SUPPLY CHAIN CHAPTER NO 2

PURCHASING: Purchasing is the process of buying goods or services that a company needs to
operate. It focuses on finding the best products or services at the right price and in the right
quantity. Purchasing often involves selecting suppliers, negotiating prices, and placing orders for
specific items.
PROCUREMENT: Procurement is a broader term that includes the entire process of acquiring
goods and services for a company. It encompasses not only the act of purchasing but also
activities like supplier selection, contract negotiation, quality assurance, and supplier relationship
management. Procurement looks at the bigger picture of how a company acquires what it needs
to operate efficiently.
PURCHASING MANAGEMENT
In the context of supply chain management (SCM), The purchasing profession can be defined as
the act of obtaining merchandise; capital equipment; raw materials; services; or maintenance,
repair and operating (MRO) supplies in exchange for money or its equivalent.

The purchasing profession can be broadly classified into two categories:

 Merchants
 Industrial buyers.

Merchants
 The first category, merchants, includes the wholesalers and retailers, who primarily purchase
for resale purposes.
 Generally, merchants purchase their merchandise in volume to take advantage of quantity
discounts and other incentives such as transportation economy and storage efficiency.
 They create value by consolidating merchandise, breaking bulk and providing the essential
logistical services..
 Industrial Buyers
 The second category is the industrial buyers, whose primary task is to purchase raw materials
for conversion purposes.
 Industrial buyers also purchase services; capital equipment; and maintenance, repair and
operating supplies.
 The typical industrial buyers are the manufacturers, although some service firms such as
restaurants, landscape gardeners and florists also purchase raw materials for conversion
purposes
 The Role of Supply Chain In An Organization
The primary goals of purchasing are:
1. Ensure uninterrupted flows of raw materials at the lowest total cost,
2. Improve quality of the finished goods produced, and
3. Optimize customer satisfaction.
4.
Purchasing contributes to these objectives by:
• Actively seeking better materials and reliable suppliers,
• Work closely with strategic suppliers to improve quality materials, and
• Involving suppliers and purchasing personnel in new product design and development
efforts.

The Financial Significance of Supply Management

• Purchasing has become more global and gained strategic corporate focus over the last two
decades.
• The increasing use of outsourcing non-core activities has further elevated the role of
purchasing in a firm.
In addition to affecting the competitiveness of a firm, purchasing also directly affects
profitability.

Profit-Leverage Effect Purchase spend is the money a firm spends on goods and services
Dollar decrease in purchase spend directly increases profits before taxes by the same amount.
The profit-leverage effect of purchasing measures how much a change in purchase spend will
affect a company's profit before taxes, assuming that sales and other expenses stay the same.In
simple words, this means that if a company can reduce its purchase spend, it will directly
increase its profit before taxes by the same amount.For example, if a company reduces its
purchase spend by $100, its profit before taxes will increase by $100, assuming that all other
factors remain the same.

Return on Assets Effect: Return on assets (ROA) is a financial ratio of a firm’s net income in
relation to its total assets. A high ROA suggests that the management is capable of generating
large profits with little investment.

Inventory Turnover Effect

Inventory turnover shows how many times a firm’s inventory is utilized and replaced over an
accounting period, such as a year. Widely used formula is the ratio of the cost of goods sold over
average inventory at cost.low inventory turnover indicates poor sales, overstocking and/or
obsolescence.

Advantages for the e-Procurement System

Time savings: E-procurement is more efficient when (a) selecting and maintaining
a list of potential suppliers, (b) processing requests for quotation and purchase
orders, and (c) making repeat purchases. Individual buyers can create preferred
supplier lists for each category of products and services. Supplier performance data can be
updated quickly and made available online in real time.

Cost savings: Buyers can handle more purchases, and the manual task of matching
bids to purchase requisitions is reduced. Other cost savings include lower prices
of goods and services (since more suppliers can be contacted), reduced inventory
costs (due to the ability to purchase on a more frequent basis), use of fewer buyers,
lower administrative costs, elimination of the need for preprinted purchase requisition forms, and
faster order fulfillment.

Accuracy: The system eliminates double-key inputs—once by the material users

and then once again by the buyers. The system also enhances the accuracy of communications
between buyers and suppliers. More up-to-date information on suppliers,
with goods and services readily available online.

Real time: Buyers have real-time access to the purchase requisition once it is
prepared. Once the purchase requisition is processed, the buyer can post the bid
instantly, instead of waiting to contact all the suppliers individually to alert them of
the bids. The system enables buyers to initiate bids and suppliers to respond in real
time on a 24/7 basis.
Mobility: The buyer can submit, process, and check the status of bids, as well as
communicate with suppliers regardless of the buyer’s geographical location and
time of day. Thus, the e-procurement system is highly flexible.
Trackability: The e-procurement system allows submitters and buyers to track
each purchase requisition electronically through the process—from submission, to
approval, and finally conversion to a purchase order.
Supplier benefits: Benefits include lower barriers to entry and transaction costs,access to more
buyers, and the ability to instantly adjust to market conditions, thus
making e-procurement attractive to most suppliers.

SOURCING DECISIONS: THE MAKE-OR-BUY DECISION

• Outsourcing -buying materials and components from suppliers instead of making them in-
house. The trend has moved toward outsourcing.
• Backward integration refers to acquiring sources of supply
• Forward integration refers to acquiring customer’s operations.

The Make or Buy decision is a strategic decision.

Reasons for Buying or Outsourcing
Organizations buy or outsource materials, components, and/or services from suppliers
for many reasons. Let us review these now:

1. Cost advantage: Companies outsource non-vital supplies and components to save money. This
is because suppliers can produce these items in large quantities, which gives them an advantage
in terms of cost. In most cases, the amount of supplies and components that a company needs is
too small to justify buying the equipment to make them.

2. Insufficient capacity: A firm may be running at or near capacity, making it unable

to produce the components in-house. This can happen when demand grows faster
than anticipated or when expansion strategies fail to meet demand. The firm buys
parts or components to free up capacity in the short term to focus on vital operations.

means that a firm does not have enough resources to produce all of the goods or services that it
needs to meet demand. This can happen for a variety of reasons, such as unexpected growth,
supply chain disruptions, or equipment failures.

When a firm is running at or near capacity, it may not be able to produce all of the components
that it needs in-house. This can force the firm to buy parts or components from other suppliers.
This can be a more expensive option, but it can be necessary to meet demand in the short term

3. Lack of expertise: The firm may not have the necessary technology and expertise to
manufacture the item.
4. Quality: Purchased components may be superior in quality because suppliers have
better technologies, processes, skilled labor, and the advantage of economies of
scale. Suppliers’

Reasons for Making

An organization also makes its own materials, components, services, and/or equipment
in-house for many reasons. Let us briefly review them:

1. Protect proprietary technology: A major reason for the make option is to protect proprietary
technology. A firm may have developed an equipment, product, or process
that needs to be protected for the sake of competitive advantage. Firms may choose
not to reveal the technology by asking suppliers to make it, even if it is patented. An
advantage of not revealing the technology is to be able to surprise competitors and
bring new products to market ahead of competition, allowing the firm to charge a
price premium.
2. No competent supplier: If existing suppliers do not have the technology or capability to
produce a component, the firm may be forced to make an item in-house, at least for
the short term. The firm may use supplier development strategies to work with a new
or existing supplier to produce the component in the future as a long-term strategy.
3. Better quality control: If the firm is capable, the make option allows for the most
direct control over the design, manufacturing process, labor, and other inputs to
ensure that high-quality components are built. The firm may be so experienced
and efficient in manufacturing the component that suppliers are unable to meet
its exact specifications and requirements.

4. Use existing idle capacity: A short-term solution for a firm with excess idle capacity
is to use the excess capacity to make some of its components. This strategy is valuable
for firms that produce seasonal products.
5. Control of lead time, transportation, and warehousing costs: The make option provides
better control of lead time and logistical costs since management controls all
phases of the design, manufacturing, and delivery processes.

Lower cost: If technology, capacity, and managerial and labor skills are available,
the make option may be more economical if large quantities of the component are
needed on a continuing basis.

MAKE OR BUY BREAK EVEN ANALYSIS

SEVERAL ASSUMPTION UNDERLINE THE ANALYSIS
1. All cost involved can be classified under either Fixed Cost or Variable Cost.
2. Fixed cost remains the same within the range of analysis.
3. A linear variable cost relationship exists.
4. Fixed cost of the make option is higher because of initial capital investment in equipment
5. Variable cost of the buy option is higher because of supplier profits.
A retailer in Las Vegas has an ending inventory of $250,000 as of December 31, 2016,
and the following accounting information.

Month Ending Invento ry Cost of Goods Sold

January $225,000 $1,200,000
February $325,000 $1,250,000
March $240,000 $1,350,000
April $325,000 $1,500,000
May $460,000 $950,000
June $220,000 $850,000
July $85,000 $1,650,000
August $156,000 $1,325,000
September $220,000 $1,750,000
October $265,000 $850,000
November $100,000 $2,200,000
December $350,000 $3,500,000
a. Compute the monthly inventory turnover ratio for each of the twelve months.
b. What are the annual cost of goods sold and the average inventory for the year?
c. Compute the annual inventory turnover ratio. How is the retailer’s performance
compare to the industry standard, assuming its business is similar to Walmart’s?

You are given the following information:

Costs Make Option Buy Option
Fixed Cost $125,000 $5,000
Variable Cost $15 $17
a. Find the break-even quantity and the total cost at the break-even point.
b. If the requirement is 150,000 units, is it more cost-effective for the firm to buy or
make the components? What is the cost savings for choosing the cheaper option?
10. You are given the following information:
Costs Make Option Buy Option
Fixed Cost $25,000 $3,000
Variable Cost $8 $12
a. Find the break-even quantity and the total cost at the break-even point.
b. If the requirement is 4,500 units, is it more cost-effective for the firm to buy or
make the components? What is the cost savings for choosing the cheaper option?
c. If the requirement is 6,000 units, is it more cost-effective for the firm to buy or
make the components? What is the cost savings for choosing the cheaper option?
Supplier Selection
The decision to select a supplier for office supplies or other noncritical materials is likely to be
an easy one.
 However, the process of selecting a group of competent suppliers for important materials,
which can potentially impact the firm’s competitive advantage, is a complex one and should
be based on multiple criteria.
 In addition to cost and delivery performance, firms should also consider how suppliers can
contribute to product and process technology.
Factors that firms should consider while selecting suppliers include:
Process and Product Technology ( Competent Process Technology ):
suppliers should have the technology to make high-quality products at a low cost. This will
help the buyer to be more competitive in the market because they will be able to sell their
products at a lower price or offer a higher quality product at the same price.
Willingness to Share Technology & Information ( Early Supplier Involvement (ESI) ):
Sharing technologies and information with suppliers is crucial in today's business environment,
where outsourcing is common. When suppliers are willing to share their knowledge, it helps
companies focus on what they do best. This collaboration, known as early supplier involvement
(ESI), allows suppliers to contribute to designing new products, making cost-effective choices,
suggesting alternative solutions, and helping assess designs. By involving suppliers early on,
businesses can benefit from their expertise, leaving them with more time and resources to
concentrate on their core strengths.
Quality ( Raw material quality & consistent ): Quality levels of the purchased item should be
a very important factor in supplier selection. Product quality should be high and consistent since
it can directly affect the quality of the finished goods.

Cost ( Total Cost of Ownership / Total Cost of Acquisition ): While the unit cost of an item is
not typically the sole criterion in supplier selection, total cost of ownership is an important
factor.
Reliability ( Financial Stability / Delivery Lead Time ) Aside from a reliable product quality
level, reliability can refer to other supplier characteristics. For example, is the supplier
financially stable? Otherwise, It may not be able to invest in research and development or stay in
business.
Order system and cycle time: quick, and effective. Delivery lead time should be short, so that
small lot sizes can be ordered on a frequent basis to reduce inventory holding costs.
Agar quick nai hoga to hum ko zada lekar rkhna hoga or quick hoga to hamara rkhna ki cost
reduce hogi .
Capacity: The firm should also consider whether the supplier has the capacity to fill
orders to meet requirements and the ability to fill large orders if needed.

8. Communication capability: Suppliers should possess a communication capability

that facilitates communication between the parties.

9. Location: Geographical location is another important factor in supplier selection,

as it impacts delivery lead time, transportation, and logistical costs. Some
firms require their suppliers to be located within a certain distance from their
facilities.
10. Service:
Suppliers should be able to help customers with their products after they buy them. Suppliers
must be able to back up their products by providing good services
when needed. For example, when product information or warranty service is
needed, suppliers must respond on a timely basis .suppliers who provide good after-sales service
are more valuable to customers
Reasons Favoring a Single Supplier
1. To establish a good relationship: Using a single supplier makes it easier for the firm
to establish a mutually beneficial strategic alliance relationship with the supplier,
as with well-managed supply chains, especially when the firm can benefit from the
supplier’s technologies and capabilities.

2. Less quality variability: Since the same technologies and processes are used to produce
the parts when using a single source, variability in the quality levels is less
than if the parts are purchased from multiple suppliers.

3. Lower cost: Buying from a single source concentrates purchase volume with the
supplier, typically lowering the purchase cost per unit. Due to the large purchase
volume, the supplier is more likely to ensure that it meets all of its performance
goals to keep the business. Single sourcing also avoids duplicate fixed costs, especially
if the part requires special tooling or expensive setups.

4. Transportation economies: Because single sourcing concentrates volume, the firm

can take advantage of truckload (TL) shipments, which are cheaper per unit than
the less-than-truckload (LTL) rate. By moving up to full truckloads, the firm has
the option of using both rail and motor carriers. Rail carriers are more efficient for
hauling heavy loads over long distances.

5. Proprietary product or process purchases: If it is a proprietary product or process, or

if the supplier holds the patents to the product or process, the firm has no choice
but to buy from the sole source.

6. Volume too small to split: If the requirement is too small, it is not worthwhile to split
the order among many suppliers. Single sourcing is a good approach for acquiring
supplies and services that do not contribute to the firm’s core competencies.
Reasons Favoring Multiple Suppliers
1. Need capacity: When demand exceeds the capacity of a single supplier, the firm has no choice
but to use multiple sources.
2. Spread the risk of supply interruption: Multiple sources allow the firm to spread the
risk of supply interruptions due to a strike, quality problem, political instability,
and other supplier problems.
3. Create competition: Using multiple sources encourages competition among suppliers in terms
of price and quality.
Information: Multiple suppliers usually have more information about market conditions, new
product developments, and new process technologies. This is particularly important if the
product has a short product life cycle.
5. Dealing with special kinds of businesses: The firms, particularly government contractors,may
need to give portions of their purchases to small, local, or women- orminority-owned businesses,
either voluntarily or as required by law.

Purchasing In Organization
Centralized purchasing is where a single purchasing department, usually located at the firm’s
corporate office, makes all the purchasing decisions, including order quantity, pricing policy,
contracting, negotiations and supplier selection and evaluation.
Decentralized purchasing is where individual, local purchasing departments, such as at the plant
level, make their own purchasing decisions.