone and paid for on arrival. Payment can be made using petty cash or a
departmental check written on an account set up for such purchases.
Purchase Credit Card
The use of corporate credit cards by employees for MRO purchases has become commonplace during
the past few years. In addition to eliminating the need for most purchase orders, this buying technique
reduces the purchasing cycle time, improves purchasing relations with operating departments, provides
much faster payment to suppliers, and significantly reduces the workload in the accounts payable
department.
Here is how the system usually works. First, purchasing makes arrangements with a known and
respected group of suppliers tor company credit card purchases. Usually, though not always, a blanket
order contract is negotiated with the supplier to make the arrangement attractive, because the supplier
will have to pay the credit card company or its bank a service fee for each purchase made. For this
reason, purchasing reduces the number of suppliers used and consolidates certain types of purchases
with each turn Through this leveraged action, some companies have reported price reductions of up to
15 percent on the items covered by the blanket order.
Internally, credit cards are issued to operating department personnel selected by their supervisors.
Each card carries the appropriate departmental accounting charge number, along with a dollar
purchase limit, usually ranging from $500 to $2,000. Subsequent purchases must be approved by the
department supervisor—and can be made in person or by telephone or fax. Billing arrangements made
with most suppliers call for invoicing on a monthly basis, with a copy to the appropriate department
head.
Although this type of credit card system offers the buying firm a number of benefits, it also entails
some additional exposure to risk: (1) The firm inevitably loses some control over what is actually
purchased on the card; (2) it is sometimes possible for card holders to bypass departmental
authorization and control; and (3) there is always the possibility that card use will provide some
opportunities for petty fraud. On the other hand, purchasing can maintain indirect control in three
ways: (1) It selects the suppliers where the card can be used, usually those with which the firm has had a
long-term relationship; (2) with the help of department supervisors, it determines who receives
cards; and (3) it sets the purchase limit for each card.
To date, most firms that use a carefully designed credit card system are pleased with the results.
Supplier Stores/Consignment System
If a purchaser buys a large enough volume of certain materials from a single supplier, the supplier
sometimes can afford to staff a small "store" at the purchaser's plant and operate it on a consignment
basis. Some suppliers find that annual purchases of approximately $100,000 justify such a branch
operation. Users then simply go to the store and sign for their purchases. At the end of the month the
company is billed for its purchases just as if the user had "gone downtown" to buy the material.
This system clearly is not a short-term arrangement. The purchaser, therefore, must take great care in
selecting the supplier and in negotiating the terms of the agreement.
Supplier Delivery System
The supplier delivery system is somewhat similar to a supplier stores system, but it is more feasible for
firms with a smaller volume of purchases. Many suppliers who are not willing to set up a store at the
buyer's plant are willing to stock numerous miscellaneous materials and make daily or semiweekly
deliveries. The buyer typically reviews and accumulates purchase requisitions for such materials. The
supplier's delivery person then picks them up on the specified day, and at the same time delivers the
material ordered on the preceding batch of requisitions. This continuous shuttle service provides
reasonably fast delivery and also reduces the purchaser's paperwork and inventory problems. Properly
designed, the system can provide for adequate accounting control.
A variation of this approach is used by Bethlehem Steel's Burns Harbor plant. This organization uses
what it calls a "single-sourced bin-stocking" concept. For related families of inventory items,
Bethlehem single-sources them with a proven supplier, covering the arrangement with a blanket order.
 The supplier checks Bethlehem's inventory bin levels once a week, replenishing the supply of any item
that has reached the reorder point. This ongoing inventory control/delivery service by 21 MRO item
suppliers has saved Bethlehem approximately $1.3 million per year through leveraged price
reductions, significantly reduced its MRO inventory, reduced the number of purchase orders by
approximately 41,000 per year, and improved material delivery time immensely.
EVOLVING ORDERING ARRANGEMENTS
Purchasing and supply managers long have been interested in reducing the time and administrative
cost involved in ordering, receiving, and paying for materials that are used repetitively in a firm's
operation. In progressive firms, the purchasing and supply unit focuses on adding value, not time-
consuming paperwork. This section describes briefly several approaches that many firms use to help
achieve this basic objective.
Long-Term Contracts—Annual and Multiyear
Because of the economies of scale, large-quantity buyers generally purchase their high-dollar-value
materials under long-term contracts. Today, contracts extending up to three years, sometimes five, are
commonly used for the purchase of regular production materials. Such contracts eliminate duplicate
yearly supplier investigations and purchasing administrative efforts. Lower prices and total purchase
costs are the natural result.
In addition to the cost benefits which accrue from the economies of scale, long-term contracts provide the
buying firm other benefits. For example, under such contracts, the seller is assured a large volume of
business. It may adopt just-in-time manufacturing techniques or agree to carry inventories for the buyer.
Consequently, the buying firm can reduce its inventory. When the seller knows the buyer's delivery
schedule well in advance, distribution costs and production costs both can be reduced. Some of this
saving should be passed along to the buyer. In times of scarcity, the buyer is assured of a reliable
source of supply, as well as the best possible protection against unjustified price increases. Because
long-term contracts are negotiated only once every several years, buying personnel are freed for other
productive work such as supplier management, purchasing research, value analysis, and so on. The
sophisticated buyer schedules major contracts to expire at approximately equal intervals throughout
the year to balance his or her workload.
The use of multiyear contracts is increasing. As markets for certain materials become more volatile
and availability becomes more uncertain, long-term contracts can offer significant advantages for both the
buyer and the seller. Larger volumes, over longer periods of time, justify additional supplier invest- ment
in research, training, and tooling, thus contributing to lower unit costs and prices. Many of these contracts
have an automatic renewal feature which is operationalized unless one of the parties objects. Such
contracts frequently are called "evergreen" contracts.
Some of the contractual arrangements that buyers commonly use to cope with variable demand and
varying delivery schedules are discussed below.
Definite Delivery-Type Contracts When production schedules for the entire period of a contract are
known, definite quantities for delivery on definite dates can be established. A contract with these
provisions is called a definite delivery-type contract. This is the ideal type of ordering arrangement
when such a degree of certainty is present.
Indefinite Delivery-Type Contracts In some cases, production schedules cannot be planned precisely;
hence, the quantities of materials required and their times of use, or both, are unknown. Materials and
services for the support of such operations must be contracted for on an indefinite delivery schedule.
There are three basic types of indefinite delivery contracts. In order of preference for the best pricing,
they are (1) definite quantity contracts, (2) require- merits contracts, and (3) indefinite quantity
contracts.
Definite Quantity Contracts These provide for the purchase of definite quantities of materials or
services—whose time of use is uncertain. The contract therefore specifies that instructions regarding
delivery schedules will be provided later. Because the quantities are known, however, favorable prices are
possible for this type of agreement.
Requirements Contracts These contracts provide for the purchase from one supplier of all of a buyer's
requirements, for a stipulated time period, for specified materials or services for a designated operation or
activity. Requirements contracts typically are used in applications such as the support of a firm's
automotive repair shop, with parts being purchased from a specific parts dealer during the life of the
agreement. To be certain that this type of contract is both legal and mutually satisfactory, the contract
should provide for a minimum quantity the buyer is committed to take, and it should stipulate that
neither party can terminate the contract during its life, as long as performance is satisfactory and as
long as the buyer's requirements continue to exist. Without such provisions, requirements
contracts have been found by courts to be unenforceable.
Indefinite Quantity Contracts During an agreed-upon period of time, these contracts provide for the
delivery of a specific category of materials or services. Quantities and delivery dates are indefinite, but the
buyer is committed to purchase between designated high- and low-quantity limits.
The indefinite quantities associated with both indefinite quantity contracts and requirements contracts
preclude optimum pricing. However, the contracts represent a total volume of business that, although
indefinite, is large enough for suppliers to want and to price competitively to obtain.
Scheduling order releases for these three types of indefinite delivery-type contracts usually is delegated
to the using department, often the production scheduling group. In some cases releases are issued
automatically by a buyer's MRP system directly to the supplier's MRP system.
National Agreements
National agreements are used by many firms that have two or more operating locations. Such an
agreement usually takes the form of a long-term contract with a supplier for the purchase of material
that is used regularly at a number of different operating sites. The item purchased can range from light
bulbs to personal computers to production materials. At firms such as Hewlett Packard, national
contracts are awarded by the corporate purchasing organization. At other firms, such as the General
Electric Company, the operating location with the largest volume of purchases for the item in question
usually is assigned responsibility for sourcing the corporation's domestic requirements.1
National contracts provide a number of benefits—continuity of supply, consistent quality, material
standardization throughout the organization, reduced prices, lower inventory levels, reduced delivery
costs, and improved efficiency for the corporationwide procurement staff. Such contracts normally
provide price protection for both the buying and selling organizations by means of an escalation
formula that usually is tied to the supplier's basic costs of production. Consequently, prices may
increase or decrease during the life of the contract, depending on the behavior of the selected price or
cost indexes.
"National contracts require considerable time to establish and administer. Purchasers must continually
monitor the performance of selected suppliers, the market conditions concerning price and
availability, and how the selected supplier compares with competitors."16 Nevertheless, the benefits of
such agreements offset the cited costs many times over.

FOR DISCUSSION
Q.1. Discuss the general procedure of a typical purchasing cycle.
Q.2. How should purchasing handle the emergency needs that inevitably arise in any business
operation? Illustrate.
Q.3. Discuss the various methods a purchasing manager can use to minimize the small-order problem.
Q.4. Write short notes on:
1) Supplier Delivery System
2) Supplier Stores/Consignment System
3) Purchase Credit Card
4) Petty Cash and C.O.D.
5) Electronic Ordering Systems
6) Telephone/Fax Order System
7) Term Contracting System Coupled with MRP
8) Systems Contracting
9) Blanket Order System
10) Centralized Stores System
Q.5. describes briefly several approaches that many firms use to help achieve adding value,
Q.6. Discuss receiving practices in firms that use JIT production/purchasing systems.
Q.7. How does a blanket purchase order system work? What are its advantages? What are its
disadvantages?
Q.8. How does a purchase credit card system work? What are its advantages
and disadvantages?