Purchasing in Production and Operation Management

Purchasing is an important function of materials management. In any industry purchase means buying of equipments, materials, tools, parts etc. required for industry. The importance of the purchase function varies with nature and size of industry. In small industry, this function is performed by works manager and in large manufacturing concern; this function is done by a separate department. The moment a buyer places an order he commits a substantial portion of the finance of the corporation which affects the working capital and cash flow position. He is a highly responsible person who meets various salesmen and thus can be considered to have been contributing to the public relations efforts of the company. Thus, the buyer can make or mar the company’s image by his excellent or poor relations with the vendors.

1. Objectives of Purchasing

The basic objective of the purchasing function is to ensure continuity of supply of raw materials, sub-contracted items and spare parts and to reduce the ultimate cost of the finished goods. In other words, the objective is not only to procure the raw materials at the lowest price but to reduce the cost of the final product.

The objectives of the purchasing department can be outlined as under:

1. To avail the materials, suppliers and equipments at the minimum possible costs: These are the inputs in the manufacturing operations. The minimization of the input cost increases the productivity and resultantly the profitability of the operations.
2. To ensure the continuous flow of production through continuous supply of raw materials, components, tools etc. with repair and maintenance service.
3. To increase the asset turnover: The investment in the inventories should be kept minimum in relation to the volume of sales. This will increase the turnover of the assets and thus the profitability of the company.
4. To develop an alternative source of supply: Exploration of alternative sources of supply of materials increases the bargaining ability of the buyer, minimisation of cost of materials and increases the ability to meet the emergencies.
5. To establish and maintain the good relations with the suppliers: Maintenance of good relations with the supplier helps in evolving a favourable image in the business circles. Such relations are beneficial to the buyer in terms of changing the reasonable price, preferential allocation of material in case of material shortages, etc.
6. To achieve maximum integration with other department of the company: The purchase function is related with production department for specifications and flow of material, engineering department for the purchase of tools, equipments and machines, marketing department for the forecasts of sales and its impact on procurement of materials, financial department for the purpose of maintaining levels of materials and estimating the working capital required, personnel department for the purpose of manning and developing the personnel of purchase department and maintaining good vendor relationship.
7. To train and develop the personnel: Purchasing department is manned with varied types of personnel. The company should try to build the imaginative employee force through training and development.
8. Efficient record keeping and management reporting: Paper processing is inherent in the purchase function. Such paper processing should be standardised so that record keeping can be facilitated. Periodic reporting to the management about the purchase activities justifies the independent existence of the department.

2. Parameters of Purchasing

The success of any manufacturing activity is largely dependent on the procurement of raw materials of right quality, in the right quantities, from right source, at the right time and at right price popularly known as ten ‘R’s’ of the art of efficient purchasing. They are described as the basic principles of purchasing. There are other well known parameters such as right contractual terms, right material, right place, right mode of transportation and right attitude are also considered for purchasing.

1. Right Price

It is the primary concern of any manufacturing organization to get an item at the right price. But right price need not be the lowest price. It is very difficult to determine the right price; general guidance can be had from the cost structure of the product. The ‘tender system’ of buying is normally used in public sector organizations but the objective should be to identify the lowest ‘responsible’ bidder and not the lowest bidder. The technique of ‘learning curve’ also helps the purchase agent to determine the price of items with high labour content. The price can be kept low by proper planning and not by rush buying. Price negotiation also helps to determine the right prices.

2. Right Quality

Right quality implies that quality should be available, measurable and understandable as far as practicable. In order to determine the quality of a product sampling schemes will be useful. The right quality is determined by the cost of materials and the technical characteristics as suited to the specific requirements. The quality particulars are normally obtained from the indents. Since the objective of purchasing is to ensure continuity of supply to the user departments, the time at which the material is provided to the user department assumes great importance.

3. Right Time

For determining the right time, the purchase manager should have lead time information for all products and analyse its components for reducing the same. Lead time is the total time elapsed between the recognition of the need of an item till the item arrives and is provided for use. This covers the entire duration of the materials cycle and consists of pre-contractual administrative lead time, manufacturing and transporting lead time and inspection lead time. Since the inventory increases with higher lead time, it is desirable to analyse each component of the lead time so as to reduce the first and third components which are controllable. While determining the purchases, the buyer has to consider emergency situations like floods, strikes, etc. He should have ‘contingency plans’ when force major clauses become operative, for instance, the material is not available due to strike, lock-out, floods, and earthquakes.

4. Right Source

The source from which the material is procured should be dependable and capable of supplying items of uniform quality. The buyer has to decide which item should be directly obtained from the manufacturer. Source selection, source development and vendor rating play an important role in buyer-seller relationships. In emergencies, open market purchases and bazaar purchases are restored to.

5. Right Quantity

The right quantity is the most important parameter in buying. Concepts, such as, economic order quantity, economic purchase quantity, fixed period and fixed quantity systems, will serve as broad guidelines. But the buyer has to use his knowledge, experience and common sense to determine the quantity after considering factors such as price structure, discounts, availability of the item, favourable reciprocal relations, and make or buy consideration.

6. Right Attitude

Developing the right attitude, too, is necessary as one often comes across such statement: ‘Purchasing knows the price of everything and value of nothing’; ‘We buy price and not cost’; ‘When will our order placers become purchase managers?’; ‘Purchasing acts like a post box’. Therefore, purchasing should keep ‘progress’ as its key activity and should be future-oriented. The purchase manager should be innovative and his long-term objective should be to minimise the cost of the ultimate product. He will be able to achieve this if he aims himself with techniques, such as, value analysis, materials intelligence, purchases research, SWOT analysis, purchase budget lead time analysis, etc.

7. Right Contracts

The buyer has to adopt separate policies and procedures for capital and consumer items. He should be able to distinguish between indigenous and international purchasing procedures. He should be aware of the legal and contractual aspects in international practices.

8. Right Material

Right type of material required for the production is an important parameter in purchasing. Techniques, such as, value analysis will enable the buyer to locate the right material.

9. Right Transportation

Right mode of transportation have to be identified as this forms a critical segment in the cost profile of an item. It is an established fact that the cost of the shipping of ore, gravel, sand, etc., is normally more than the cost of the item itself.

10. Right Place of Delivery

Specifying the right place of delivery, like head office or works, would often minimize the handling and transportation cost.

3. Purchasing Procedure

The procedure describes the sequence of steps leading to the completion of an identified specific task. The purchasing procedure comprises the following steps as indicated in Fig. 4.4.

1. Recognition of the Need

The initiation of procedure starts with the recognition of the need by the needy section. The demand is lodged with the purchase department in the prescribed Purchase Requisition Form forwarded by the authorised person either directly or through the Stores Department. The purchase requisition clearly specifies the details, such as, specification of materials, quality and quantity, suggested supplier, etc. Generally, the low value sundries and items of common use are purchased for stock while costlier and special items are purchased according the production programmes. Generally, the corporate level executives are authorized signatories to such demands. Such purchases are approved by the Board of Directors. The reference of the approval is made on requisition and a copy of the requisition is sent to the secretary for the purpose of overall planning and budgeting.

2. The Selection of the Supplier

The process of selection of supplier involves two basic aspects: searching for all possible sources and short listing out of the identified sources. The complete information about the supplier is available from various sources, such as, trade directories, advertisement in trade journals, direct mailing by the suppliers, interview with suppliers, salesmen, suggestions from business associates, visit to trade fair, participation in industries convention, etc. Identification of more and more sources helps in selecting better and economical supplier. It should be noted that the low bidder is not always the best bidder. When everything except price is equal, the low bidder will be selected. The important considerations in the selection are the price, ability to supply the required quantity, maintenance of quality standards, financial standing etc. It should be noted that it is not necessary to go for this process for all types of purchases. For the repetitive orders and for the purchases of low-value, small lot items, generally the previous suppliers with good records are preferred.

3. Placing the Order

Once the supplier is selected the next step is to place the purchase order. Purchase order is a letter sent to the supplier asking to supply the said material. At least six copies of purchase order are prepared by the purchase section and each copy is separately signed by the purchase officer. Out these copies, one copy each is sent to store-keeper, supplier, accounts section, inspection department and to the department placing the requisition and one copy is retained by the purchase department for record.

4. Follow-up of the Order

Follow-up procedure should be employed wherever the costs and risks resulting from the delayed deliveries of materials are greater than the cost of follow-up procedure, the follow-up procedure tries to see that the purchase order is confirmed by the supplier and the delivery is promised. It is also necessary to review the outstanding orders at regular intervals and to communicate with the supplier in case of need. Generally, a routine urge is made to the supplier by sending a printed post card or a circular letter asking him to confirm that the delivery is on the way or will be made as per agreement. In absence of any reply or unsatisfactory reply, the supplier may be contact through personal letter, phone, telegram and/or even personal visit.

5. Receiving and Inspection of the Materials

The receiving department receives the materials supplied by the vendor. The quantity are verified and tallied with the purchase order. The receipt of the materials is recorded on the specially designed receiving slips or forms which also specify the name of the vendor and the purchase order number. It also records any discrepancy, damaged condition of the consignment or inferiority of the materials. The purchase department is informed immediately about the receipt of the materials. Usually a copy of the receiving slip is sent to the purchase department.

6. Payment of the Invoice

When the goods are received in satisfactory condition, the invoice is checked before it is approved for the payment. The invoice is checked to see that the goods were duly authorised to purchase, they were properly ordered, they are priced as per the agreed terms, the quantity and quality confirm to the order, the calculations are arithmetically correct etc.

7. Maintenance of the Records

Maintenance of the records is an important part and parcel of the efficient purchase function. In the industrial firms, most of the purchases are repeat orders and hence the past records serve as a good guide for the future action. They are very useful for deciding the timings of the purchases and in selecting the best source of the supply.

8. Maintenance of Vendor Relations

The quantum and frequency of the transactions with the same key suppliers provide a platform for the purchase department to establish and maintain good relations with them. Good relations develop mutual trust and confidence in the course of the time which is beneficial to both the parties. The efficiency of the purchase department can be measured by the amount of the goodwill it has with its suppliers.

4. Selection of Suppliers

Selection of the right supplier is the responsibility of the purchase department. It can contribute substantially to the fundamental objectives of the business enterprise. Different strategies are required for acquiring different types of materials. The selection of supplier for standardised products will differ from non-standardised products. Following factors are considered for the selection of suppliers:

Sources of Supplier

The best buying is possible only when the decision maker is familiar with all possible sources of supply and their respective terms and conditions. The purchase department should try to locate the appropriate sources of the supplier of various types of materials. This is known as ‘survey stage’. A survey of the following will help in developing the possible sources of supply:

1. Specialised trade directories.
2. Assistance of professional bodies or consultants.
3. The buyer’s guide or purchase handbook.
4. The manufacturer’s or distributor’s catalogue.
5. Advertisements in dailies.
6. Advertisement in specialised trade journals.
7. Trade fair exhibitions.

Development of Approved List of Suppliers

The survey stage highlights the existence of the source. A business inquiry is made with the appropriate supplier. It is known as ‘Inquiry Stage’. Here a short listing is made out of the given sources of suppliers in terms of production facilities and capacity, financial standing, product quality, possibility of timely supply, technical competence, manufacturing efficiency, general business policies followed, standing in the industry, competitive attitude, and interest in buying orders etc.

Evaluation and Selection of the Supplier

The purchase policy and procedure differ according to the type of items to be purchased. Hence, evolution and selection of the supplier differ accordingly. In the ‘purchasing handbook’ edited by Aljian, it has been described that the following variables to be considered while evaluating the quotations of the suppliers:

1. Cost Factors

Price, transportation cost, installation cost if any, tooling and other operations cost, incidence of sales tax and excise duty, terms of payment and cash discount are considered in cost factor.

2. Delivery

Routing and F.O.B. terms are important in determining the point at which the title to the goods passes from vendor to the buyer and the responsibility for the payment of the payment charges.

3. Design and Specification Factors

Specification compliance, specification deviations, specification advantages, important dimensions and weights are considered in line with the demonstration of sample, experience of other users, after sale services etc.

4. Legal Factors

Legal factors include warranty, cancellation provision, patent protection, public liability, federal laws and reputation compliance.

5. Vendor Rating

The evaluation of supplier or vendor rating provides valuable information which help in improving the quality of the decision. In the vendor rating three basic aspects are considered namely quality, service and price. How much weight should be given to each of these factors is a matter of judgment and is decided according to the specific need of the organization. Quality would be the main consideration in the manufacturing of the electrical equipments while price would be the prime consideration in the product having a tense competitive market and for a company procuring its requirements under the blanket contract with agreed price, the supplier rating would be done on the basis of two variables namely quality and delivery.

The Development Project Committee of the National Association of Purchasing Agents (U.S.A.) has suggested following methods for evaluating the performance of past suppliers.

• • The categorical plan: Under this method the members of the buying staff related with the supplier like receiving section, quality control department, manufacturing department etc., are required to assess the performance of each supplier. The rating sheets are provided with the record of the supplier, their product and the list of factors for the evaluation purposes. The members of the buying staff are required to assign the plus or minus notations against each factor. The periodic meetings, usually at the interval of one month, are held by senior man of the buying staff to consider the individual rating of each section. The consolidation of the individual rating is done on the basis of the net plus value and accordingly, the suppliers are assigned the categories such as ‘preferred’, ‘neutral’ or ‘unsatisfactory’. Such ratings are used for the future guidance.

This is a very simple and inexpensive method. However, it is not precise. Its quality heavily depends on the experience and ability of the buyer to judge the situation. As compared to other methods, the degree of subjective judgment is very high as rating is based on personal whim and the vague impressions of the buyer. As the quantitative data supported by the profits do not exist, it is not possible to institute any corrective action with the vendor. The rating is done on the basis of memory, and thus it becomes only a routine exercise without any critical analysis.

• • The weighted-point method: The weighted-point method provides the quantitative data for each factor of evaluation. The weights are assigned to each factor of evaluation according to the need of the organization, g, a company decides the three factors to be considered— quality, price and timely delivery. It assigns the relative weight to each of these factors as under:

Quality            …………………………  50 points

Price                ………………………… 30 points

Timely delivery ………………………… 20  points

The evaluation of each supplier is made in accordance with the aforesaid factors and weights and the composite weighted-points are ascertained for each suppliers—A, B and C— are rated under this method. First of all the specific rating under each factor will be made and then the consolidation of all the factors will be made for the purpose of judgment.

Quality rating: Percentage of quantity accepted among the total quantity is called quality rating. In other words, the quality of the materials is judged on the basis of the degree of acceptance and rejections. For the purpose of comparison, the percentage degree of acceptance will be calculated in relation to the total lots received. Price rating is done on the basis of net price charged by the supplier. Timely delivery rating will be done comparing with the average delivery schedule of the supplier.

• • The cost-ratio plan: Under this method, the vendor rating is done on the basis of various costs incurred for procuring the materials from various suppliers. The cost-ratios are ascertained delivery etc. The cost-ratios are ascertained for the different rating variables such as quality, price, timely delivery etc. The cost-ratio is calculated in percentage on the basis of total individual cost and total value of purchases. At the end, all such cost-ratios will be adjusted with the quoted price per unit. The plus cost-ratio will increase the unit price while the minus cost-ratio will decrease the unit price. The net adjusted unit price will indicate the vendor rating. The vendor with the lowest net adjusted unit price will be the best supplier and so on. Certain quality costs can be inspection cost, cost of defectives, reworking costs and manufacturing losses on rejected items etc. Certain delivery costs can be postage and telegrams, telephones and extra cost for quick delivery etc.

VENDER RATING ILLUSTRATIONS

ILLUSTRATION 1: The following information is available on 3 vendors: A, B and C. Using the data below, determine the best source of supply under weighed-point method and substantiate your solution.

Vendor A: Delivered ‘56’ lots, ‘3’ were rejected, ‘2’ were not according to the schedule.

Vendor B: Supplied ‘38’ lots, ‘2’ were rejected, ‘3’ were late.

Vendor C: Finished ‘42 ’ lots, ‘4 ’ were defective, ‘5 ’ were delayed deliveries. Give 40 for quality and 30 weightage for service.

SOLUTION: Formula:

Vendor ‘A’ is selected with the best rating.

ILLUSTRATION 2: The following information is available from the record of the incoming material department of ABC Co. Ltd.

The factor weightage for quality, delivery and price are 40%, 35% and 25% as per the decision of the mar. Rank the performance of the vendors on the QDP basis interpret the result.

SOLUTION: Formula:

Total vendor rating = Quality performance + Delivery performance rating + Price rating

Formal mode:

Vendor B is selected with higher rating.

5. Special Purchasing Systems

The following are some of the importnat purchasing systems:

1. Forward Buying

Forward buying or committing an organization far into the future, usually for a year. Depending upon the availability of the item, the financial policies, the economic order quantity, the quantitative discounts, and the staggered delivery, the future commitment is decided. This type of forward buying is different from speculative buying where the motive is to make capital out of the price changes, by selling the purchased items. Manufacturing organizations normally do not indulge in such buying. However, a few organizations do ‘Hedge’, particularly in the commodity market by selling or buying contracts.

2. Tender Buying

In public, all semblance of favouritism, personal preferences should be avoided. As such, it is common for government departments and public sector undertakings to purchase through tenders. Private sector organizations adopt tender buying if the value of purchases is more than the prescribed limits as Rs. 50000 or Rs. 100000. The steps involved are to establish a bidders’ list, solicit bids by comparing quotations and place the order with the lowest bidder. However, care has to be taken that the lowest bidder is responsible party and is capable of meeting the delivery schedule and quality requirements. Open tender system or advertisement in newspapers is common in public sector organizations. As advertising bids is costly and time consuming, most private sector organizations solicit tenders only from the renowned suppliers capable of supplying the materials.

3. Blanket Order System

This system minimizes the administrative expenses and is useful for ‘C’ type items. It is an agreement to provide a required quantity of specified items, over a period of time, usually for one year, at an agreed price. Deliveries are made depending upon the buyer’s needs. The system relieves the buyers from routine work, giving him more time for focusing attention on high value items. It requires fewer purchase orders and thus reduces clerical work. It often achieves lower prices through quantity discounts by grouping the requirements. The supplier, under the system maintains adequate inventory to meet the blanket orders.

4. Zero Stock

Some firms try to operate on the basis of zero stock and the supplier holds the stock for these firms. Usually, the firms of the buyer and seller are close to each other so that the raw materials
of one is the finished products of another. Alternatively, the system could work well if the seller holds the inventory and if the two parties work in close coordination. However, the price per item in this system will be slightly higher as the supplier will include the inventory carrying cost in the price. In this system, the buyer need not lock up the capital and so the purchasing routine is reduced. This is also significantly reduces obsolescence of inventory, lead time and clerical efforts in paper work. Thus, the seller can devote his marketing efforts to other customers and production scheduling becomes easy.

5. Rate Contract

The system of rate contract is prevalent in public sector organizations and government departments. It is common for the suppliers to advertise that they are on ‘rate contract’ for the specific period. After negotiations, the seller and the buyer agree to the rates of items. Application of rate contract has helped many organizations to cut down the internal administrative lead time as individual firms need to go through the central purchasing departments and can place orders directly with the suppliers. However, suppliers always demand higher prices for prompt delivery, as rate difficulty has been avoided by ensuring the delivery of a minimum quantity at the agreed rates. This procedure of fixing a minimum quantity is called the running contract and is being practised by the railways. The buyer also has an option of increasing the quantity by 25% more than the agreed quantity under this procedure.

6. Reciprocity

Reciprocal buying means purchasing from one’s customers in preference to others. It is based on the principle “if you kill my cat, I will kill your dog”, and “Do unto your customers as you would have them do unto you”. Other things, like soundness from the ethics and economics point of view being equal, the principles of reciprocity can be practiced. However, a purchasing executive should not indulge in reciprocity on his initiative when the terms and conditions are not equal with other suppliers. It is often sound that less efficient manufacturers and distributors gain by reciprocity what they are unable to gain by price and quality. Since this tends to discourage competition and might lead to higher process and fewer suppliers, reciprocity should be practised on a selective basis.

7. Systems Contract

This is a procedure intender to help the buyer and the sellers to reduce administrative expenses and at the same time ensure suitable controls. In this system, the original indent, duly approved by competent authorities, is shipped back with the items and avoids the usual documents like purchase orders, materials requisitions, expediting letters and acknowledgements, delivery period price and invoicing procedure, Carborandum company in the US claims drastic reduction in inventory and elimination of 40000 purchase orders by adopting the system contracting procedure. It is suitable for low unit price items with high consumption.

Source: KumarAnil, Suresh N. (2009), Production and operations management, New Age International Pvt Ltd; 2nd Ed. edition.