Introduction to Purchasing

Dr. Kunal Ghosh

 Introduction

❑ Purchasing is the “process of buying.” Many assume

purchasing is solely the responsibility of the purchasing
department.

⮚ However, the function is much broader and, if it is carried out

effectively, all departments in the company are involved.

⮚ Obtaining the right material, in the right quantities, with the

right delivery (time and place), from the right source, and at
the right price are all purchasing functions.
 Introduction

⮚ Choosing the right material requires input from the marketing,

engineering, manufacturing, and purchasing departments.
⮚ Quantities and delivery of finished goods are established by
the needs of the marketplace.
⮚ However, manufacturing planning and control (MPC) must
decide when to order which raw materials so that marketplace
demands can be satisfied.
⮚ Purchasing is then responsible for placing the orders and for
ensuring that the goods arrive on time.
 Introduction

⮚ The purchasing department has the major responsibility for

locating suitable sources of supply and for negotiating prices.

⮚ Input from other departments is required in finding and

evaluating sources of supply and to help the purchasing
department in price negotiation.

⮚ Purchasing, in its broad sense, is everyone’s business.

 Purchasing Objectives

• Purchasing is responsible for establishing the flow of materials

into the firm, following up with the supplier, and expediting
delivery.

• Missed deliveries can create havoc for manufacturing and

sales, but purchasing can reduce problems for both areas,
further adding to the profit.
 Purchasing Objectives

• 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.
 Purchasing Objectives

• Developing and maintaining good supplier relations and

developing potential suppliers.
• To satisfy these objectives, some basic functions must be
performed:
⮚ Determining purchasing specifications: right quality, right

quantity, and right delivery (time and place).

⮚ Selecting supplier (right source).

⮚ Negotiating terms and conditions of purchase (right price).

⮚ Issuing and administration of purchase orders.

 Purchasing Cycle

❑ The purchasing cycle consists of the following steps:

⮚ Receiving and analyzing purchase requisitions.
⮚ Selecting suppliers.

⮚ Finding potential suppliers, issuing requests for quotations,

receiving and analyzing quotations, and selecting the right

supplier.
⮚ Determining the right price.
⮚ Issuing purchase orders.
⮚ Following up to ensure delivery dates are met.
⮚ Receiving and accepting goods.
⮚ Approving supplier’s invoice for payment
 Purchasing Cycle

• Receiving and analyzing purchase requisition.

⮚ Purchase requisitions start with the department or person who

will be the ultimate user.

⮚ In the material requirements planning environment, the

planner releases a planned order authorizing the purchasing

department to go ahead and process a purchase order.
⮚ At a minimum, the purchase requisition contains the following

information:
 Purchasing Cycle

⮚ Identity of originator, signed approval, and account to which

cost is assigned.
⮚ Material specification.
⮚ Quantity and unit of measure.
⮚ Required delivery date and place.
⮚ Any other supplemental information needed.
 Purchasing Cycle

⮚ Electronic requisition systems are now widely used and are

often part of enterprise resource planning (ERP) software.
⮚ The minimum requisition information is still required, and the
system can supply much of the details and control of the
information.
⮚ For example, the requester can enter the desired part number
and the system database will provide the appropriate
description, specification, suggested vendors, shipping
instructions, and so on.
⮚ The system will then forward the requisition for the
appropriate approvals with controls in place for account
number and spending limits
 Purchasing Cycle

⮚ Once all the approvals have been completed, the requisition is

sent to the purchasing department to produce the purchase
order without reentering all the information.

⮚ For items of small value (‘c’ items) that are ordered frequently,
the system may send an electronic release of material directly
to the approved supplier.

⮚ The benefits to the company are ease of entry for the requester,
reduced paperwork, decreased turnaround time of requisitions,
and improved accuracy of information.
 Purchasing Cycle

⮚ Selecting suppliers.
⮚ Identifying and selecting suppliers are important
responsibilities of the purchasing department.
⮚ For routine items or those that have not been purchased before,
a list of approved suppliers is kept.
⮚ If the item has not been purchased before or there is no
acceptable supplier on file, a search must be made.
⮚ If the order is of small value or for standard items, a supplier
can probably be found on the Internet, in a catalogue, trade
journal, or directory.
 Purchasing Cycle

⮚ Requesting quotations.
⮚ For major items, it is usually desirable to issue a request for
quotation.
⮚ This is a written inquiry that is sent to enough suppliers to be
sure competitive and reliable quotations are received.
⮚ After the suppliers have completed and returned the quotations
to the buyer, the quotations are analyzed for price, compliance
to specification, 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.
 Purchasing Cycle

⮚ For items where specifications cannot be accurately written,

the items quoted will vary.
⮚ The quotations must be evaluated for technical suitability.
⮚ The final choice is a compromise between technical factors
and price.
⮚ Usually both the issuing and purchasing departments are
involved in the decision.
 Purchasing Cycle

⮚ Determining the right price.

⮚ This is the responsibility of the purchasing department and is
closely tied to the selection of suppliers.
⮚ The purchasing department is also responsible for price
negotiation and will try to obtain the best price from the
supplier.
 Purchasing Cycle

⮚ Issuing a purchase order.

⮚ A purchase order is a legal offer to purchase.
⮚ Once accepted by the supplier, it becomes a legal contract for
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 from any other additional information
needed.
⮚ A copy is sent to the supplier; copies are retained by
purchasing and are also sent to other departments such as
accounting, the originating department, and receiving.
 Purchasing Cycle

⮚ 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, purchasing
must find out in time to take corrective action.
⮚ This might involve expediting transportation, alternate sources
of supply, working with the supplier to solve its problems, or
rescheduling production.
 Purchasing Cycle

⮚ The purchasing department is also responsible for working

with the supplier on any changes in delivery requirements.

⮚ Demand for items changes with time, and it may be necessary

to expedite certain items or push delivery back on some others.

⮚ The buyer must keep the supplier informed of the true

requirements so that the supplier is able to provide what is
wanted when it is wanted.
 Purchasing Cycle

⮚ Receiving and accepting goods:

⮚ When the goods are received, the receiving department

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 its copy of the purchase order and the bill of lading
supplied by the carrier, the receiving department then accepts
the goods and writes up a receiving report noting any variance
 Purchasing Cycle

• If further inspection is required, such as by quality control, the

goods are sent to quality control or held in receiving for
inspection.
• If the goods are received damaged, the receiving department
will advise the purchasing department and hold the goods for
further action.
• Provided the goods are in order and require no further
inspection, they will be sent to the originating department or to
inventory.
 Purchasing Cycle

⮚ A copy of the receiving report is then sent to the purchasing

department noting any variance or discrepancy from the
purchase order.
⮚ If the order is considered complete, the receiving department
closes out its copy of the purchase order and advises the
purchasing department.
⮚ If it is not, the purchase order is held open awaiting
completion.
⮚ If the goods have also been inspected by the quality control
department, they, too, will advise the purchasing department
whether the goods have been accepted or not.
 Purchasing Cycle

⮚ Approving supplier’s invoice for payment.

⮚ When the supplier’s invoice is received, there are three pieces

of information that should agree: the purchase order, the
receiving report, and the invoice.

⮚ The items and the quantities should be the same on all;

⮚ The prices, should be the same on the purchase order and the
invoice.
 Purchasing Cycle

⮚ 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 payable for
payment.
 Establishing Specifications

⮚ The first concern of purchasing—what to buy—is not

necessarily a simple decision.
⮚ For example, someone deciding to buy a car should consider
how the car will be used, how often, how much one is willing
to pay, and so on.
⮚ Only then can an individual specify the type of car needed to
make the “best buy.”
⮚ The following section looks at the problems that organizations
face when developing specifications of products and the types
of specifications that may be used.
 Establishing Specifications

⮚ In purchasing an item or a service from a supplier, several

factors are included in the package bought.
⮚ These must be considered when specifications are being
developed and can be divided into three broad categories:

⮚ Quantity requirements.

⮚ Price requirements.

⮚ Functional requirements.
 Establishing Specifications

⮚ Quantity Requirements:
⮚ Market demand first determines the quantity needed.
⮚ The quantity is important because it will be a factor in the way
the product is designed, specified, and manufactured.
⮚ For example, if the demand was for only one item, it would be
designed to be made at least cost, or a suitable standard item
would be selected.
⮚ However, if the demand were for several thousand, the item
would be designed to take advantage of economies of scale,
thus satisfying the functional needs at a better price.
 Establishing Specifications

⮚ Price Requirements
⮚ The price specification represents the economic value that the
buyer puts on the item—the amount the individual is willing to
pay.
⮚ If the item is to be sold at a low price, the manufacturer will
not want to pay a high price for a component part.
⮚ The economic value placed on the item must relate to the use
of the item and its anticipated selling price.
 Establishing Specifications

⮚ Functional specifications:
⮚ Functional specifications are concerned with the end use of
the item and what the item is expected to do.
⮚ By their very nature, functional specifications are the most
important of all categories and govern the others.
⮚ In a sense, functional specifications are the most difficult to
define.
⮚ To be successful, they must satisfy the real need or purpose of
an item.
⮚ In many cases, the real need has both practical and aesthetic
elements to it
 Establishing Specifications

• A coat is meant to keep one warm, but under what

circumstances does it do so and what other functions is it
expected to perform?

• How cold must it get before one needs a coat?

• On what occasions will it be worn?

• Is it for working or dress wear?

• What color and style should it be?

 Establishing Specifications

• What emotional needs is it expected to fill?

• In the same way, we can ask what practical and aesthetic needs
a door handle or side-view mirror on a car is expected to
satisfy.
 Establishing Specifications

⮚ Functional specification can be described in the following

ways or by a combination of them:
⮚ By brand.
⮚ By specification of physical and chemical characteristics,
material and method of manufacture, and performance.
⮚ By engineering drawings.
⮚ Miscellaneous.
 Description by Brand

⮚ Description by Brand
⮚ Description by brand is most often used in wholesale or retail
businesses but is also used extensively in manufacturing.
⮚ This is particularly true under the following circumstances:
⮚ Items are patented, or the process is secret.
⮚ The supplier has special expertise that the buyer does not have.
⮚ The quantity bought is so small that it is not worth the buyer’s
effort to develop specifications.
⮚ The supplier, through advertising or direct sales effort, has
created a preference on the part of the buyer’s customers or
staff.
 Description by Brand

• When buying by brand, the customer is relying on the

reputation and integrity of the supplier.

• The assumption is that the supplier wishes to maintain the

brand’s reputation and will maintain and guarantee the quality
of the product so repeat purchases will give the buyer the same
satisfaction.
 Description by Brand

⮚ Most of the objections to purchasing by brand center on cost.

⮚ Branded items, as a group, usually have price levels that are
higher than non-branded items.
⮚ It may be less costly to develop specifications for generic
products than to rely on brands.
 Description by Brand

⮚ The other major disadvantage to specifying by brand is that it

restricts the number of potential suppliers and reduces
competition.

⮚ Consequently, the usual practice, when specifying by brand, is

to ask for the item by brand name or equivalent. In theory,
this allows for competition.
 Specification by Characteristics

⮚ Physical and chemical characteristics:

⮚ The buyer must define the physical and chemical properties of

the materials wanted.

⮚ Petroleum products, pharmaceuticals, and paints are often

specified in this way.
 Specification by Characteristics

⮚ Material and method of manufacture:

⮚ Sometimes the method of manufacture determines the
performance and use of a product.
⮚ For example, hot and cold rolled steels are made differently
and have different characteristics.
 Specification by Characteristics

⮚ Performance:
⮚ This method is used when the buyer is primarily concerned
with what the item is required to do and is prepared to have the
supplier decide how performance is to be attained.
⮚ For example, a water pump might be specified as having to
deliver so many gallons per minute.
⮚ Performance specifications are relatively easy to prepare and
take advantage of the supplier’s special knowledge.
 Specification by Characteristics

⮚ To be useful, specifications must be carefully designed. If they

are too loosely drawn, they may not provide a satisfactory
product.

⮚ If they are too detailed and elaborate, they are costly to

develop, are difficult to inspect, and may discourage possible
suppliers.
 Specification by Characteristics

⮚ Specifications must allow for multiple sources and for

competitive bidding.
⮚ If performance specifications are used, the buyer is assured
that if the product does not give the desired results, the seller is
responsible.
⮚ They provide a standard for measuring and checking the
materials supplied.
⮚ Not all items lend themselves to specification. For example, it
may not be easy to specify color schemes or the appearance of
an item.
 Specification by Characteristics

⮚ An item described by specification may be no more suitable,

and a great deal more expensive, than a supplier’s standard
product.

⮚ If the specifications are set by the buyer, they may be

expensive to develop.

⮚ They will be used only when there is sufficient volume of

purchases to warrant the cost or where it is not possible to
describe what is wanted in any other way.
 Specification by Characteristics

⮚ An item described by specification may be no more suitable,

and a great deal more expensive, than a supplier’s standard
product.

⮚ If the specifications are set by the buyer, they may be

expensive to develop.

⮚ They will be used only when there is sufficient volume of

purchases to warrant the cost or where it is not possible to
describe what is wanted in any other way.
 Buyer developed specifications

⮚ Buyer-developed specifications are usually expensive and

time consuming to develop.

⮚ Companies usually do not use this method unless there is no

suitable standard specification available or unless the volume
of work makes it economical to do so.
 Standard specifications.

⮚ Standard specifications have been developed as a result of

much study and effort by governmental and nongovernmental
agencies.
⮚ They usually apply to raw or semi-finished products,
component parts, or the composition of material.
⮚ In many cases, they have become de facto standards used by
consumers and by industry.
⮚ When we buy motor oil for a car and ask for SAE 10W30, we
are specifying a standard grade of motor oil established by the
Society of Automotive Engineers.
⮚ Most of the electrical products we buy are manufactured to
Underwriters Laboratory
 Standard specifications.

⮚ There are several advantages to using standard specifications.

⮚ First, they are widely known and accepted and, because of this
, are readily available from most suppliers.

⮚ Second, because they are widely accepted, manufactured, and

sold, they are lower in price than nonstandard items.

⮚ Finally, because they have been developed with input from a

broad range of producers and users, they are usually adaptable
to the needs of many purchasers.
 Standard specifications.

⮚ Market grades are a type of standard specification usually set

by the government and used for commodities and foodstuffs.

⮚ When we buy eggs, for example, we buy them by market

grade—small, medium, or large.
 Benefits of Standardization

• Enables mass production:

• Mass production becomes possible through the creation of
interchangeable parts.
• Standardized parts and components enable management to
stabilize production processes and focus on continuous
improvement, thereby reducing costs.
 Benefits of Standardization

• Enables customization:
• Standardized parts and modules enable manufacturers to make
a wide variety of finished products from a relatively small
number of parts.
• With standardization, the wide variety of finished products
may be assembled when ordered, thereby reducing inventory
carrying costs and increasing flexibility to meet specific
consumer demands.
• Dell exemplifies this in its ability to customize computers for
customers on the same day the order is placed.
• Dell accomplishes customization largely through standard
components and modules
 Benefits of Standardization

• Improves supplier coordination:

• Standardized parts and components provide a very clear
specification for the supplier.
• The dimensions, characteristics, and performance of a standard
part or component improve the ability to communicate
between the buying and selling companies.
 Benefits of Standardization

• Improves quality:
• Standard parts and components are repetitively manufactured
to the same design, enabling investment by the producing
company in better machinery, training, and materials. The
result is a significantly lower defect rate.
 Benefits of Standardization

• Enables simplification:
• Once standard parts are identified, simplification can be used
to identify redundant standard parts that can be eliminated.

• Enables delayed differentiation:

• Using delayed differentiation the manufacturer stocks standard
components and modules that can be quickly be assembled
into customized configurations. Delayed differentiation results
in carrying much lower inventory levels.
 Benefits of Standardization

• Lowers Inventories:
• Lower inventories result from the number of distinct parts
carried being reduced.
• Better quality from greater use of standard parts and
components reduces safety stock.
• Delayed differentiation reduces the need to carry as many
finished goods in stock, thereby reducing overall inventory
levels.
• Standard parts and modules usually have more certain and
shorter supply lead times.
 Benefits of Standardization

• Lowers Inventories:
• Reduced uncertainty in production lead time reduces the need
for additional inventories required for unreliable lead times.
Shorter lead times directly translate into smaller order
quantities.
 Benefits of Standardization

• The use of standards permits a firm to purchase fewer items, in

larger quantities at lower prices.

• Thus, fewer items are processed and stocked.

• This reduces supply management, receiving, inspection and

payment costs.

• Stocking fewer items makes controlling inventories easier and

less costly.
 Benefits of Standardization

• The use of standardized approved items drastically reduces the

number of defects in incoming materials.

• Consequently, the purchase of standardized materials reduces

total costs in four ways; lower prices, lower processing costs,
lower inventory carrying costs, and fewer quality problems.
 Simplification

• Simplification is a corollary of standardization.

• Simplification means reducing the number of standard items a
firm uses in its product design and carries in its inventory
• For example, one company formerly used 27 different kinds of
standard lubricating greases in the maintenance of its
machinery.
• Analysis showed that in some cases the same grease could be
used for several different applications and that a total of only 6
kinds of grease were needed
• Hence, through simplification the number of greases were
reduced from 27 to 6.
 Simplification

• Similar analysis showed that the number of standard bearings

and fasteners used in production could be reduced by about 50
percent.
• Reductions of this scope are commonplace.
• Simplification savings result primarily from reduced
inventory investment, more competitive prices, greater
quantity discounts (because of larger volume purchases
and the use of blanket orders), and reduced clerical and
handling costs (because fewer different items have to be
handled and controlled)
 Simplification

• Some authorities consider simplification an integral part of

standardization, rather than a corollary of it.
• They visualize the simplification process as taking place
primarily at the design level, rather than at the stocking level.
• They think in terms of simplifying (or reducing) the number of
related items that are approved as standards in the first place
 Developing a Standardization Program

• The benefits of standardization cannot be fully realized when

solely developed internally by design engineers.

• The next level up is to involve cross-functional teams with

internal members from supply management, marketing,
quality, and other relevant functional areas.

• However, to yield all of the benefits of standardization

presented earlier, standardization should be addressed across
the supply chain through cross-functional teams containing
chain members
 Developing a Standardization Program

• A standardization program can be approached in various ways,

but because so many departments and suppliers are affected by
standards decisions, a team effort is the most appropriate
approach.
 Developing a Standardization Program

❑ Standards Team
⮚ A standards team typically consists of representatives from

engineering, supply, operations, marketing, and transportation.

⮚ Relevant suppliers should also be included in the team under

the guidance of supply management.

⮚ The standards team typically is charged with the responsibility

of obtaining input from all user departments and relevant

suppliers, reconciling differences between them, and making
the final standards decisions.
 Developing a Standardization Program

❑ Standards Team
❑ Theoretically, a member from any department could serve as
head of the team.
❑ Purchasing and supply management is particularly well
qualified to head the team in companies at which materials
complying with national standards or MRO items form a large
portion of the company’s total purchases.
❑ In companies that manufacture highly differentiated technical
products assembled from parts made to company standards,
engineering is well qualified to head the team
 Developing a Standardization Program

❑ Standards Team

❑ No program for standardization can be optimally successful

unless supply management is assigned a major role in the
program.
 Materials Catalog

❑ Once the decision to implement a standardization program has

been made, the most common approach is to work toward
developing a comprehensive materials catalog.
❑ A current, easily accessible materials catalog or database of
approved standard items is the logical output of a
standardization program.
❑ The catalog greatly aids the firm’s design efforts.
 Benefits of a Materials Catalog

❑ Improved quality: The documentation of materials is the first

step toward accumulating data to determine which materials
have quality problems.

❑ The availability of such a catalog virtually eliminates the

possibility that designers will incorporate materials that
previously caused problems.
 Benefits of a Materials Catalog

❑ Reduction in design time:

⮚ Access to a materials catalog provides designers with a

resource that will shorten the materials selection process in the

design stage, thereby reducing the total design time.
❑ Reduction of nonstandard parts:
⮚ The exercise of developing a materials catalog facilitates the

use of standard parts.

❑ Reduction of inventory:
⮚ The reduction is primarily owing to the decrease in the variety

of parts carried and the improved quality.

 Benefits of a Materials Catalog

❑ Benefits of Centralization:
⮚ Development of a materials catalog for a company with

several physically separated facilities provides the opportunity

to take advantage of centralization benefits, including pricing
leverage.
 Engineering Drawings

⮚ Engineering drawings describe in detail the exact

configuration of the parts and the assembly.
⮚ They also give information on such things as finishes,
tolerances, and material to be used.
⮚ These drawings are a major method of specifying what is
wanted and are widely used because often there is no other
way to describe the configuration of parts or the way they are
to fit together.
⮚ They are produced by the engineering design department and
are expensive to produce, but they give an exact description of
the part required.
 Miscellaneous

⮚ There are a variety of other methods of specification including

the famous phrase “Gimme one just like the last one.”

⮚ Sometimes samples are used, for example, when colors or

patterns are to be specified.

⮚ Often a variety of methods can be used, and the buyer must

select the best one.

⮚ The method of description is communication with the supplier.

How well it is done will affect the success of the purchase and
sometimes the price paid.
 Factors in Selecting Suppliers

⮚ Technical ability
⮚ Manufacturing capability
⮚ Reliability
⮚ After-sales service
⮚ Supplier location
⮚ JIT capabilities
⮚ Other considerations include credit terms, reciprocal business,
willingness of the supplier to hold inventory for the buyer if
required.