Understanding market management in

procurement and supply

2.1. Analyse the different types of markets utilised by procurement and
supply
2.2. Compare the competitive forces that influence markets
2.3. Contrast the breakdown between direct and indirect costs and the types
of data that can provide information on cost and price

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2.1. Analyse the different types of markets utilised by
procurement and supply

2.1.1 Manufacturing sector

2.1.2. Construction sector
2.1.3. Retail Sector
2.1.4. Financial Sector
2.1.5. Agriculture Sector
2.1.6. Service Sector
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Introduction
• A market is a place where goods are bought and sold.
• They are created in order to facilitate trade in products and services between
buyers and sellers so that a real or perceived need is met
• To meet the more complex and increasingly global markets, markets are not
always a physical place
• Buyers and sellers may not be aware of each other or the goods/services that are
available
• Sellers deploy a range of marketing techniques to advertise their offers and buyers
use tendering processes to broadcast their requirements and then choose the
best price
• Understanding supply markets is a vital task for procurement professionals
• By analysing markets, a buyer can potentially find new sources of supply and new
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2.1. Analyze the considerations for procurement and
supply when working and with different market
• An industry is formed to service a market
• Industries are made up of segments which are groups of organisations that
share common characteristics such as the type of customers served
• Individual organisations operate within these segments although a specific
organisation may work in more that one segment see fig 2.1 page 68

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How industries, segments and businesses are integrated

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Market Analysis and considerations
Industry Classification
• Industries are classified into 3 main groups: primary activities (essentially extractive
industries such as mining), secondary activities (manufacturing) and tertiary activities
(services)
• These are further analyzed using a coding system see table 2.1.

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Generic Strategies
• Michael Porter suggest that there are 3 generic strategies for competing in an
industry
• Cost Leadership
• Differentiation
• Focus on a narrow niche segment
• An organisation that is not clear about which of these 3 strategies to use is
described as ‘stuck in the middle’
• As a results it cannot compete on price in one of these strategies
• These organisations often fail.

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Generic Strategies
• The importance for the procurement is that that organization which compete
in a particular industry are suppliers to the buying organization
• having an understanding of the supplier’s strategy and how it is being used in
order to compete can be a valuable information when managing a market or
supplier or negotiating with a supplier.
• For example, if the organization’s strategy is to charge a premium price for a
product or service that is differentiated from that of its competitors, then
procurement needs to ensure that all of the points of difference in the
product or service are really needed and add sufficient value to compensate
for the additional price.

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Segment analysis
• A segment is a group of products or services that provide specific but different
value for their buyers for e.g. the car manufacturer can segment their products
by demographics (Low income versus high income buyers )
• Understanding segments helps procurement and supply to shape and manage
the supply markets
• There are two other variables that can lead to a different segment. These are
distribution channels used to reach buyers and geographical location of those
buyers
• The following variable can be considered:
Product or service segment
Buyer segments
Channel segments
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Geographical segments -
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Product or service segment
• The segment contains individual products or services, ancillary services
such as maintenance or consumables
• Groups of products can be sold together or single products bundles with
other ancillary services e.g. a washing machine can be bought on its own or
with insurance in case it breaks down
• The physical size of the product can also create a segment e.g. an
organisation that makes excavation equipment might have a very large
product for use in a quarry and a much smaller to use in a construction of
houses
• The parts used here will be different and so as the costs and buyers

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Product or service segment cont…
Other factors that can create different segment
• Price Levels
• Features- the characteristics of a product or service that give benefits to the
buyer
• Design- better product design better sales
• Packaging
• Performance
• New versus Replacement

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Segment based on buyers
• On consumer goods segments can be based on age, income or household
size
• Industrial markets can be segmented based on the size of the buying
organisation, the technology used or how the buyer uses the product
• Other factors that determine how industrial markets are segmented based
on buyers include:
 Buyer’s strategy- e.g if the focus is on product quality using
differentiation strategy- charge premium prices
 Buyers size e.g. the larger the value the more bargaining power the
buying organization will have.
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Segment based on buyers
 Ownership- multi- national company may follow the practices and
strategy set by its head office
 Financial strength
 Order patterns
• Consumer markets can also be segmented on the basis of their buyers
• They can be segmented using
 Lifestyle
 Language
 Purchase occasion

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Segment based on distribution channels
• Segment based The distribution costs has implications on costs e.g. in some
industries organisations ship items in large quantities to wholesalers but in
much smaller quantities to an individual retail customer
• Some others factors include
 Direct sale vs distributors
 Direct marketing versus retail
 Exclusive versus non exclusive outlets

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Segment based on geography
• Segmenting based on the required attributes of products and cost of
the different distribution channels.
• Other factors include:
• Localities , regions or countries
• Weather zones
• Country groupings-

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Finding new segment
• The key task for procurement and supply is to monitor suppliers and
industries in which they operate in order to find new opportunities to
reduce or to find opportunities to reduce costs or find means by
which suppliers can provide products and services in a way that adds
more value
• If all the opportunities to do this in a particular industry segment have
been exhausted then it may be worthwhile to look at different ways to
segment supply markets as this could reveal more opportunities
• An organization can make a breakthrough in the outcomes it achieves
and also reduce costs by identifying new segments
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Finding new segment
Other factors that can create new segment
• Use of technologies and other product designs
• Improved product or service
• Reducing the number of functions the product and service delivers at
the same time reducing prices
• Including other bundles of products and services and ancillaries
• Using different channels to reach additional buyers
• The way in which new segment are identified is to use a segmentation
matrix
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Analysis of organisations
• the 3rd level of market analysis is that of understanding individual
companies within each segment of the industry
• This is important for professionals because they interact with these
companies through activities such as tenders and negotiations
• There is also need to understand how a company organizes itself to
meet these pressures and constraints in a way that is profitable
• This provide valuable information that helps procurement and
supply to manage supply markets to their advantage.
• A useful way to do this is to use Porter’s Value Chain model
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Analysis of organisations cont..
• An organisation takes inputs to make outputs that deliver outcomes
to the buyers of its products or services.
• This is achieved using primary activities such as logistics, operations,
sales and marketing and after sale service
• In turn these primary activities are supported by secondary
activities such as procurement, technology, human resources and
infrastructure see and read case study on page 75

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Analysis of organisations cont..
• A role for procurement is to understand the value chain of major
suppliers and use that knowledge to identify how suppliers use
differentiation to best support their value chains
• Procurement can also use the value chain to identify suppliers
major costs.
• This information will assist when negotiating or working with
suppliers to find improvements and cost reduction
•

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Specific Market
Specific markets that need to be considered are derived from the
following areas: Manufacturing, Finance construction, agriculture,
services
When analyzing markets, the following factors should be considered:
• Objectives
• Drivers
• Governance (rules, structure and institutions
• Ownership
• Commodity or non-commodity see summary of these factors on
page 72-73
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Manufacturing Sector
• Manufacturing is the transformation of raw materials and
components by mechanical, physical or chemical means into
products that are sold to other companies or to consumers
Common generic issues that affect most of these markets:
• High investments, skilled workforce and raw materials are needed
• High capital cost and it takes time to build a network of suppliers
• Low profitability and barriers to entry are high
• No immediate substitute available
• Switching costs can be high in the short term
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Automotive Market (an example of an market analysis in the
manufacturing Sector)
• According to recent report by Mckinsey the following challenges
shape the automotive industry
• Complexity and cost pressure
• Diverging market
• Digital demands
• Shifting industry landscape

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Construction
• The two largest segments are the construction of residential, industrial
commercial buildings and heavy construction of infrastructure such as
roads and railways
• The biggest barriers to new entrants are those of experience and
reputation hence barriers to entry are considerable very high
• Although there substitutes for materials and components used but there
are no substitute for constructions
• There are many sources of supply for materials and therefore the
switching costs are low
• This means also that the bargaining power is also low and limits the
prices they can charge
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Construction
• For smaller construction contracts, buyers generally have many alternative suppliers
and so their bargaining power is quite higher
• For many construction contracts, buyers have many alternatives suppliers and so their
bargaining power is quite high
• For large and complex project there are fewer companies with the necessary
capabilities and experience and so buyer bargaining power is lower
• However most contracts are awarded following tendering process which can create a
degree of power in limiting prices but this is highly dependent on the quality of the
specifications and the ability to negotiate any additional costs during the life of the
contract
• The second drive is the need to improve project performance
• The third driver is the shortage of skilled labour
• The fourth driver is sustainability
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The retail industry
• Barriers to entry are often high due to high investment costs.
• Threats of substitute are usually high because they are several alternatives
open to the buyer.
• Competition is often intense and this can be mitigated in some instances by
creating a brand that attracts loyalty from customers.

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Financial
• The financial service market is extremely diverse in the types of services offered
• It consists mainly of business that engage in the creation, liquidation and change of
ownership of financial assets such as shares, bonds and derivatives
• Customers ranges from individuals to businesses, non profit organisations and the public
sector
• There are 3 main segment in the Financial services sector:
1. Financial services (Banks, building societies, savings banks and credit unions
2. Insurance and Reinsurance and pension funding (insurances, employee benefits,
pensions and retirement plans)
3. Auxiliary activities - includes financial markets such as commodity and future contracts
and stock exchanges, brokerages, insurances agents and insurance loss adjustment )

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Financial Cont..
• In a segment that is dominated by few very large banking brands, it
would be difficult for a new entrant to march assets and history of
the incumbents
• Currently there are few if substitutes if any substitutes for banks
• Customers have little or no bargaining power

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Agriculture
There are 5 main subdivisions for Agriculture:
• Agriculture production –crops
• Agriculture production –livestock
• Agricultural services-soil preparation, crop services, veterinary
• Forestry- farms, nurseries and reforestation
• Fishing, hunting and trapping- commercial fishing, operations of fish and game
preserves

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Agriculture cont.…
• Significant investment in land and machinery and access to buyers required.
• Margins are low hence threats of new entrants is low.
• Many products used in Agriculture e.g. seeds can be subject to shortages
hence the supplier strength is often high
• Some of the buyers of Agriculture products are very large e.g. retail food
store chains and they have a high level of bargaining power
• Many business in the industry are relatively small with little bargaining power

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Agriculture cont.…
The drivers for change include:
• The level of income
• The limited availability of land and water for crop production

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Services
The market can be considered to include :
• Information and communication
• Professional, scientific and technical activities
• Administrative and support service activities
• Other service activities
• For new entrants, start up costs are generally low in services industries
• The main requirement is the level of knowledge and skill
• There are few if any substitutes available
• The market for services is generally high with fragmented buyer group

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Services
• Price sensitivity is often low as buyers have insufficient information to
understand the true cost of supply and so tend to pay the going rate.
• Buyers perceive that the service provided by an individual company is
unique.
• Therefore the bargaining power of buyers is low
• Competition is often intense as there are many suppliers of a particular
service and switching costs are low.
• Lawyers, architects and management consultants are examples of
professionals who work mainly in the service market
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Services
• The primary objectives :
• To build trust with existing and potential clients
• To establish uniform processes so that a common way of working is
established even though each set of client needs are different
• To achieve the highest levels of customer satisfaction
• Companies in this type of service market are predominantly self
employed individuals or partners

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A general approach to understanding and managing markets
• Markets can be diverse in terms of the companies competing in them, their
customers and suppliers, the technology used and the threat of new entrants
and substitutes.
• A key role for procurement and supply is to analyse and assess this diversity
and find strategies that maximize the value they can get from that
understanding
• Understanding and managing markets is time consuming and not relevant to
every market that an organisation buys from.
• One way to decide which markets need this level of this understanding is to
use the concept called “supply positioning”

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Supply positioning
• The technique of supply positioning produces a two by two matrix based on
the importance of the spend category and complexity or commercial risk
involved in purchasing it.
• The results is four possible combinations
• High importance and high complexity/ risk- strategic
• High importance and low complexity/ risk- Leverage
• Low importance and high complexity/ risk- critical
• Low importance and Low complexity/ risk- tactical
• Understanding markets and managing them is clearly the most important for
items in the strategic quadrant.
• A sound knowledge of markets is also key for items in the leverage quadrant
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Supply positioning cont..
• Many people use the value of annual spend on a category as a means of
deciding on its importance.
• Kraljic’s original definition of importance was based on profit impact of a
category.
• This means that the category might be low in terms of spend but might be
used to manufacture products that will generate 80% of organisation sales.
• The price rise of that category or a failure in delivery can have a significant
impact on the organization's overall sales and profit.

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Supply positioning cont…
Factors that determines the importance of a category
• Value of spend i.e. the 80/20 rule
• Importance of the delivery of the organization's service
• Universality i.e. it may be a low cost component but is present in the majority
of the service offerings or products, in which case lacking this component
would have a significant impact on the organization's output
• Impact of the category on the quality of the product
• Volume purchased
• Impact on the organization's plans for growth

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Supply positioning cont..

• The second component of the supply positioning matrix is commercial supply

risk which provides a segmentation between high risk and low risk and
includes consideration of the complexity of buying organisation form that
market
• Fig 2.4 on page shows these two components together with possible generic
strategies for each quadrant page 89
• Understanding markets and managing them is clearly the most important for
items in the strategic quadrant. A sound knowledge of markets is also key for
items in the leverage quadrant

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2.2 Compare the competitive forces that
influences markets

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Industry Analysis: Porter’s Five Forces
• The basic purpose of a market is to provide products or service that
deliver value to the buyer by meeting its need. If this can be done at a
price that is greater than costs then profit is created and it is
sustainability of this profit that results in a healthy market
• However this depends on the structure of the industry that delivers
products or services to those markets

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Industry Analysis: Porter’s Five Forces
• For a market to be sustainable in the long-term, it must be a profitable
industry for the businesses competing in it, and those businesses must
be able to find ways to remain competitive.
• Analyzing the forces that act on an industry help to understand the
attractiveness of the industry.
• Porter proposed five forces that act on an industry

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Porter’s Five Forces

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Porters five forces

• Porter’s five forces together determine the ability of organisations in the

industry to earn a profit that gives an acceptable return on the financial
investment made by each organisation.
• This is because the forces influence prices that can be charged and costs that
have to be met.

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Porters five forces
• Threat of new entrants – if a market enables all firms within it to make profits then it is
likely to attract new firms into the industry. However, there can be a number of barriers to
a firm entering a market.
• Threat of substitution – the risk of buyers switching to alternative products or services,
known as substitutes.
• Buyer power – the amount of bargaining power that buyers exert in an industry. It can
come from a group of buyers all asking for the same thing or an individual company in an
industry that has few buyers.
• Supplier power – the amount of bargaining power that suppliers can exert on firms in an
industry.
• Rivalry – if this exists between firms it means that they take positive action to try and take
market share from each other, which in turn can lead to increased profits for those that
gain market share and lower profits for those that lose market share. If market share is
taken by reducing prices, it can reduce profits in the industry as a whole.
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Factors that determine intensity of rivalry
• Many or equal size suppliers
• Slow industry growth
• High fixed costs
• Lack of differentiation and switching costs
• Capacity is added in significant barriers
• High exit barriers

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Bargaining Strength of buyers and suppliers
• Bargaining power is the ability of a buyer or supplier to make more
demands and take more of the available profit for themselves.
• If the supplier power is strong then more of the profit available is
captured by suppliers.
• If buyer power is strong then more of the profit will go to them

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Bargaining strength of Suppliers

Supplier’s bargaining power is strong when:

• The bargaining strength of suppliers is a major determinant of the structure of an
industry and how much profit is available to organisations operating in that
industry
• There are a number of different types of supplier e.g manufacturers, distributors
and wholesalers
• Independent crafts people and small business
• Importers and exporters
• For service firms, individuals are important suppliers of skills and capability

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Bargaining strength of Suppliers

Supplier’s bargaining power is strong when:

• There are no substitutes
• Suppliers are larger than firms in the industry and more concentrated
• The industry is not very important to the seller
• The seller’s product or service is an important part of the industry’s value chain
• The seller’s product or service is differentiated
• There are significant switching costs
• Sellers pose a definite threat of forward integration

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Leading global excellence in procurement and supply

Buyer Strength
• Buyer strength is the ability of buyer to drive down prices and take
more of the available profit for themselves.
• When buyers’ bargaining power is strong, it means they are able to
make more demands on suppliers in respect of factors, such as
product quality and product functionality.
• This increases supplier costs and reduces their profitability.

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Leading global excellence in procurement and supply

Factors that determine buyer strength

Figure 2.6 Factors determining buyer strength (Source: based on Porter, M. E. (2004), Competitive
Advantage: Creating and Sustaining Superior Performance. New York: Free Press)

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Slide 15
Leading global excellence in procurement and supply
Buyer’s strength
Buyer power is strong when:
• Buyers are more concentrated than sellers
• Buyer switching costs are low
• Threat of backward integration is high
• Buyers are price sensitive
• Buyers are well informed about the product or service
• The product or service is undifferentiated
• Buyers purchase in large volumes
• Substitutes for the product or service are available
• The amount purchased by the buyer is a significant proportion of the seller’s sales If
suppliers’ bargaining power is high then they can keep the price of their product or service
high and so retain more of the available profit.
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Leading global excellence in procurement and supply

Product Cycle
• The product life cycle suggests that products go through a number of stages from the point
at which they are introduced to the market to the point that they are withdrawn
• The stages in the product life cycle are as follows:

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Leading global excellence in procurement and supply

Product Cycle
• Introduction- covers R&D of a product or service to meet the identified need, sales can be
slow, marketing effort is on innovators, profits tend to be low, skimming price
All of the activities associated with launching of the product or services
• Growth - Sales starts to grow, competitors starts to entre the market, Early adopters fuels
the sales
• Maturity – Sales are still near their peak but the growth of sales starts to slow down, price
competition sets in because of new entrants. New buyers at this stage are called the middle
majority
• Decline – sales fall to such a level that the product or service is withdrawn from the market
• Buyers who continues to buy in this stage are called laggards
• This is important for procurement and supply because the lifecycle is a major determinant
of a supplier’s pricing policy
• It is useful in deciding the target price when tendering or negotiating
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Product Cycle
• If a product or service that has just been introduced is important to the buyers 'own
organisation and the buyer then attempts to reduce the price, this will discourage the
supplier, tis will discourage the supplier rom bringing future innovations to this buyer as it
is at this phase in which the supplier recoups its research and development cost
• If the product is in the maturity stage , then the supplier may be more open to reduced
price as its strategy is to gain market share from competitors.
• The product lifecycle is closely aligned with the Boston Consulting group Matrix which
again expand the life of a product, service or market into four distinctive phases see fig 2.7
page 95

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Leading global excellence in procurement and supply

Availability of substitutes and threat of entry
Substitutes
• Substitutes are alternative ways for buyers to meet its needs and so all business
at some time or other face the threat of substitute
• Substitutes put a ceiling on the prices that can be charged and so the amount of
profit that can be made.
• This is because higher prices for existing products or services make substitutes
from other suppliers more attractive to the buyer.
• A substitute can be a different product or service which performs the same
function as the existing one e.g. the use of gas or oil
• The higher the price the more likely it is for the organisation will look for a
substitute that can meet needs but at a lower price
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Leading global excellence in procurement and supply

Substitutes
• There are wider alternatives of substitutes:
• A substitution takes place if a buyer decides to purchase nothing rather than
the product or a service
• A buyer can opt to reduce the usage rate
• Instead of a regular product, a buyer may be able to choose a recycled or
reconditioned product
• The buying organisation may also choose to perform the function of the
purchased item itself a form of backward integration e.g self- insure than take
out insurance.
• A key factor when considering a substitution is the economic factors.
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Economics of substitution
There are 3 aspects to this
• The relative price between the existing product and the substitution
• The switching cost involved in moving from the existing or service to the
substitute
• The inclination of the buying organisation to make the switch to the substitute

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Relative value prices
 Value to price is the value that a product or services provides in meeting a
buyer’s needs compared to its purchase price
 The factors to consider before making the decision to switch
Usage rate
Significant delivery and installation costs
Significant financing cost involved
Stability of the supplier’ costs
Availability issues in terms of capacity to meet all projected orders
Any significant direct and indirect costs

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Leading global excellence in procurement and supply

Switching Costs
• These are all of the costs involved for the buying organisation in moving from one
product or service to another or from one supplier to another
• Switching products often means switching suppliers as well which means that there
are two switching costs involved
• Examples of switching costs include:
• The redesign of the buyer’s product in order to accept the substitute
• The cost of retraining and relearning
• A possible change to the role of the user
• A perceived or actual risk of failure
• The cost of switching back to the former product or service if the new one fails or the
relative value to price changes
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Leading global excellence in procurement and supply

Buyer inclination
• Buyers in the same industry and with the same understanding of the relative
value and price may still make different decisions about whether to switch.
• This is because of differing inclinations or propensity to change
Some of these are as follows:
• Resources such as access to finance,
• Risk profile,
• Technological understanding,
• Previous substitutions,
• Intensity of rivalry
• Buying organisation strategy
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Threats to new entrants
• New entrants to an industry reduce the profitability of existing companies in that
industry.
• The barriers to a new entrants include
 Economies of scale
 Product differentiation
 Brand identity
 Capital requirements
 Access to distribution
 Access to technology
 Cost advantages – economies of scale, learning curve
 Access to market relationships or associations
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Leading global excellence in procurement and supply

Threats to new entrants
• The threats of new entry is high if…
• Many companies in the industry with no dominant companies
• No proprietary differentiation of products or services
• No brand recognition in the industry and or brand loyalty is low
• Low or no capital requirements to enter the industry
• Easy access to distribution channels or suppliers
• No threat of retaliation from existing companies in the industry

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Leading global excellence in procurement and supply

Contrast the breakdown between direct and
indirect costs and the types of data that can
provide information on cost and price

Leading global excellence in procurement and supply

How to collate Sources of information
• Direct costs are the cost involved in the primary activities and indirect costs
are those costs of support activities
• Direct costs can be calculated by subtracting the gross profit from the revenue
for a period.
• Indirect costs can be calculated by subtracting revenue from the net profit.

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Leading global excellence in procurement and supply

Information sources

1. Company Annual Reports

• These are reports released once a year as a way of communicating with
shareholders about the performance of a company
• It contain statements from directors and chief executive about the main issues
facing the organisation, how the organisation faced those issues in the current
year and its plan for the future
• They also contain financial statements
• The report will contain sales and profit values from last year.
• Deducting the profit from the sales will give total cost value of organisation

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Leading global excellence in procurement and supply

Line of the best Fit
Fixed and variable costs can be calculated as follows.
• Obtain cost and output values for a number of similar organisations
• Plot them on a graph to find the line of best fit – this is the line that
goes approximately through the middle of the data points
• The point where the line of best fit crosses the y-axis (where output
is zero) is the probable value of fixed costs for the industry.
• The slope of the line of best fit is the approximate variable costs for
the industry.

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Line of the best fit

Figure 2.9 Line of best fit

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Line of the best Fit
• Calculate by doing the following.
• Take a point at the right-hand end of the line of best fit and note its cost and
output levels.
• Divide the cost by the output and this gives an approximate figure for the cost
per unit of output or variable cost.
• At this stage, the view could be taken that fixed costs are mostly indirect costs
and variable costs are mostly direct costs.
• Understanding the breakeven point of a company provide information that
can be used for negotiations

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Sources of Information cont.…

Market Data
• Some organisation specialize in collecting and analyzing information on
arrange of markets and selling the subsequent reports .
• These reports contain both primary research and financial analysis which can
be used to a supply market for procurement and supply.

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Sources of Information cont.…
Technical Data
• It is data provided by an organization's technical staff e.g. manufacturing
engineers , research and development staff .
• This data is then used to build useful information for procurement and supply
such as a supplier’s likely direct and indirect costs
• However it is easy to collect such information within the organisation but
difficulty in doing the same to the supplier since there is limited or no access
to the supplier’s accounting system

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Sources of Information cont.…
Technical Data
• A technique called cost synthesis or should cost analysis can be used
• In this method procurement staff work with their colleagues in operations
who understand how the supplier’s product is made or service is delivered
• The idea is that the technical people will be able to document how the
product is made, using what manufacturing processes and what bought in
materials and components.

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Sources of Information cont.…
Request for Information
• It is a standard process that is often used to collect information when an
organisation is not yet sure of the details of the product or service that it
wishes to procure
• This process can be adapted to ask potential suppliers for information on their
direct and indirect cost
• If they are reluctant to divulge that information, the organisation could ask for
the ratio between the two.
• Combining with other sources of information will help to refine the estimate
of the direct and indirect costs of a particular product or service

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Sources of Information cont.…
Plant Visit
• Viewing facility can give an organisation an insight into the following aspects:
 How well the company is doing. does it look busy
 How old the equipment is. Old equipment might mean low cost but might
nee to be replaced
 The work practices. Do staff look well trained, motivated and efficient?
 How efficient the supplier’s own buying is. Does the raw material look lean
and well run
• All these can provide insights into the supplier’s direct and indirect cost
• This can be used for negotiations to explore ways of reducing costs without
reducing the supplier’s profit
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Sources of Information cont.…
Discounts Lists
• Sometimes companies are prepared to give discounts once their breakeven
point is reached in order to win market share
• The extent the company give discounts and the size for additional different
order volumes can give an insight into fixed and variable costs and also direct
and indirect costs.

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How to use information to prepare budgets or to negotiate prices
• A budget sets out the plan for the next year as to how much the company is expecting t sell
and how much profit it is planning to make
• Purchasing budget estimates how much money will be spent on raw materials and
components, services and outsourcing for a period.
• Direct and indirect costs are used to construct a purchasing budget.
Calculate the quantity of a raw material needed by the following
• Budgeted number of units to be manufactured multiplied by the quantity of raw material
per item.
• To calculate the quantity of raw material that the organisation needs to buy in the next
year.
• Inventory at the start of the budget period + quantity needed for production – the
inventory needed at the end of the budget period
• Both of these figures can be obtained from the manufacturing budget and the bill of
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 Purchasing budgets and costs

Table 2.10 Format of a purchasing budget

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Slide 17
Leading global excellence in procurement and supply
Preparing budgets cont…

• If you have a thorough understanding of the cost build-up (direct and indirect
costs) of the item that the organisation buys, you can work with the supplier
to identify ways to reduce the cost (and therefore price) for both parties,
without reducing quality. This is called ‘evidence-based negotiation’.
• The following are some things to test with the supplier prior to purchase.
• Do any of the material or component costs look high? Is it because the
supplier has little negotiating power with its suppliers? Could any of the
materials be swapped to alternatives that cost less
• What utilisation levels of the machinery used in manufacture have been
assumed?
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Preparing budgets cont…
• Is this reasonable given that there will be downtime for setting up machines and for
maintenance? Would a change in specification allow different machines to be used that
have a higher utilisation as this would give a lower unit cost?
• Is the manufacturing process different to what the organisation expected?
• Can its own manufacturing engineers offer alternatives with or without a change to the
specification of the product?
• What batch sizes is the supplier using? Is the utilisation of machinery low because of many
short production runs? Can this be improved with better production planning?
• What labour costs are involved? Are these appropriate for the type of process being used?
Are staff properly trained?
• What are the indirect costs for this product? On what basis have they been apportioned to
the product? Is this a fair basis? What is the supplier’s break even point? Is the supplier
over-recovering its costs?
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Leading global excellence in procurement and supply

How to research and use market data to estimate and negotiate current and
future prices and costs for purchased gods and services
• One process for collecting and analyzing the data and information needed in any field is
called OWN-IT
• Outline
• Wide search
• Narrow search
• Increase your stockpile information
• Transform your stock pile into new knowledge

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Learning exercise: Celine’s market analysis

Celine is the buyer for a large national chain of supermarkets. She is tasked with negotiating
contracts with well-known brands to ensure they have the products that competitors will stock.
Which industries will Celine be working with?
1. Carry out a Porter’s Five Forces analysis from the perspective of the supermarket chain.
• Who will have the greater bargaining power: Celine’s organisation or the suppliers?
• How high is the threat of substitution in this market?
• How high is the threat of new entrants?
2. How could Celine estimate the probable fixed and variable costs for the suppliers she works
with?

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Slide 18
Leading global excellence in procurement and supply