CE588

Construction Equipment &

Material Management
(2 Credit, Elective)

Chaminda S. Bandara
Material Management

Section 2
Purchasing

Chaminda S. Bandara
Introduction Construction projects:

• The procurement department alone

• Purchasing is the “process of buying.” should not decide the material. The
site should give details of approved
• Purchasing of companies are looked after by a separate specifications, actual quantities, etc.
purchasing department/ unit.
• All the materials should not be
• Purchasing is not solely the responsibility of the purchasing
ordered at once. The ordering
department. The function is much broader and all
should follow the procurement plan
departments in the company may involve.
prepared based on the work
• Obtaining the right material, in the right quantities, with schedule.
the right delivery (time and place), from the right source,
and at the right price are all purchasing functions. • Materials should be ordered a few
days ahead but not months ahead.
• Choosing the right material requires input from the This causes cashflow issues, storage
marketing, engineering, manufacturing departments other issues, expiration of materials, etc.
than the purchasing department.
• Wastage during handling should be
considered when ordering.
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Introduction In construction companies:

• Purchasing may be centralized to

• Quantities and delivery of finished goods are established by the head office procurement
the needs of the marketplace. department.
• Manufacturing Planning and Control (MPC) must decide the • Time of ordering of a raw material:
time of ordering and the raw materials so that the when there is a project to start,
marketplace demands can be satisfied. when there is a discount for a
• The purchasing department is then responsible for placing material, when there is a problem
the orders and for ensuring that the goods arrive on time. for getting the material in the future
etc.
• Purchasing department has the major responsibility for
locating suitable sources of supply and for negotiating • The company has to invest money in
prices. materials. Early orders and
• Input from other departments is required in finding and payments may cause cash flow
evaluating sources of supply and to help the purchasing problems.
department in price negotiation. • Some materials cannot be kept in
• Purchasing, in its broad sense, is everyone’s business. storage for a long time (eg. Cement)
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Purchasing & profit leverage Examples – Civil Engineering Construction
Projects: 45% cost on materials.
1. Al Wathba Waste Water Treatment
Plant – Abu Dhabi (2009-2011).
• On average, manufacturing companies spend 2. Machinery & Component Repair
Workshop - Abu Dhabi (2011-2012).
about 50% of their sales on the purchase of
raw materials, components, and supplies.
• In civil engineering construction, about 35% –
45% of costs are for materials (purchasing of
materials)
• Therefore, the purchasing function has a
tremendous potential to increase profits or
losses.
• Stringent cost control is essential for projects.
(There are various software used by
.
companies for cost control).
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Example 1
• A company spends 50% of its revenue on purchased goods and shows
a net profit before taxes of 10%. (Eg. For every Rs. 10,000 in sales, it
receives Rs. 1,000 in profit and spends Rs. 5,000 on purchases. Other
expenses are Rs. 4,000). Assume that all costs vary with sales.
a) To increase profits by Rs.100, what should be the sales?
b) If a better negotiation can reduce the cost of purchase, to increase the
profit by Rs. 100 for Rs. 10,000 of sales, what should be the cost reduction
needed for purchases?

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Example 1
• Income statement – normal circumstances

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Example 1 (a)
• Income statement – Case (a)

• However, the
percentage
of profit is
still 10%.

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Example 1 (b)
• Income statement – Case (b)

• If the cost of
purchases is
reduced, the
percentage of
profit can be
increased
(11%)

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Purchasing objectives
• Purchasing is responsible for establishing the flow of materials into the
site/factory, following up with the supplier, and expediting delivery.
• Well managed purchasing can increase the profit.
• The objectives of purchasing can be divided into four categories:
• Obtaining goods and services of the required quantity and quality
• Obtaining goods and services at the lowest cost
• Ensuring the best possible service and prompt delivery by the supplier
• Developing and maintaining good supplier relations and developing potential
suppliers
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Purchasing objectives
• Basic functions to be performed to satisfy the purchasing objectives:
• Determining purchasing specifications: right quality, right quantity, and right
delivery (time and place)
• Selecting suppliers (right source)
• Negotiating terms and conditions of purchase (right price)
• Administration of purchase orders (issuing, follow up, etc)

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Purchasing cycle
• The purchasing cycle consists of the following
steps:
1. Receiving and analysing purchase requisitions.
2. Selecting suppliers: finding potential suppliers,
issuing requests for quotations, receiving and
analysing quotations, and selecting the right
supplier.
3. Determining the right price.
4. Issuing purchase orders.
5. Following up to ensure delivery dates are met.
6. Receiving and accepting goods.
7. Approving supplier’s invoice for payment.
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Receiving and analysing purchase requisition
• Usual practice in the
• Purchase requisitions start with the department or person who construction site:
will be the ultimate user (eg. the construction site). • Site/Construction Manager
knows the quantity of
• In the material requirements planning environment, the materials and the time the
planner releases a planned order authorizing the purchasing materials is required based on
the construction schedule.
department to go ahead and process a purchase order.
• The cost control section
• At a minimum, the purchase requisition contains the following (Contracts Manager/ QS)
knows the budget allocation
information: for that particular material
(based on the BoQ and cost
• Identity of originator, signed approval, and account to which cost is analysis).
assigned.
• The Contract Documents
• Material specification. include the material
specifications and drawings
• Quantity and unit of measure. etc.
• All the above details are
• Required delivery date and place. analysed to get the most
suitable material without
• Any other supplemental information needed losses, and with the required
quality etc.

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Selecting suppliers
Supplier and Subcontractor
• Identifying and selecting suppliers: by the (Construction Projects):
purchasing department.
The difference between the
• List of approved suppliers: for routine items etc, a supplier and the subcontractor
list of approved suppliers is kept at the company. is:

• New materials: if the material has not been (a) supplier is one who supplies
purchased before or there is no approved supplier goods/ services
on the list, a search must be made. (b) subcontractor is a
• Looking for new suppliers: to select new suppliers, contractor hired by the
main contractor of a project
the Internet, in catalogues, trade journals, or (employed by a contractor
directories of suppliers may be useful. However, rather than directly hired by
suppliers’ qualifications, history, capacity, and the customer/client).
financial status, etc should be investigated.
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Requesting for quotations (RFQ)
• Request for quotation (RFQ): This is a written inquiry that is sent to enough
suppliers (approved list of suppliers) to be sure competitive and reliable
quotations are received.
• After the suppliers send the quotations to the buyer, the quotations are
analysed for the price, compliance with specifications, terms, and conditions of
sale, delivery, and payment terms.
• For items where specifications can be accurately written, the choice is probably
made on price, delivery, and terms of sale.
• For items where specifications cannot be accurately written, the items quoted
will vary. The technical suitability should be checked.
• The supplier selection: a compromise between technical factors and price.

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Determining the right price
Some points to consider:
• Right Price for purchased goods: This is the • There can be new good suppliers
with good price than those who
responsibility of the purchasing are working with the company.
department. • Price can be less if paid while
buying.
• This is closely tied to the selection of
• In construction projects, the
suppliers. construction company receives
money based on the IPC, a few
• The purchasing department is responsible weeks after the work. If the
for price negotiation (to obtain the best company has to pay the supplier
early, there can be a cash flow
price from the supplier). problem.
• Sum suppliers give credit facility:
Payment is made a few weeks
later.

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Issuing a purchase order
• A purchase order: legal offer to purchase.
• Once accepted by the supplier, it becomes a Legal Contract for the
delivery of the goods according to the terms and conditions specified
in the purchase agreement.
• The purchase order is prepared from the purchase requisition or the
quotations and any other additional information needed.
• Copies of the purchase order: to be retained by the purchasing
department and are also sent to other departments such as
accounting, originating department, and receiving (site, etc).
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Following up and delivery
• The supplier is responsible for delivering the items ordered on time.
• The purchasing department is responsible for ensuring that suppliers do deliver
on time.
• If there is doubt that delivery dates can be met, the purchasing department
must find out in time to take corrective actions: expediting transportation,
alternate sources of supply, working with the supplier to solve its problems, and
rescheduling production (construction).
• The purchasing department is responsible for working with the supplier on any
changes in delivery requirements: changes in the schedule of production
(construction) that may change the delivery time of materials.
• The purchasing department should keep the supplier informed of the true
requirements so that the supplier can provide what is wanted when it is wanted.

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Receiving and accepting goods
• When the goods are received, the receiving department (construction site)
inspects the goods to be sure the correct ones have been sent, are in the right
quantity, and have not been damaged in transit.
• Using a copy of the purchase order and the bill of lading supplied by the carrier,
the receiving department (construction site) then accepts the goods and writes
up a receiving report noting any variance (Goods Acceptance Report).
• If further inspection is required, such as by the engineer (client), the goods are
presented for those inspections.
• If the goods are damaged, the receiving department will advise the purchasing
department and hold the goods for further action.
• If the goods are in order, they will be sent to the inventory.

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Approving supplier’s invoice and payment
• Upon the receipt of the supplier’s invoice, before payments, the following should
be focused on:
1. the purchase order
2. the receiving report (goods acceptance report)
3. the invoice from the supplier
• The items and the quantities should be the same on all; the price, and extensions
to price, should be the same on the purchase order and the invoice.
• All discounts and terms of the original purchase order must be checked against
the invoice.
• It is the job of the purchasing department to verify these and to resolve any
differences.
• Once approved, the invoice is sent to accounts for payment.
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Discussion
• Discuss the purchasing cycle based on
some of your industrial training
experience. Were there any issues related
to purchasing (reliability of suppliers,
delay of delivery, payment delays to
suppliers etc.) ?
Specifications
• The first concern of purchasing is Examples:
“what to buy ?” to buy a car:
• how the car will be
• In purchasing goods or services from a used, how often,
supplier, there should be a specification that • type, size, model,
features etc
specifies the requirements of the buyer.
• cost - how much ?
• Factors to be considered when developing to buy tiles for a
specifications are: building:
• Colour, texture etc.
• Quantity requirements.
• Size
• Price requirements.
• Price
• Functional requirements.
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Functional specification description
• Functional specification can be described in the following ways or by
a combination of them:
1. By brand.
2. By specification of physical and chemical characteristics, material and
method of manufacture, and performance.
There are two major sources of specifications:
1. Buyer specifications (developed by the buyer).
2. Standard specifications.
3. By engineering drawings.
4. Miscellaneous

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Selecting suppliers
• Once the decision is made about what to buy, the selection of the right
supplier is the next most important purchasing decision.
• A good supplier is one that has the technology to make the product to the
required quality, has the capacity to make the quantities needed, and can
run the business well enough to make a profit and still sell a product
competitively.
• There are three types of sourcing:
• sole
• multiple
• single

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Selecting suppliers • If sole supplier has no adequate
material, there is a problem.
• Sole sourcing: Therefore, the reliability and the
capacity of the sole supplier is
• only one supplier is available because of patents, very important.
technical specifications, raw material, location etc.
• Multiple sourcing is better. This
• Multiple sourcing: provides better price, service
etc. If one suppler does not have
• the use of more than one supplier for an item.
adequate materials, there is
• The advantages of multiple sourcing are: lower price always an alternative supplier.
and better service, continuity of supply (due to However, quality may be
competition). different and to be monitored.

• Single sourcing: • Most of the companies have

suppliers working with them for
• planned decision by the organization to select one some years. Therefore, there is a
supplier for an item when several sources are tendency to deal with those
available (a long term partnership etc). suppliers even for slightly higher
price.
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Factors in selecting suppliers
• There are several factors in selecting a Some points for a discussion:

supplier. • Suppliers past records,

experience, projects involved
• Technical ability etc.
• Visiting the suppliers facilities
• Manufacturing capability before selection.
• Reliability • Reliability of lowest priced
supplier.
• After-sales service
• Suppliers location (low
• Supplier location transportation and storage
cost).
• JIT capabilities (Just in time) • Credit facility (pay later).
• Other: credit terms, willingness of the supplier
to hold inventory for the buyer etc.
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Price of the supplier
• Competitive prices: this does not necessarily mean the Landed total cost
lowest price. It is the one that considers the ability of the includes all the handling
supplier to provide the necessary goods in the quantity costs.
and quality wanted, at the time wanted, as well as any This may include a
other services needed. number of times
transport at various
• Total acquisition cost (landed cost): this includes the price places from store to store
paid plus all the handling and delivery costs. by your self including
loading and unloading
• A buyer will often get a transportation discount by ordering in
larger quantities. cost etc.

• The total acquisition cost may increase when the costs of storage
and inventory are included.
• A low acquisition cost may not always be a good decision. There
can be higher costs for processing the materials due to poor
quality, defects, etc. of a low-cost material.
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Price of the supplier
• The supplier selection and the supplier–buyer
relationship is of the utmost importance to
have profits.
• The supplier-buyer relationship has a mutual
dependency. This opens the doors for
continuous business.
• The supplier can rely on future business while
the buyer can expect quality products, technical
support, etc.
• Communications between buyer and supplier
must be open and full so both parties
understand the problems of the other and can
work together to solve problems to their
mutual advantage.

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Final selection of supplier
Factors for evaluating suppliers:
• Quantitative factors:, i.e. a money value can be used to evaluate. (Example - price).
• Qualitative factors: these factors require some judgments to determine them. These are
usually set out descriptively. (Example: the supplier’s technical competence).
• One method for combining these two major factors to identify the best supplier is the
ranking method. This is a two-step process:
1. Select those factors that must be considered in evaluating potential suppliers.
2. Assign a weight to each factor based on the importance of the factor in relation to the other
factors (Usually on a scale of 1 to 10).
3. Rate the suppliers for each factor. Suppliers are rated on their ability to meet the requirements
of each factor (usually on a scale of 1 to 10).
4. Rank the suppliers. (The weight of each factor is multiplied by the supplier rating for that factor.
Then obtain the total ranking score. Then choose the supplier with the highest ranking.)

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Final selection of supplier
• Supplier rating (Suppliers compared are A, B, C & D. Best supplier is B (Ranking score is 223)

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Example 2 (in-class exercise)
• If suppliers were to be rated on the following basis, what would be the
ranking of the two suppliers listed?

Total ranking

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Price determination
• Price is not the only factor in making purchasing decisions. However,
price is the most important factor.
• In the average manufacturing company, purchases account for about 50% of
the cost of goods sold, and any savings made in purchase cost have a direct
influence on profits.
• “You only get what you pay for.”
• We should know what we want and not pay more than necessary.
• When a purchase is made, the buyer receives a package of function,
quantity, service, and price that is suited to the individual’s needs.
• “Best Buy” is the mixture that serves the purpose best.
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Basis for pricing
Some points to discuss:
• Fair price: the competitive price that gives the seller a
profit, and allows the buyer ultimately to sell at a profit. • Price may be low when the
material is reaching its expiry
• Fair price is the reasonable price of an item. It may be the date, the material is defective,
lowest price at which the item can be bought. the seller has other issues due
to which he wants to sell
• However, sellers who charge too little to cover their costs materials at a low price, etc.
(sell at a very low price) will not stay in business. Because,
• Sometimes there can be
to survive, they may attempt to cut costs by reducing problems with materials
quality and service. supplied due to technical
issues. For example, the
• Pricing should be such that, both the buyer and the seller strength of concrete can be
must be satisfied. lower than expected due to
technical issues during mixing.
• Since we want to pay a fair price and no more, it is good Professional suppliers may
to develop some basis for establishing what is a fair price. bear the cost of the defective
construction.

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Basis for pricing
• Prices have upper and lower limits.
• Upper limit: decided by the market, depending on the buyer’s perception of demand, supply,
and their needs.
• lower limit: set by the seller, determined by the costs of manufacturing and selling the product
and profit expectation.
• If buyers are to arrive at a fair price, they must develop an understanding of market demand and
supply, competitive prices, and the methods of arriving at a cost.

• One widely used method of analysing costs is to break them down into fixed and variable costs.
• Fixed costs: costs incurred irrespective of the volume of sales. Ex. administrative overhead,
equipment depreciation, taxes, insurance, etc.
• Variable costs: costs directly associated with the amount produced or sold. Ex. direct labour,
direct material, and commissions of the sales force.

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Basis for pricing
Total cost = fixed cost + variable cost per unit × number of units
Unit cost (average) = total cost / number of units
= (fixed cost/number of units) + variable cost per unit
Unit cost × number of units sold = fixed cost + (variable cost per unit) x (number of units)

• This formula shows that as the number of units produced increases, the unit cost
decreases. This is an important factor when determining price. Buyers can lower the unit
price paid by increasing the volume per order using longer-term contracts or through the
standardization of parts. Sellers will offer quantity discounts to encourage larger orders,
also taking advantage of this reduction in unit cost.

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 Basis for pricing
Revenue = cost + profit
• Break-even analysis
Total cost = fixed cost + variable cost

Fixed cost = overhead,

equipment depreciation,
taxes, insurance, etc
AMOUNT

Variable costs: direct labour,

direct material, etc

Revenue is the total amount of

income generated by the sale of
goods and services related to the
primary operations of the business.
Commercial revenue may also be
referred to as sales or as turnover.
Some companies receive revenue
from interest, royalties, or other
fees.
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 Example 3
• To make a particular component requires an overhead (fixed) cost of $5000 and a
variable unit cost of $6.50 per unit.
• What is the total cost and the unit cost of producing a lot of 1000?
• If the total is 800 units, what is the unit cost?
• If the selling price is $15 per unit, what is the break-even point?
AMOUNT

To make a profit, the number of units to be sold

should be more than 588.2 (589) units.
Higher the number of units sold, higher the profit.
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Competitive bidding
• Competitive bidding occurs when a buyer compares the price of a product
from various suppliers and simply chooses the lowest price.
• This can be the formal process of sending out quotations and analysing the
results or simply comparing catalogue or advertised prices.
• The process does take some time, and a number of sources must be
available.
• At least three sources are desired to make a good comparison.
• Competitive bidding also requires that the product be well-specified and
widely available.

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Price negotiation
• Prices can be negotiated if the buyer has the knowledge and the influential
capacity/power to do so.
• A small retailer probably has little possibility, but a large buyer may have much power for
negotiation.
• Through negotiation, the buyer and the seller try to resolve the conditions of purchase to
the mutual benefit of both parties.
• Skill and careful planning are required for the negotiation to be successful.
• It also takes a great deal of time and effort, so the potential profit must justify the
expense.
• One important factor in the approach to negotiation is the type of product.
• There are four categories of products: Commodities; Standard products; Items of small
value; Made-to-order items.

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Price negotiation
1. Commodities: materials such as metals, coal, wheat and meat, etc. Price is set
by market supply and demand and can fluctuate widely. Negotiation is
concerned with contracts for future prices.
2. Standard products: items provided by many suppliers. Since the items are
standard and the choice of suppliers is large, prices are determined based on
listed catalogue prices. There is not much room for negotiation except for large
purchases.
3. Items of small value: items such as maintenance or cleaning supplies and,
represent purchases of such small value that price negotiation is of little
purpose. The prime objective should be to keep the cost of ordering low.
4. Made-to-order items: items made to specification or for which quotations from
several sources are received. These can generally be negotiated.
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Planner/buyer concept
• In a traditional system, the material requirements planner (MRP) releases an order either
to the production activity control department or to the purchasing department.
• The purchasing department issues purchase orders based on the material requirements
plan.
• The production activity control department prepares shop orders, schedules
components into the workflow, and controls material progress through the plant.
• When plans change, as they invariably do, the production planner must advise the buyer
of the change, and the buyer must advise the supplier.
• The production planner is in continuous contact with MRP and frequently changing
schedules.
• To improve the effectiveness of the planner/buyer activity, many companies have
combined the two functions of buying and planning.

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Discussion
• A contractor is laying asphalt on a road.
Discuss the importance of break-even
analysis for a contractor to make the
targeted profit.
• If the contractor get materials for a low
price, how it changes the break-even
point?