Chapter 1-7

Principle of Purchasing I
CHAPTER ONE
INTRODUCTION
LEARNING OBJECTIVE
After successfully completing this chapter, students should be able

to:
 Define the term “purchasing”
 Compare and contrast purchasing with procurement
 Indentify basic importance and objectives of purchasing
 Identify the purchasing relation with other departments
1.1. Nature of Purchasing
No organization is self-sufficient. Every organization is in varying degrees,

dependent on materials and services supplied by other organizations. Even
the smallest office needs space, heat, light, power, office equipment,
communication, furniture stationary, etc., to carry on its functions
purchasing is , therefore, one of the basic common functions of every
organization structuring the purchasing/material management functions to
obtain effective contribution to objectives is one of the challenges of
management.
In many organizations, materials form the largest single expenditure item.

An analysis of financial statements of a large number of private and public
sector organizations indicated that materials account for nearly 60% of the
total expenditures. Thus, the importance of purchasing management lies in
the fact that any significant contribution made by the purchasing manager in
reducing materials cost and wastage will go a long way in improving the
profitability and rate of return on investment.
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Department of Logistic and Supply Chain Management

Purchasing is an organizational activity concerned with acquisition of

materials and services of the right quality, in the right quantity, at the right
time, at the right price, from the right supplier, with the right service to be
delivered at the right place.
 Right quality. Quality has no meaning in purchasing except as it is

related to function and ultimate cost that means quality is related to
suitability and cost (not price) rather to intrinsic excellence.
Quality frequently defined as “Fitness, merit, excellence”. The best

quality is that which can be purchased at the lowest cost to fulfill the
need or satisfy the intended function for which the materials are being
purchased.
 Right quantity –refers to the quantity adequate enough to serve the

intended purpose. It is the quantity which could lead to overcome
doubt of operational interruption & its adverse consequence. It could
be determined either through forecasting techniques, material
requirement planning or other techniques.
 Right Time-is making the materials available when it is required. It is

exerting managerial effort to timely delivery of materials. Because fail
to deliver a given materials on time will result in delay that called bring
undesirable consequences such as;
 Interruption of production
 increasing of operational cost e.g. wage
 Temporary lay off
 Bankruptcy (insolvency)
 decline in profit & sale

 laying behind planning horizon
 shift of customer to competitors, loss of
market share, etc
 Right price–is buying required quality and quantity material with

maximum possible lowest price.
 Right source (supplier)–It is looking for right supplier that means

eligible and reputable supplier.
Activity: 1
1. Explain the difference and similarity between of Purchasing and
Procurement.
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1.2. Purchasing Vs Procurement
A. Purchasing
The purchasing function comprises of essential the activities

associated with the acquisition of materials, services and equipment
used in the operation of the organization.
The major activities are:
 Co-ordination with user department to identify purchase need
 Discussion with sales representatives

 Identification of potential suppliers
 Conduct of market studies for important materials
 Negotiation with potential suppliers
 Analyzes proposals
 Administration of contracts and resolution of related problems
 Selection of Suppliers
 Issuance of purchase orders
 Maintenance of a variety purchasing records
B. Procurement
The procurement process or concept encompasses a wider range of

supply chain activities than those included in the purchasing function.
Specific activities usually included in the procurement process are:
 Participation in the development of material and service requirements

and their specification
 Conduct of materials studies and management value analysis activities
 Conduct or more extensive materials market studies
 Conduct of all purchasing function activities
 Management of supplier quality
 Purchase of inbound transportation
 Management of investment recovery activities (salvage or surplus and

scrap)

In essence, procurement tends to be broader and more proactive, with some

focus on strategic matters, as compared with the typical implementation of
the purchasing process.
1.3. Objectives of Purchasing
Objective of purchasing: the standard statement of overall objectives of the

purchasing function is that it should obtain the right materials (meeting
quality requirements) in the right quantity, for delivery at the right time and
right place from the source (a vendor who is reliable and will meet its
commitment in a timely fashion), with the right service (both before and
after the sale) and at the right price.
A more specific statement of the overall goals of purchasing would include

the following
1) Provide Uninterrupted Flow of Materials, Supplies, and

Services Required to Support Company Operations.
Stock outs of raw materials and production parts would shutdown an

operation and are extremely costly in terms of lost production,
escalation of operating costs due to fixed costs and inability to satisfy
delivery promises to customers. For example, an automobile producer
cannot complete the car without tires, an airline cannot keep its planes
flying on schedule without purchase fuel; a hospital cannot perform
surgery without the necessary instruments and solutions. This is the
most fundamental of all purchasing and supply objectives. It is a key
reason for the existence of the department.

2) To Buy Competitively.
It involves an understanding of supplier’s cost structure, and then to

negotiate price and service arrangements that are fair relative to the
supplier’s actual costs. A buyer who pays significantly more than his or
her competitor does for a given material or service generally is not
buying competitively.
3) To Buy Wisely.
Buying wisely involves a continual search for better values that yield
the best combination of quality, service and price, relative to the
buyer’s needs. This frequently involves co-ordination with users in
defining the need.
4) To keep Inventory Investment and Inventory Losses at a

Practical minimum.
The inventory level of materials/supplies that should be maintained at

a time should be such that it ensures the smoothing of operations
without stoppage and at the same time, with minimum total costs, as
inventory assets require use of capital which cannot be invested
elsewhere. Although maintaining a large inventory is one way to
achieve objective of continuous flow of operation, it is also costly.
Through proper buying, packaging and storing, it is also the

department’s objective to minimize losses that occur as a result of
deterioration, obsolescence, theft and so on.
5) Maintain Adequate Quality Standards
To produce the desired produce or service, a certain quality level is

required for each material input; otherwise the end product or service
will not meet expectations or will result in higher-than-acceptable

production costs. The need to improve quality to compete effectively

on a worldwide basis has become very important to maintain and
improve the firms’ competitive capability.
6) Develop Competent Vendor.
In the final analysis, the success of the purchasing department

depends on its skill in locating or developing vendors, analyzing
vendors’ capabilities, and then selecting the appropriate vendor.
Only if the final selection results in vendors who are both responsive
and responsible will the firm obtains the items it needs at the lowest
ultimate. Cooperative suppliers that are willing to work with a buyer to
help solve the buying firms’ problems and to minimize its materials-
related costs are an invaluable resource.
7) Improve the Organization’s Competitive Position
An organization will be competitive if it can control costs in order to

protect profit margins. Purchase costs are the largest single element in
the operations of many organizations. Additionally, product design and
manufacturing methods changes are needed to keep pace with
changing technology and production environments; the purchasing
department can supply information to product design and
manufacturing engineering on new products available and what
changes are occurring and are likely to occur in production technology.
Finally, purchasing is responsible for assuring the smooth flow of
materials necessary to enable the production of products and provision
of services as required to meet delivery commitments to customers; in
the long-run success is dependent on its ability to create customers.

8) Achieve Harmonious, Productive Working Relationships with

Other Departments Within the Organization.
Purchasing actions cannot be effectively accomplished solely by the

efforts of the purchasing unit; cooperation with other functional units
and individuals within the organizations is vital to success. For
example, the using departments and production control must provide
information on materials requirements on time if purchasing is to have
the lead time needed to locate competent vendors and make
advantageous purchase agreement purchasing must work closely with
quality control in determining inspection procedures for incoming
materials and in assisting the performance of current vendors.
Accounting must pay vendors in timely fashion, to get advantage of
quantity discounts and maintain good long-term vendor relations.
Purchasing should work towards achieving maximum integration with
other departments.
9) Accomplish the Purchasing Objectives at the Lowest Possible

Level of Administrative Costs.
It takes resources to operate the purchasing department; salaries,

telephone and postage expense, supplies, travel costs, and
accompanying overhead. If purchasing procedures are not effective
purchasing administrative costs will be excessive. The objectives of
purchasing should be achieved as efficiently and economically as
possible, which requires that the purchasing manager continually
review the operation to assure that it is cost effective.
These objectives apply in apply in principle to all categories of

industrial buying activities: manufacturing concerns, government units,
schools, hospitals, and all other types of buying units that buy for
consumption or conversion. A principle common to all types of

purchasing activities is to obtain the greatest value from each

birr/dollar the purchasing department.
1.4. Importance of Purchasing
 Keep the operations running smoothly by ensuring a reliable
source of supply
 It impacts customer service and customer satisfaction
 The receipt of high quality, reliable goods and services on

a timely basis at a reasonable cost often directly affects
customer satisfaction.
 Help to gain important information about new technologies.
 Support potential new materials or services, new sources of supply
and changes in market conditions.
 To determine the organization requirement.
Activity: 2
1. Discuss purchasing department relationship with other
departments.
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1.5. Purchasing Department Relationship With Other

Departments
A purchasing department is the hub of a large part of a company’s business

activity. By its very nature, purchasing has continuing relationship with all
other departments in the firm, as well as with the firm’s suppliers.
Purchasing operations cut cross all department lines. Purchasing and other
departments (production, engineering, marketing, and finance) often view
common problems differently. This is normal and healthy situation-provided
the departmental opinions are held objectively.
A. Purchasing and Engineering
Purchasing, engineering, and production have mutual problems. Design

engineering, like production, greatly influences the amount of time
purchasing has to handle a procurement assignment. Engineering usually
has the initial responsibility for preparing the technical specifications for a
company’s products and the materials that go into them. To exercise this
responsibility effectively, engineering must have the constant help of
purchasing and production. The prices paid for production materials and
costs to fabricate them are inextricably related to their specifications.
Similarly, specifications can be written in a manner that reduces or enlarges
the number of firms willing to supply specific items. If profits are to be
maximized, the materials specified by engineering must be both economical
to procure and economical to fabricate, and they should normally be
available from more than one efficient, low-cost producer. Generally, the co-
ordination of purchasing and engineering help to handle two major activities,
these are:
 Preparation of specification for purchase materials.
 Quality assurance or defect prevention
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B. Purchasing and Production/Operation
The purchasing-production relationship begins when the production

department transmits manufacturing schedule or materials requisition to the
purchasing department. Purchasing subsequently translates these
documents into a procurement schedule. Purchase timing is often a cardinal
difficulty in making this translation. When production does not allow
purchasing sufficient time to purchase wisely, many needless expenses
inevitably creep into the final costs of a company’s products. When
purchasing is not given sufficient time to develop competition, premium
prices are certain to be paid for materials. Costly special production runs and
premium transposition costs are two additional factors that frequently result
from inadequate purchasing lead time. The serious result of possible from
insufficient procurement lead time is a production shutdown.
Coordination between purchasing and production pays off in many ways. For
example, a more expensive alternative material that will save the company
money can on occasion be selected. The severe consequences of a
production stoppage cause many production managers to advocate an
excessively large inventory of production materials. Again, this is
understandable. In order for production managers to reach their main
manufacturing objective of low unit costs, they must keep the production line
operating. A large inventory is a logical safeguard to prevent possible
production stoppages resulting from materials shortages.
Purchasing shares in the production managers to keep the production line

operating, in fact, to do so is purchasing first objective. In addition to keeping
the production line operating, however, purchasing has the correlative
objective of accomplishing the task with minimum reasonable capital
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investment in inventory, a major concern which production typically does not

share with equal intensity.
C. Purchasing and Marketing
All companies recognize the direct relationship between the marketing

function and profit. In their enthusiasm to increase sales, however, many
companies overlook the leaks in profit that can occur when the sales activity
is not properly meshed with the purchasing and production activities.
The purchasing-production-sales cycle has its genesis in a sales forecast.

Most sales forecast includes two important parts: (1) an estimate of sales
based on what has happened in the past to a company’s products,
territories, and markets; and (2) an adjusting of this estimate to include
changes the company expects in its future sales. The change reflects
alterations in the marketing program and shifts in economic and competitive
conditions. The sales forecast is the basis for the production schedule. The
sales forecast also influences a firm’s capital equipment budget, as well as
its advertising campaigns and other sale activities.
Prompt communication to purchasing and production of changes of in the

sales forecast permits these department to change their schedules painlessly
and as economically as possible. Purchasing must immediately transmit to
sales, as well as other management groups, information concerning increase
in material price. Purchasing and sales must wisely blend their interests in
the delicate area of reciprocity (buying from customers).
Purchasing department can be of major help to its sales department by

serving as its practical sales laboratory. Therefore, a company’s buyers can
be an excellent source of information for developing and refining company’s
own sales policies and procedures.
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D. Purchasing and Finance
The relationship between Purchasing and finance is different from its

relationships with production, engineering, and sales. The difference stems
from the facts that cost determinations cannot be hidden in the purchasing-
finance relationship as they often can in the other relationships. The
importance of good financial planning is highlighted by the fact that poor
financial planning is the major cause of business failure. Having good
relationship between these two departments benefits the following
advantage two the organization:
 Providing information regarding materials cost
 Preparation of cost data for use in negotiation with suppliers.
 Forward buying- is purchasing for more than a current

requirement. This means the finance department has to allow
fund for forward buying by considering future gain.
 Certifying invoice of payment and progress of payment.
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Summery
Every organization is dependent on materials and services differ degrees,
supplied by other organizations from the smallest office equipment needs to
large machinery tools to carry on its functions to obtain effective contribution
to objectives is one of the challenges of management. Purchasing is an
organizational activity concerned with acquisition of materials and services
of the right quality, in the right quantity, at the right time, at the right price,
from the right supplier, with the right service to be delivered at the right
place.
The standard statement of overall objectives of the purchasing function is

that it should obtain the right materials, in the right quantity, for delivery at
the right time and right place from the source, with the right service, and at
the right price.
By its very nature, purchasing has continuing relationship with all other
departments in the firm, as well as with the firm’s suppliers. Purchasing
operations cut cross all department lines.
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Self Checking Exercise

1. Differentiated between purchasing and procurement.
2. Explain the statement ‘No organization is sufficient’ in light of its
implication to organizational buying?
3. What is purchasing? How does purchasing contribute to organizational
effectiveness and success? Describe the rights of purchasing?
4. Discuss the objective of purchasing with their implication in your
surrounding factory.
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CHAPTER TWO
ORGANIZATION FOR PURCHASING
LEARNING OBJECTIVE
After the chapter is completed successfully, you would be able to:
 Recognize the location of purchasing in organization
 Identify the organization for purchasing in single and multi-plant
companies.
 Describe the advantage of centralized and decentralized purchasing in
organization.
 Understand the meaning and importance of materials management.
 Examine materials management objectives.
2.1 Purchasing in the Organizational Structure

The purchasing organization is an organizational unit/ personal/ or individuals
which purchase/ procures machine, raw materials and equipment and
negotiates general purchase price conditions with vendors. It is responsible
for all purchasing transactions in the company.
An organizational structure defines jobs the reporting hierarchy. In doing so

it defines people’s specialties, ideally their lines of business and their
relationships with their peer in an organization.
 It is the sum of ways in which the enterprise divides its labor into
distinct tasks and achieves co-ordination.
 It is the division of organizational activities into their functions, jobs,
tasks by means of vertical and horizontal authority.
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From the materials and purchasing point of view the purchasing is

responsible for all purchasing activities (including the processing of requests
for quotation and purchase orders for example). In the case of purchasing,
the functions location in the management hierarchy of a firm is important for
this decision either facilitates or limits the influence purchasing policies and
action can have on the firm’s total performance.
Within the department itself, the form of organization selected influences the
types and level of expertise developed and also, to great extent the
effectiveness with which the talents of individuals are utilized.
Activity:1
1. Discuss the location of purchasing manager in your nearby
organization (Aksum University).
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Location of the purchasing and supply function in industrial

organization
A firm’s organizational structure reflects management basic attitudes toward
the major activities involved in its operation. In a given firms purchasing and
supply management is a top level function that report to a general
management executives or sub-function which report to the top function.
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President
President
Finance and
Executive Vice
Accounting Human Resource Engineering Manufacturing
Marketing manager President
manager manager manager manager
Purchasing and Supply manager
Fig. 2.1 Organizational structure, with purchasing and supply as a top level
function
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President
President
Executive Vice
President
Finance and Manufacturing

Human Resource Engineering Marketing manager
Accounting manager
manager manager
manager
Purchasing and
Supply manager
Fig 2.2 Organizational structure with purchasing & supply as a second level
function
The importance of purchasing and supply management in any specific firm is
determined largely by the following factors
1. Availability of Materials– is the major materials used by the firm
readily available in a competitive market? If materials used by the firm
readily available in competitive market and some key materials bought
in volatile market & subject to periodic shortage and price instability
the purchasing function is a top level group.
2. Percent of Product Cost Represent By Materials– when a firm’s

materials costs are 40% or more of its product cost (or its total
operating budget), small reductions in material costs increase profit
significantly.
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3. Types of Materials Purchased – it is determined by purchaser’s

creative purchasing performance over materials availability, quality,
costs and services. The largest company uses a wide range of
materials, many of whose price and service arrangement definitely can
be influenced by creative purchasing performance. On the other hand,
some firms use a fairly small number of standard production and
supply materials, from which even a top flight purchasing and supply
department can produce little profit, despite what it does as a result of
creative management, pricing, and supplier selection activities. A
given company may use standard or non standard materials. If most of
the materials used in the company are non-standard the purchasing
and supply function is at top level function.
2.2. Organization for Purchasing

Purchasing and supply work naturally divides into five distinct classifications
each of which encompasses a fairly wide range of activities.
There are five classification of work found in a purchasing and supply
operation are, these are:
1. management
2. buying
3. follow-up and expediting
4. strategic planning and research work
5. clerical activities
1. Management
Management of the purchasing and supply function involves all the tasks
associated with the management process with emphasis on the development
of policies procedures controls and the mechanics for coordinating
purchasing operation with those of other dep’t. On an exception basis, it also
involves the management of unique supplier and commodity problems.
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2. Buying
This includes a wide variety of activities such as working with users to help
develop requirements, and specifications, reviewing requisitions, analyzing
specifications, investigating supplier, analyzing supplier capabilities,
interviewing sales people, studying costs and prices, analyzing bids,
negotiating and selecting suppliers.
3. Follow-up and Expediting

Buying supervisory –the size of buying staff and complexity of the purchase
handled determined the need for buying supervisor.
Order follow-up activity involves various types of suppliers liaison work such
as reviewing the status of orders, writing letters, telephoning and faxing
suppliers and occasionally visiting supplier’s plant.
4. Strategic Planning and Research Work

A well developed [purchasing and supply management operation has an
unending number of research projects and system studies requiring
specialized knowledge and analytical ability. The core activity in this area
includes economic, industry and supply market study, development of
materials buying strategy, development of supply base and partner’s plans,
product research and value analysis work and operating and information
system analysis.
5.Clerical Activities-
It includes activities such as maintaining different records examples
commodity records, special tools records supplier records different
documents belongs to buying catalogs and library materials maintaining
working files.
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2.3 Centralized and Decentralized Purchase

Centralization or decentralization is concerned with the placement of
purchasing authority; it has nothing to do with the location of the buying
personnel. Centralization of purchasing authority deals with putting the
responsibility of buying activities under one person or unit within an
organization. Decentralization of purchasing occurs when personnel from
other functional areas production, engineering, marketing, finance, etc.
decided unilaterally on sources of supply or negotiate with suppliers directly
for major purchases.
To what extent should purchasing and supply management activity be
centralized at the corporate level? In practice, virtually every firm answers
this question differently. Some firms centralize the activity almost
completely doing the buying for all sites at a central head quarters office.
The activities of purchasing are completely centralized by some firms, almost
totally decentralized by others. Still other firms used both centralized and
decentralized purchasing. All have their own advantages and disadvantages.
Centralized Purchasing
Centralization of the purchasing function is essential for attainment of
both optimum operating efficiency and maximum profit. Some of the
advantages of Centralization are:
1. Greater Buying Specialization

1 Centralization permits greater technical specialization among buyers.
This leads to the development of more knowledge and more highly
skilled buying personnel.
2 Centralization enables a firms to do better technical job of buying
3 Permits a job of buying with fewer buyers
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4 Provide for the capable buying of major capital equipment
2. Consolidation of Requirement
1 Consolidation results in larger purchase from smaller number of
supplier
2 Yields more favorable prices and increase supplier services
3 Increase purchased volume also permit the negotiation of highly
profitable long term contract for many production materials.
3. Easier Purchasing Coordination and Control
When all company purchasing activity consolidated in one office
procedures of coordinating and controlling individuals segments of
activity can be affected more quickly with less paper cost.
4. Effective Planning and Research Work

When requirements of multi-plant company are centralized all purchasing
planning needs can be conducted in more depth with greater efficiency for
all purchasing activities throughout the company.
5. Duplication of effort and haphazard purchasing practice are minimized.
6. Uniform policies, form and procedure can be adopted.
Demerits of Centralized Purchasing
 Slow decision making
 May not spread risk
 May not satisfy local interest
Decentralized Purchasing
Decentralized of purchasing occurs when personnel from other
functional unit areas decide unilaterally on sources of supply or
negotiates with suppliers.
Advantages of Decentralized Purchasing
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 Fast and quick decision

 Satisfaction of local interest – for multi Plant Company, if plants
are separated by great distances.
 Helps to spread risk
 A fundamental principle of management holds that the
delegation of responsibility must be accompanied by the
delegation of adequate authority to carry out the responsibility.
 To minimize one of the major disadvantages of decentralization
purchasing firms may use purchasing councils. In decentralized
operation a purchasing council is simply a coordinating group
made up of purchasing managers and selected senior buyers
from each of the firm’s plants. Council members meet periodically
to coordinate policies and buying activities, to consolidate
purchase for selected major materials and so stay abreast of the
latest trends and their implication for the corporation.
Disadvantages of Decentralized Purchasing

 Loose of control
 Difficult to get quality discount
 Inefficient utilization of resources
 Weak negotiation power
Thus to balance the limitations of the above placement authorities, it is
better to use hybrid structure where a combination of both centralization and
decentralization used.
Factors Affecting Feasibility or Desirability of Centralization

Three factors determine how feasible/ desirable centralization of the
purchasing function may be in a given situation.
1. similarity of the classes of materials used in each of the plants
2. size of each plants purchasing department/ requirement size
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3. distance separating the individual plants
1. Similarity of the classes of materials used in each of the plants

If firm’s plants are use different materials centralization of purchasing offers
only minimal benefits, the major benefits of increased specialization and
requirements consolidation cannot be achieved. But if a firms plant used
similar materials centralization of purchasing offers significant benefits.
2. Size of each plants purchasing department/ requirement size

As general rule centralization is more advantageous when a firm’ individual
plant purchasing department are not large. If plant purchasing operations
are large a high degree of buyer specialization may already have been
achieved. Similarly the benefits to be gained from consolidating
requirements of a large department are less significant than those gained
from consolidating the requirements of small plants. This is not to say that
consolidation of large departments does not yield benefits. It usually does.
The benefits however are not as significant as in the case of small
departments and they are frequently outweighed by the offsetting
disadvantages.
3. Geographic dispersion of plants/ distance separating the
individual plants
The closer a firms plant are situated geographically the easier centralization
becomes. Conversely, if much centralized buying is done the more widely
the plants are dispersed the more serious the disadvantage of centralization
becomes. Even if a centralized purchasing office has direct telephone and
fax service to the production scheduling offices at each plant when a plant is
1000 miles distant the problems of communication and coordination with
what plant are difficult indeed.
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Activity:2
1. Explain the centralized and decentralized purchasing activity.
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2. Write the merits and demerits of centralized and decentralized
purchasing.
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2.4. The Materials Management Concept

The significance of materials to the efficient operation of organizations is
increasing more than ever. Shortages of raw materials, components, and
products have been experienced on a global scale with demand exceeding
supply; the price of many materials has increased significantly. Every
organization requires materials for its operation, and there will always be the
necessity for some stores and stocks to be maintained either for immediate
consumption, conversion, or re-use. Manufacturing organizations require a
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variety of raw and other materials that must be acquired, stored, and
handled. Similarly, service organizations need materials, equipment, and
some stores to run their operations. In both cases enough stocks of materials
and equipment have to be maintained to meet at least short-run
requirements. These stocks or inventory are cash in kind that need at most
care. Therefore, their safe custody, upkeep, and maintenance, handing and
proper supply are of great importance.
Almost all organizations, regardless of their nature, are demanding proper

and efficient management of materials. Furthermore, both real and contrived
shortage of materials, including food stuffs, metals, and energy resources,
have made materials management an important and difficult organizational
function. The reason is that materials, especially components and sub-
assemblies, have specific uses and have low flexibility. And they need more
care in procurement, storage, handling, and distribution.
Activity: 3
1. Define materials management using your own words?

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2.4.1. What is Materials Management?
Materials management is concerned with the flow of materials from suppliers

to production and the subsequent flow of products through distribution
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centers to the user. Materials management is, thus, an activity that involves
planning, acquisition, storage, control and disposition of inputs like raw
materials and in-process goods which go into the production process directly
and also capital equipment, tools and accessories, spare parts and other in-
direct materials which are required for everyday operations. It is designed to
ensure supply of materials of the right quality, in the right quantity, at the
right time, at the right price, and at the right place acquired from the right
source in order to ensure economy, efficiency, and smooth operation of an
organization.
2.4.2 The Objectives of Materials Management
Poor materials performance may jeopardize any plant's capacity to provide

the goods and services that the society so urgently requires. The primary
objective of materials management is thus to provide service and support to
operating functions, mainly to production and operations, accordingly,
materials management is established to achieve the following objectives.
A. Purchasing and Procurement

Materials should be purchased in required quality, at a minimum cost, and
to be made available in time. However, as purchasing objectives vary in
relative importance from one organization to other, one may concentrate
efforts more on one rather than the other. When raw materials are
available at a low price, price objective is paramount. Here the key
objective is to procure raw materials at a minimum price and much
depends on intelligent timing of purchases. When the materials to be
procured for the manufacture of some components and parts that are to
be used in complex machines are scarce, timely availability is dominant;
and cost factor does not dominate. Still in others, such as aircraft and ship
building industries, consistency in quality and reliability may be the sole
criterion because of the complexity of the end-products.
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B. Stores and Inventory Management

Although inventory function is more complex, more subtle, and the
balance of costs and gains is much more difficult to find out, one of the
objectives of materials management is to have the correct quantity and
right quality of material on hand at the time required keeping the right
balance of inventory is important because when inventory turn-over is
high, storage and carrying costs are low. Sometimes, however, inventory
turnover may be the turning point because we stock not because
thousands of spares and parts go to make complicated machine, but
because we keep them ready for after-sale customer service. Here,
striking a balance between stock-outs and built-in-inventory becomes the
most important materials management objective. The objective of stores
and inventory management is achieved by proper receipt and inspection
of materials, issue and dispatch, storage and storekeeping, stock records
and stores accounting, identification and coding, materials control,
materials handling and traffic, and disposals of surpluses, wastes and
obsolete materials.
C. Continuity of Supply
In automated processes, where costs are rigid and are not easily
amendable to reduction due to lack of production materials, continuity of
supply is of paramount importance. This foreshadows all other objectives,
because idle time costs of men and machines push up overall costs of
production and expediting supply means additional transport costs.
D. Quality of Materials
Where quality materials presents cost plus production engineering
problems it may well become one of the prime objectives of materials
management, where other objectives are sacrificed at quality – cost.
E. Good Supplier Relations
29

Good supplier relations greatly depend on the product or service

reputation of the company. However, suppliers respond favorably to fair
treatment; they are uncooperative and unwilling if indifferently treated.
The materials management can thus improve relations by providing the
required stimuli for their better performance.
F. Product Development and New Product

The discovery and improvement of materials frequently leads to a new
product development and lower costs on existing products. Materials
management can suggest materials and components that will do better or
equivalent jobs at a lower cost. Product efficiency is basically a
compromise between engineering design and economic means of utilizing
the by - products or wastes product development is always profitable and
materials management can render substantial help by adding new
products to the existing product - line. Besides materials management
can also help in price, demand, and requirements forecasting. Materials
management has intimate knowledge of the market conditions through
daily contacts with suppliers. Therefore, by analyzing and interpreting
data of past sales, seasonal variations in prices, availability and demand
for materials, it helps to forecast the future trends and plan material
requirement accordingly.
Activity: 4
1. Take one nearby organization and look at its material

management objectives.
____________________________________________________________
____________________________________________________________
____________________________________________________________
____________________________________________________________
___________________________________________________________.
30

2.4.3. System Approach to Materials Management
Materials management is a management activity which is primarily

concerned with the efficient flow of materials to, through, and out of an
organization for optimum use of materials. Materials required for
manufacturing have to match the production schedules that must be related
to marketing possibilities. The function, therefore, covers maximum
utilization, conservation, elimination of waste, avoidance of unnecessary
delays, and assurance of right quality and needed quantity at an economic
cost.
There is a good deal of misunderstanding with regard to its scope. Some

emphasize the acquisition aspect, some refer to it as inventory control and
stores management, some again attach great importance only to materials
logistics and movement control and handling aspects. However, as the term,
materials management has now been universally accepted, and is being
widely used, the only thing that has to be answered is the question of
integration. The general trend is, therefore, towards an integrated systems
approach which covers the availability, flow, conservation, utilization, quality
and cost of materials.
Materials management is responsible for planning, acquisition, storage,

movement and control of materials and finally goods so as to optimize
personnel and physical facilities and capital while providing better customer
service in its perfect harmony with the organizational goals, it involves the
provision of the right quantity, at the right time, and from the right source. It
is, therefore, a systematic and dynamic approach for the control of materials
to, through and out of an organization throughout its flow cycle.
Seen in this light materials management is an integrated activity that starts

functioning with the designing, planning, sourcing and procurement of
31

materials and then getting the materials through successive stages of

operations for the final embodiment into an end-product, awaiting final
distribution so as to be of service to human needs. An objective analysis of
materials management reveals that it does not start with purchasing and
end with production, but it concerns itself with total flow of materials from
forecasting of future demands down to final distribution of end products. All
the sub-functions are individually important, but at the same time it has to
be realized that they are not isolated phenomena.
Materials management is, therefore the systematic integration of the

following functions or activities.
1. Materials forecasting, budgeting, planning, and programming.

2. Scheduling, purchasing and procurement.
3. Receiving and inspection as to quantity and quality
4. Inventory control, storage and warehousing.
5. Material handling, movement control and traffic etc.
6. Dispatch, shipping and disposals (including wastes, scraps and reclaimed
and surplus products.)
2.4.4. Organization for Materials Management
Organizing may be defined as a process of identifying, classifying, and

grouping various activities establishing authority-responsibility relationships
to create a structure capable to accomplish predetermined objective.
Organization structure is thus an established pattern in which various parts
of an organization are interrelated and interconnected. The activities of
materials management are similarly grouped and integrated to form the
organization structure. The underlying purpose of organization, logically, is to
facilitate efficient operation of each work group.
32

General Manager
Materials Department
Procurement Supply Handling and

Maintenance
Receiving Stores Traffic
Material planning
Scrap
and and
surplus
Inventory control disposal
Fig. 2.3. Organization structure for Materials Management
33

Summary
 The purchasing organization is an organizational unit/ personal/ or
individuals which purchase stationary, machine, raw materials and
equipment and negotiates general purchase price conditions with
vendors. An organizational structure defines jobs the reporting
hierarchy. The importance of purchasing and supply management in
any specific firm is determined largely by the following factors;
availability of materials, percent of product cost represent by
materials, and types of materials purchased
 In purchasing and supply chain management operation five
classification of work found; these are: 1) Management, 2) Buying 3)
Follow-up and expediting 4) Strategic planning and research work and
5) Clerical activities
 Centralization or decentralization is concerned with the placement of
purchasing authority; it has nothing to do with the location of the
buying personnel. Centralization of purchasing authority deals with
putting the responsibility of buying activities under one person or unit
within an organization. Decentralization of purchasing occurs when
personnel from other functional areas production, engineering,
marketing, finance, etc. decided unilaterally on sources of supply or
negotiate with suppliers directly for major purchases. Both have their
own advantages and limitations.
 Every organization requires materials for its operation, and there will
always be the necessity for some stores and stocks to be maintained
34

either for immediate consumption, conversion, or re-use. The

significance of materials to the efficient operation of organizations is
increasing more than ever. Therefore, materials management is
concerned with the flow of materials from suppliers to production and
the subsequent flow of products through distribution centers to the
user.
Self Check Exercise
1. Take as an example the Aksum university organizational structure and
draw the location of purchasing manager.
2. List the advantage of decentralized purchasing activity.
3. Explain the meaning and objective of materials management.
4. What is organizational hierarchy?
5. Mention and elaborate the factors that determine feasible
centralization of the purchasing function in a given situation.
35

CHAPTER III
OUTLINES OF PURCHASING POLICIES
LEARNING OBJECTIVES:
After successfully completing this chapter, learners should able to:
1. Define the term policy;

2. State the functions of policy;
3. Explain purchasing polices concerns;
4. Distinguish the buying policies related to volume and timing;
5. Describe the purchasing ethics;
3.1. Basic Purchasing Operating Policies

What is Policy?
It is a statement that describes in very general terms an intended course of
action. After the fundamental objectives of an activity are established,
polices are developed, to serve as general guidelines of an activity in making
operating decisions that channel actions towards achievement of the
objectives. To facilitate this process, as set of operating procedures is
subsequently developed that details the specific actions to be taken to get
the job done. Every purchasing department has policies, whether or not they
are put in to writing. They are one of administrative tools of departmental
management and a reflection of top management philosophy.
Activity: 1
36

1. What do you think the function of policy in any organization? Discuss

using practical examples.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
An established policy serves for two functions. These are:

1 It serves as a base to be used in formulating operating procedures
2 It serves as a general guide in making decisions about unusual
problems, which fall outside clear- cut procedural boundaries.
Purchasing policies deals with three things like,
1. Purchasing authority
2. External relationship
3. The firms general conduct and image
1. Policies Defining Purchasing Responsibility
The following purchasing responsibilities should be clearly and unequivocally
stated in the firm’s policy manual
a) Centralization or Decentralization of Purchasing
As you learned in previous chapter centralization or decentralization is
concerned with the placement of purchasing authority, it has nothing to do
with the location of the buying personnel.
Centralization of purchasing authority deals with putting the responsibility of

buying activities under one person or under one unit within an organization.
Decentralization of purchasing occurs when personnel from other functional
areas like production, engineering, marketing, finance, and etc decide
unilaterally on source of supply or negotiate with suppliers directly for major
purchases.
b) Liaison Responsibility for External Contracts

37

Channeling external contracts through the purchasing department serves

useful function. It permits buyers to maintain reasonable control of vender
relationships. Developing some relationship with supplier is the
responsibilities of purchasing departments for two main points (reasons):
1. Good supplier relationships contributes to the formation of good
public image
2. The treatments and services that a supplier provides to a buyer
depend on how the seller feels about the buyer.
Starting from this basic policy most companies issues a serious of additional
policy statement which give more precise guidance in specific situations. For
example when the head of an operating dep’t wishes to talk with a supplier
sales or technical representative about a potential procurement issue, unless
it relates to an ongoing communication, the request normally should be
made through the purchasing dep’t. The appropriate buyer then makes the
initial contact, arranges the appointment and keep informed on significant
aspect of selection of supplier and contract provision review of materials
specification etc
c) Selection of Suppliers and Contract Provisions
One of the most important responsibilities of purchasing and organization is
to locate and/or develop suppliers that are competent and uniquely qualified
to fulfill the buying firm’s needs, staying abreast of the large number of
potential suppliers in the market place and their respective capabilities and
potential can be a difficult and time-consuming task if it is done well.
Consequently most firms have a policy that requires buyers to spend a
certain percentages of their time for searching, identifying and investigating
potential suppliers in the market for their important materials. Despite the
cross-functional aspects of sourcing team operations in most cases the
ultimate responsibility for matters of supplier selection price determination
and the development of specific contractual provisions nevertheless belongs
to the purchasing and supply department.
38

d) Review of Material Specifications and Requests

Purchasing dep’t has the responsibility and authority to critically review
material specifications and purchase requests is a policy of paramount
importance.
It must be stated clearly and unequivocally in the firm’s policy manual. The
purchasing department and subsidiary purchasing managers have the duty
and the authority to requests considerations of specification or quantity of
materials requested if, in the opinion of the buyer the interest of company’s
or its subsidiaries may be better served. However, any change in the
purchase request is prohibited unless it is approved by the person or dep’t
initiating the requisition, the bill of materials or the production plan. Without
the established of this basic policy the profit making potential of centralized
purchasing is severely curtailed. Its importance cannot be over emphasized.
2. Policies Affecting External Relationships and Image

It deals with developing and maintaining a favorable public image. These
policies guide the purchasing contract with the business community,
especially in promoting a favorable relationship with the supplier community.
Irrespective of public relations and advertising expenditures, a firms
purchasing and sales departments contributes heavily to the shaping of its
public image.
It is in purchasing best interest to establish policies that promote favorable
vender relations. Some of the important policy issues to be addressed are
a) Sales people
To treat all sales people fairly and courteously to promote favorable supplier
relations.
b) Orientation and Policy Booklets

To provide orientation and policy booklet to acquaint suppliers with the
39

company’s operations, products or services, the type of materials it requires,

on major polices and purchasing practices facilitate the development of good
relations.
c) Presale Technical Services

The purchase of certain technical items requires a potential supplier to
conduct a pre sale study of the buyer’s specific application of the item to be
purchased.
Therefore purchasing policy must establish distinct limits with respect to the
acceptance of presale technical services. While buyers want all the
assistance legitimately available, they cannot afford to place their companies
under obligation to a supplier by accepting an unreasonable amount of
presale services.
d) Plant and Distribution Center Visits:
Such visits yield three distinct benefits. These are:

1. They provide an opportunity for a buyer to teach more about the
current technical or manufacturing aspects of the materials he she
buys.
2. It enables a buyer to discover a great deal of inside information about
specific suppliers. In the other way the buyers can become intimately
acquainted with their suppliers strengths and weaknesses or unique
conditions under which each supplier operates
3. It permits a buyer to develop valuable personal acquaintances and
basins friendships with supplier’s personnel.
Activity: 2
1. Differentiated hand-to-mouth buying and just-in-time buying.
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
40

_______________________________________________________________.
2. Compare and contrast forward buying and speculative buying.
________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
_______________________________________________________________.
3. Buying Policies (Related to Volume and Timing)
The purchasing executive must make a fundamental policy decision

concerning the volume and timing of purchase for certain major materials.
The buyer can choose one of the two alternatives
1. Purchase according to current requirement (volume) or
2. Purchase according to market conditions
Based on the two alternatives some companies coordinate buying with
production schedules and buy in small lots to minimize their cost of
inventories. While other companies buy greater/ larger quantity at one time
to take the advantage of low market prices and quantity discounts.
According to market condition purchasing is purchasing need is depends up
on the market behavior.
The following are some of the policies relating to buying timing.
I. Hand-to-Mouth (JIT)
It is the practice of buying materials to satisfy current operating requirement
in quantities smaller than those normally considered economical buying.
The difference between hand to mouth buying and JIT buying include:
1. Under JII there is a long term contract between the supplier and the
buying companies were as in the case of hand to mouth buying there is no
contract between the supplier & the buying company.
2. In JII condition there is specified supplier in the case of hand to mouth
buying there is no single specified supplier etc.
41

There are a number of reasons for applying a hand to mouth buying policy
1 If material requirements can be fulfilled from local or nearly markets
2 If prices are stable and quantity discount are not available.
3 In case of shortage of working capital or shortage space
4 If forecast reveals a decline in the price of materials
5 When the products are in the process of redesigning with the result that
its material needs may change.
6 When money is required for other alternative use.
7 When materials obsolete quickly
Some disadvantage of hand to mouth buying is:

 Danger of running out of stock
 Production shut down
 High ordering cost etc.
 Does not allow for quantity discount
II. Market Purchasing

It is buying raw materials at a time when market prices are the lowest for
them and there is a high probability of an up word swing in prices in the
future. This policy is pursued for commodities of seasonal nature like cotton,
wheat, hides and etc.
The price of such materials varies time to time this may be because of:
 Weather condition
 Action of speculators
 Political factor
 Other unpredictable factor etc.
III. Open end / Blanket Purchasing
The company notifies the supplier regarding quantity requirements and
delivery schedules from time to time. In this buying approach, there exists
42

an established relationship and contract between the company and supplier

& this is the difference of blanket and hand to mouth purchasing.
Blanket purchasing has the following advantages
1. It eliminates the need for frequent searching for supplier,
negotiating and ordering.
2. It minimizes the need for storing inventories and thus results in
reduction of caring costs
3. It ensures continuing and reliable source of supply
Under this blanket purchasing
1 It is applicable for materials that are purchased repetitively
2 The contract between the buyer & the supplier is at once but the
delivery is from time to time
3 The price depends or based on market condition
IV. Speculative Buying
It involves purchasing in excess of normal requirements with the intention of
profiting on price movement. This kind of purchasing is not pursued by
manufacturing concerns. Because a manufacturing company in business is to
profit from the production and distribution, services offered to its customers,
not from speculation in the material market. As it is made for the
requirement of more than one year, it requires strategic decision making.
V. Forward Buying
1 It is a policy of buying between the two extremes i.e. hand to mouth
and speculative buying
2 It includes all purchases for contingency reserves but it excludes all
types of speculative buying as its objective is a profit from price
application
3 It is buying policy carried out to keep plant operation.
4 It differs from speculative purchase since it is purchased in advance for
keeping plant operating where as the speculative purchase is a
purchase in advance for generating profit from the escalation of price
43

of the product (material).
Advantages of Forward Buying

1. protects against interrupted operation
2. To buy in large enough quantities to earn quantity discount
3. To protect a company against a risk of perspective material shortage
4. To ensure materials designed quantity when they are needed
5. When price is expected to rise.
Disadvantages
 Carrying cost is high
 The price of materials may be high currently and may decrease in the
future.
 Materials can get obsolete/out dated quickly.
4. Policies Concerning Ethical Practices

Ethics are the guidelines or rules of conduct by which we aim to live. In
business ethics is concerned a with set of moral principles, value, and
norms that guide business behavior ethics in society converse a large
spectrum and includes honesty treatment of others, regions valves, and
the likes. Purchasing professionals in any organization have ethical
obligations to three groups of people
 Employers
 Suppliers
 Their purchasing colleagues
2.2. Policies of the Right Price, Quality, Time, Quantity, and

Suppliers.
44

A) Policies of the Right Price

Determination of the price to be paid is a major purchasing decision. The
ability to get a good price is sometimes held to be the prime test of a good
buyer. However, the right price need not be the lowest price.
While price is only one aspect of the overall purchasing job, it is extremely
important. Basically, the purchasing unit exists to satisfy the firm’s purchase
requirements at lower overall cost. The purchaser is rightly expected to get
the best value for the organization whose funds are spent. Any price quoted
should be analyzed attempts to determine if the price offered is appropriate.
It may be compared with other price previously paid with going rate if
applicable, or with the price charged for alternatives, which could substituted
for what is offered.
Price is the value of a commodity or service measured in terms of the

standard monetary unit. Price should be determined in combination factors
such as quality, ultimate life, delivery time, after sale service, quantity
required, urgency of requirements demand and supply of materials in the
market.
B) Policies of the Right Quantity

Quantity refers to the number of units of the required materials to be
purchase to continue the operation of the organization without interruption.
It deals with decisions on production planning and control, estimating allover
material requirements, the order quantity, when to make orders, number of
units in stock, delivery time, etc.
C) The Right Time

The achievement of delivery on time is a standard purchasing objective. If
goods and materials arrive late or work is not completed at the required time
(the right time), sales may be lost, production halted, or dissatisfied
45

customers may invoke damage clauses. The right quality and quantity of
materials should arrive at the time it is required without delay and in proper
condition. To obtain on time delivery, it is vital to ensure that user
departments know what lead times apply, and any other necessary
information. Purchasing has also a practical role in supply market,
convincing supplier that they must deliver as and when agreed.
Some of the reasons for late delivery are:
 Sometimes suppliers quote delivery dates which they cannot
achieve to get the order.
 Suppliers may quote in good faith but circumstances change and
delivery dates are rescheduled.
 Sometimes the firms which fail to deliver on time may not be
competent at production, planning, and control.
 Purchasers are themselves the source of the delivery problem,
through issuing inaccurate delivery schedules, continually
amended or by allowing insufficient time for delivery.
The first step to obtain delivery on time is to decide firmly and precisely what
is required and when it is required. Whichever, unit specify the delivery date,
the requirement dates should not be specified without regard to supplier
lead times and market realities, since this is likely to lead to late deliveries. A
vital step in achieving on time delivery is to ensure that supplier knows and
are fully aware that on time delivery is an important element in their
marketing mix.
D) Policies of the Right Quality

Quality in general can be stated as the whole set of feature and
characteristics of a product or service that are relevant to meeting
requirements. It is “the totality of features and characteristic of a product or
service that bear on its ability to satisfy a given need ‘It also means ‘fitness
for a purpose’ or ‘suitability’.
46

From a purchasing and supply viewpoint, however, quality is not limited to

fitness for a purpose’ or ‘suitability’. In industrial and institutional
purchasing, quality is related to suitability and cost rather than to intrinsic
excellence. The right quality is that can be purchase at the lowest cost to
fulfill the need or satisfy the intended function for which the materials are
being purchased. In purchasing, quality has no meaning except as it related
to function and ultimate cost.
E) Policies of the Right Supplier
Suppliers refer to a vendor who is reliable and will meet its commitment to
provide the right quality at the right time and place with a desirable service.
Suppliers’ performance has a great impact on the productivity, quality and
competitiveness of the purchasing organization. Outstanding supplier
performance requires extensive communication and cooperation between
various representatives of the buying organization and the selling
organization over a long period of time.
Activity: 3
1. What is your understand about business ethics?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
3.3. Purchasing Ethics

Ethics is a collection of moral principles and rules of conduct accepted by
members of the society guides individuals/group behavior. In business
ethics, we are concerned with a set of moral principles and values and norms
that guide business behavior. Every organization develops a code of conduct,
sometimes written often unwritten. Ethics in society covers a large spectrum
47

and includes honesty, treatment of others, religious valves and the like. And
inboard terms we can define Ethics as the study and philosophy of human
conduct or a set of moral principles on the determination of right or wrong.
Purchasing professionals in any organization have ethical obligations to three
groups of people: employers, vendors and their purchasing colleagues.
Obligation to the Employer

 A buyer must to protect any information that is confidential proprietary
to his or her employer.
 All buyers are obligated to protect and enhance the reputation of the
firm.
 A professional is obligated to do the best job possible to help his or her
firm achieve all legitimate objectives.
Obligation to Suppliers
 Buyer must treat all venders fairy, without bias or prejudice
 Purchasing personnel are obligated to protect a vendor’s proprietary
information – such as design concepts, pricing structure, etc.
Obligations to Professional Colleagues
 All individuals engaged in purchasing work are regarded by outside
observers. As such, they have an obligation to protect and enhance the
reputation of that body of professionals.
Generally, purchasing ethics include:
 Being fair and doing well for both firms.
 Decline personal gift or gratitude.
 To subscribe and work for honesty in buying and selling as well as to
denounce all forms and manifestations of commercial bribery.
 To avoid sharp (questionable or unethical) practice.
Moreover, purchasing executives and their buyers must be above suspicion
in matters of ethics. Even though, a buyer action are in fact ethical, if a
48

vendor believes a buyer has not been entirely ethical, the buyer and his firm
both suffer as a result of the vendor’s false impression.
Summary
 Every purchasing department has policies, whether or not they are put
in to writing. After the fundamental objectives of an activity are
established, policy are developed, to serve as general guidelines of an
activity in making operating decisions that channel actions towards
achievement of the objectives. Policy is established to serves for two
functions. These are:
1. It serves as a base to be used in formulating operating
procedures
2. It serves as a general guide in making decisions about unusual
problems, which fall outside clear- cut procedural boundaries.
 Purchasing policies deals with three important things like, Purchasing
authority, eternal relationship and the firms general conduct and
image.
 The purchasing executive must make a fundamental policy decision
concerning the volume and timing of purchase for certain major
materials. The buyer can choose one of the two alternatives
1. Purchase according to current requirement (volume) or
49

2. Purchase according to market conditions

Based on the two alternatives some companies coordinate buying with
production schedules and buy in small lots to minimize. While other
companies buy greater/ larger quantity at one time. According to
market condition purchasing need is depends up on the market
behavior.
 Policies of the 5 R are deals with price, quality, time, quantity, and
suppliers. Price is the value of a commodity or service measured in
terms of the standard monetary unit. However, the right price need not
be the lowest price. To obtain delivery on right time is to decide firmly
and precisely what is required and when it is required. Quantity refers
to the number of units of the required materials to be purchase to
continue the operation of the organization without interruption. The
right quality is that can be purchase at the lowest cost to fulfill the
need or satisfy the intended function for which the materials are being
purchased. Suppliers refer to a vendor who is reliable and will meet its
commitment to provide the right quality at the right time and place
with a desirable service.
 Every organization develops a code of conduct, sometimes written
often unwritten. In business ethics, we are concerned with a set of
moral principles and values and norms that guide business behavior.
Purchasing professionals in any organization have ethical obligations to
three groups of people: employers, vendors and their purchasing
colleagues.
50

Study Questions
1. What is a policy?
2. Why policy in purchasing is needed?
3. Explain the various policies related to purchase timing?
4. Mention and discuss the policy of five rights.
5. Define ethics and list the important things which are includes
purchasing ethics.
6. Discuss the policies which are deal with external relationships and
image.
51

CHAPTER IV
PURCHASE PLANNING, BUGDETING, AND RESEARCH
LEARNING OBJECTIVE
At the end of this chapter, students would be able to:
 Describe the basic purchasing plan concepts

 Define purchasing budget
 Discuss the role purchasing budget
 Understand area of purchasing research
 Explain importance of purchasing research
4.1 Purchase Planning
A manager’s job is complicated by the fact that he/she must coordinate

decisions with those made by other operating managers. Planning is the
52

dynamic process of making decisions today about future actions. Planning

involves selecting missions and objectives and the actions to achieve them.
The purchasing manager’s plans, for example, should be totally compatible
with the plans of managers in marketing, engineering and production. In a
highly competitive business environment, the firms most likely to succeed
are those that effectively integrate the efforts of their functional
departments in to a unified team effort. Planning includes setting objectives,
develop policies, design programs, establish procedures, set time schedules
and develop budgets.
The Basic Purchasing Plan Concepts
 Description for items to be purchased– identification of materials

requirements of the firm, such as raw materials, finished goods, etc.
 Size of total Market– analyzing the market, analyzes price, technology
and local and international market to buy.
 Major Purchase– that means giving priority for materials that will be
purchased. Considering top urgent, urgent or normal purchase.
 Methods of Purchasing – market purchase, contract purchasing, etc
 The supplier Strength and weakness on price, quality, service delivery
– evaluation and selection of supplier by setting criteria.
 Terms of plan – short term plan/long term plan
 Transportation mode – railway, road, water, air, etc.
 Cost analysis – to find eligible supplier having product
 Discount
 Low price with quality
 Method of payment – letter of credit, payment in advance, etc.
4.2. Purchase Budget
53

Purchase budget is a coordinated financial forecast of the income and

expenditure of an organization. It is a potential finance required for planned
activities.
The purchasing manager must have primarily the following constructed

program before allocating budget.
 Current material/component stock

 Outstanding orders for relevant production
 Agreed stock levels and current lead time
 The production schedule for the year
 Price trends of materials and components in long terms
Role of Purchasing Budget
 Purchase budget will give idea of materials that will be bought and
finance requirements to make payment to supplier within a year.
 Since budget derived from plans it formulate, evaluate and control the
objective set out in the plan.
 It establishes strategies to optimize material costs and give executives
an idea about product price strategies.
Activity: 1
1. Discuss regarding purchasing research and the potential area for
purchasing research.
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
__________________________________________________________________
54

_________________________________________________________________.
4.3. Purchasing Research
Purchasing research is the systematic collection, classification, recording and

analyzing of data as the basis for better purchasing decisions. The first
complete study on purchasing in 1963, reported that at that time
approximately one-third of the 304 firms participating in the study had a
purchasing research staff. Some of the data which might be required for
effective buying decisions, the study is conducted in purchasing include
projects under the major research headings of:
1. Purchase materials, products, or services

2. Vendors
3. Price analysis
4. Purchasing system
5. Value analysis
6. Ethical and legal issues
4.3.1. Organizing for Purchasing Research
A firm could conduct purchasing research in one of two ways:
A. The assignment of full-time staff personnel to the task, or

B. The use of regularly assigned buying and administrative personnel to
conduct purchasing research as a secondary assignment.
Some of the reasons for supporting the first option are:
Time: A though job of collecting and analyzing data requires blocks of time,
and in many purchasing departments the buyers and administrators just do
not have time. They are fully occupied finding workable solutions to
immediate problems.
55

Specialized skill: Many areas of purchasing research (for example,

economics studies and system analysis) require in-depth knowledge of
research techniques call for a level of skill not possessed by the typical
buyer, primarily because research skill is not one of the criteria used in
selecting persons positions.
Perspective: the purchase researcher often must take a broad view of the
overall effects of purchasing decisions on operating results. The buyer, on
the other hand, may be so engrossed in his own narrow responsibility area
that the big picture goes unrecognized. There are arguments for placing the
responsibility for purchasing research with the buyer and/or the purchasing
administrator.
Immediate knowledge: the buyer is immediate familiar with the items he

or she buys. A staff person does not have such information, initially, and may
overlook important data. A system that requires a staff person to spend a
good deal of time in going to the buyer of administrator for data may be
inefficient.
Locus of decision making: in the final analysis, purchasing decisions are

made by the buyer or administrator, the staff number merely presents data
and advises. In some instances, conflict may develop between the staff
person and the decision maker; thus the recommendations of the staff may
not receive fair consideration and the value of the researcher’s efforts will be
negated.
Cost: the salary and related organizational expenses of full-time staff

members adds to the administrative costs of operating the purchasing
department. If the results of staff analysis do not add appreciable to the
improvement of purchasing decisions, they have various unwarranted.
One possibility-somewhat of a compromise between the use of a full-time

purchasing researcher and the spreading out of research responsibility to
56

individual buyers is the formation of a committee to pursuer various projects.

Such committees have various titles such as task force, tiger team, or value
analysis committee.
The difficulty with committee approach is that it is hard to pin-point

responsibility for results when it is diffused over a number of individuals.
However, the committee approach can work satisfactorily provide that
i. Committee members are carefully selected to ensure that each

really has something to contribute;
ii. The committee has strong leadership (from a functional point of
view, it probably should be someone from the purchasing areas.);
iii. A specific set of objectives and expectations of results is formulated
and communicated to each members and the committee as a
whole; and
iv. Each committee member’s normal responsibilities are rearranged
to give that person the time and the resources necessary to ensure
results. If any of these four conditions is not present, less that
optimum outcomes are also certain.
The Importance of Purchasing Research
 Increase rapid technology and economic circumstance at difficult

purchasing.
 Strategy making in uncertain condition
 Facilitate for much quantity purchasing
 Facilitate real time ordering and payment line
Area of Purchasing Research
 Materials and commodity
-Requirement of material and commodity
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-Price and value analysis
-Specification and standard of material and commodity
 Purchasing policies and procedures

 Whether policies need revision or not
 International and external customer satisfaction with purchasing
function.
 Suppliers
 Supplier capacity and performance
 Supplier reviews – the assessment of existing supplier and to find
new supplier.
 Contracting system.
 Staff
 The responsibility of the staff
 Employee incentive
 Staff success, training, promotion and development
 Others
Application of IT in purchasing
Disposal of scrap and obsolete materials
Purchasing performance measurement
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Summer
 A manager’s job is complicated by the fact that he/she must
coordinate decisions with those made by other operating managers.
Planning is the dynamic process of making decisions today about
future purchasing actions.
 Purchase budget is a coordinated financial forecast of the income and
expenditure of an organization. The purchasing manager must have
primarily the following constructed program before allocating budget.
 Current material/component stock
 Outstanding orders for relevant production
 Agreed stock levels and current lead time
 The production schedule for the year
 Price trends of materials and components in long terms
 Purchasing research is the systematic collection, classification,
recording and analyzing of data as the basis for better purchasing
decisions. A firm could conduct purchasing research in one of two
ways:
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C. The assignment of full-time staff personnel to the task, or

D.The use of regularly assigned buying and administrative
personnel to conduct purchasing research as a secondary
assignment.
 Area of purchasing research can be carried out in
 The purchasing Staff
 Suppliers performance
 Application purchasing policies and procedures
 Requirement of materials and commodity
Self Assessment Questions

1. Elaborate the basic purchasing plan concepts.
2. Define purchasing budget using your own words.
3. Discuss the role purchasing budget.
4. Mention the possible area of purchasing research in your surroundings.
5. Explain importance of purchasing research.
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CHAPTER FIVE
BASIC PURCHASING PROCEDURES
LEARNING OBJECTIVE
After successfully completion this chapter, learners should be able
to:
 Understand the purchasing procedure.
 Investigate the purchasing procedure objectives.
 Identify general procurement procedure.
 Mention the purchasing related records.
 Differentiate handling of rush and small order purchasing
Introduction
Any activity or tasks we perform day after day either for individual or
organizational purpose have their own steps or sequences to be followed so
as to accomplish them successfully and satisfactorily. Business and non-
business organizations perform activities that range from minor task to large
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projects with significant investment in terms of money, time and level of

effort to be made. Likewise, purchasing department has a number of tasks to
be done with in prescribed steps or procedures.
Activity: 1
1. From your practical experiences and your previous related course, how
do you explain the procedure?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
What is a Procedure?
Procedures are detailed outlines of a specific action to be taken to
accomplish a given task, within the guide lines of any applicable policy. In
short, procedures establish the way of doing things.
Generally, procurement procedures and the document they utilize serve for
two fundamental purposes within organization/importance
1. They provide the frame work and direction for accomplishing the
supply and materials managing activities effectively and efficiently.
i.e. procedures are designed to indicate from where to start a given
task, what to do at specific stage of the task and where to end with
accurate and safe factory performance.
2. They provide the means for processing information input from
outside the department to produce output communication needed
by individuals in other departments to do their jobs in a coordinated
and timely manner.
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In addition to the above purposes procurement procedures, have the

following importance
 They clarify tasks
 Ensure uniformity of purchasing activity
 Assign authority and responsibility at different level of a
given task
 Enhance documentation and control
Objectives of Operating Procedures

Generally speaking properly designed procedures should accomplish four
objectives
1 Procedures are not ends to themselves. They are means to an end
2 Procedures must be designed to facilitate communication and
coordination of the efforts of one work group with another.
3 Responsibility should be assigned clearly for the accomplishment of
each step to the procedure
4 Procedures Permit effective “management by exception”. A procedure
enables an employee to handle the activity with a minimum of direct
supervision. Consultation with a manager is required only when
conditions arise that is not covered by the procedures.
5.1 General Procurement Procedure

Justification for the existence of accurate purchasing procedure or
reasons for developing sound purchasing procedure
This is to mean that following each procedure for every item or purchase
may not be necessary. Because, the value of the purchase may not justify
the cost that the organization incurs in terms of money and time, while
strictly following each procedures. Therefore, the under listed situations are
some of the reasons that why firms use purchasing procedure
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A. The large number of materials purchased

B. The high amount of dollar/birr volume involvement
C. Their essentiality for auditing purpose
D. The severe consequences of unsatisfactory (poor) performance
and
E. Their contributions for accurate and satisfactory performance are
the five major reasons for developing a sound
system/procedure.
Even though purchasing procedures differ from organization to organization,

the value and types of materials to be bought, the following steps constitutes
the typical Purchasing cycle:
1. Recognize, define, and describe the need
2. Transmission of the need
3. Selection of source of supply and evaluation of suppliers
4. Prepare and placement the purchase order
5. Follow up and expediting the order
6. Receive and inspect the material
7. Clearance of the invoice and payment to supplier
8. Closed the Order
1) Recognition of Need
Since purchasing is a need based activity, the user department has to clearly
identify and transmit its weekly, monthly or semi-annually requirements in a
written and formal way. In advanced procurement system, the purchasing
department goes to recognize or identify needs ahead of time by working in
coordination with the user department. Any purchase originates with the
recognition of a defined need by some units or persons in the organization.
Recognition of need involves determining,
 What materials are needs,
 How much are needed and
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 When they are needed.

The need for a purchase typically originates in one of firms operating dep’t
or in its inventory control section.
Steps in need recognitions for industrial firm

I. the organization needs would be established based on customers
need
II. needs would be determined based on what the market can supply
III. conclusions will be made / reached on what constitutes a best
value under a given circumstances
IV. Cost benefit analysis will be made concerning filling the needs
either from internal source or external source. Internal sources
include surplus in other department and warehouse of the
organization
Description of the Need
Description means writing the detail specifications (all elements/features of
the article).
Categories of need
Manufacturing organizations, those engaged in changing inputs of raw
material in to out or consumable products need different types of materials
which generally classified as
I. External/ direct production: - these are materials that directly form
part on the end product of the organization. E.g. Raw materials,
spare parts, semi finished products and packing and components
II. Internal/indirect production: these are materials which do not
appear in the final product. Such types of materials are used to
facilitate the smooth running of the organizations activity. E.g.
stationary, MOR items, equipments, or machineries.
2) Transmission of the Need
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No purchaser can be expected to buy without knowing exactly what the

using departments want. For this reason, it is essential to have an accurate
description of the need, the article or the service that requested. After the
need is clearly define and the requirements are determined, the user
department should accurately write the detail features of the
material/service required in the user department should accurately write
detail feature of the material/service required in a standard form called the
purchase requisition (PR).
 The Purchase requisition (PR) is an internal document filled by

requesting user department to notify the purchasing unit their
material/service requirements with detail description of the item
intended to be bought and other related conditions. PR is a
standardized document prepared in varies copies to inform all
working unit of the organization.
The essential information which every purchase requisition form should

contain includes
 Date and identification number of the requisitions
 Complete and accurate description of materials/service required
 Quantity and quality of materials
 Delivery and issuing date
 Operating account to be charged
 Authorized signature
 Originating department and
 Special shipping instructions
Some organizations may include spaces on the requesting form for

‘suggested source’ and ‘suggested price’. However, the requesting unit need
not include these items of information as the purchasing unit can handle
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them more efficiently than the requisitioner. In addition, such practices may
encourage requisitioner to begin contracting possible vendors, which opens
the door to ‘backdoor selling’ by passing the purchasing department.
The purchasing department should review/examine the descriptions on the

PR for the completeness, accuracy and clarity of the information on the PR.
An inaccurate description (specification) may result in some loss of time, in
the worst case, it may have serious financial consequence and cause
disruption of supply, hard feelings internally, and loss of suppliers respect
and trust. However, any questions regarding the accuracy of the requisition
should be referred to back to the requisitioner and should not be settled
unilaterally in the purchasing department.
Flow of the PR: At a minimum of least two copies of the PR should be

made. The original is forwarded to purchasing department and the
duplicated retained by the issuer. It is a common practice to allow only one
item to appear on any one PR. However, in case of special items, one PR may
cover several items provided they are likely to be purchase from one
supplier and for delivery at the same time. The PR may also be prepared in
many copies (5-6) depending on the policy of the buying organization.
Copies may be required by finance, inspection, receiving department, etc. in
the addition to the requesting and purchasing units.
It is important for the purchasing department to establish definitely who has

the power to requisition. Under no circumstances should the purchasing
department accept requisitions from anyone any action is taken. The
purchasing unit is equally accountable for processing any faulty purchase
requisitions.
Use of a Traveling Requisition: In the search to reduce operating

67

expenses, some companies have found it desirable to use a traveling

requisition for recurring requirements of materials and standard parts. The
traveling requisition is a requisition form used when a particular item is must
be purchased frequently for a given department. The traveler contains a
complete description of the item and it’s sent to purchasing when the user
needs a resupply of the item, indicating quantity and date of delivery.
Purchasing write the purchase order (PO), enters data on vendor, price, and
OP order number on the traveler and sends it back to the requistioner, who
put the traveler in the files until a subsequent resupply is needed. Use of a
traveler eliminates the recopying of routine description data, saving
paperwork and clerical time. It also provides a complete, cumulative
purchase history and use record on one form.
3) Selection of Source of Supply and Evaluation of Suppliers (vendor
Analysis)
As soon as a need has been established and precisely described, the buyer
begins an investigation of the market to identify potential sources of supply.
In the case of routine items for which supplier relationships have already
been, developed little additional investigation may be required. The
purchase of a new or high value item, lengthy investigation of potential
supplier may be required.
Supplier selection constitutes an important part of the purchasing function

that involves searching for qualified sources of supply; analyze the capability
of suppliers to supply the right material on time. After qualifying a
preliminary group of potential source, the
Buyers may use the techniques of competitive bidding or negotiation. If the

companies select bidding, it has the following procedure
1. a potential supplier submit their proposals by quantifying price
and terms
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2. Supplier quotation then will be analyzed by comparing one

supplier price with the other competing suppliers. This can be
done through price analysis sheet.
3. The supplier that propose the least price and fulfilled all the
condition will be selected and order is placed to the selected
supplier.
In supplier’s selection process, the purchasing department considers whether

the bids are required or not. Bidding is competing to supply the required
material. Organizations using this buying system have policies on how to use
bidding. Items requiring bidding purchase:
 Items of high value
 Items whose suppliers are not known
 Items purchased in bulk
Whereas:
 Items of repetitive and routine purchase
 Items of low value
 Items of very few or only one supplier may not require bidding
Available bidding options
 Open Bid: The bid is open to all potential suppliers. Suppliers are
very often invited for bidding through mass media
 Merit: You may get supplier you don’t know but evaluation and
selection of supplier could be difficult
 Closed Bid: Inviting or calling limited suppliers. (It could be through
phone or letter contact)
 Merit: evaluation and selection of suppliers could be easy but there
could be probability to miss good suppliers.
 Competitive bidding: It is used in project related activities and price
is the most important variable used to screen suppliers. It is the
most popular way by which many government organizations and
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institutions make their major purchases.
Activity: 2
1. What do you know about purchase order? List some of the information
incorporate in purchase order.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
4) Prepare and Placement of the Purchase Order

Once the purchasing department qualified, selected one capable supplier,
the next task that should be accomplished is, preparing and issuing purchase
order for the winner or qualified supplier.
Purchase Order (PO) is an external document generated by the purchasing

unit issued to winner supplier to provide the buying firm the item/service
that is required.
It is external and legally contracting document that constitutes terms and
conditions that guide both the buyer and seller in performing the contract.
From the above definition, we have some key terms
 External document: unlike PR form it used to communicate the buying

organization with an outside supplier, which may be either local or
foreign supplier.
 Legally contracting document: this is to mean that once the supplier
accepts/ agreed with terms and conditions he/she would be bind by the
order, which then onwards serves as a contract or legal document.
Hence, in case either party failed to discharge its duties and
70

obligations it will be questionable by court or law. For this reason, the

buyer should take great care in preparing and wording the order.
Purchase order may be prepared in many copies, depending on the
policy of the organization.
After an order is has been issued, changes in company requirements
frequently requires a change in the contract. In such cases, the buyer
issues a change order, following the procedures as were followed for the
original order. When accepted by the supplier, the changed order either
supplements or replaces the original order. In most cases, the original
copy of the purchase order, which is sent to the supplier, constitutes a
legal offer to buy. No purchase contract exists, however, until the seller
accepts the buyers offer. In order to confirm acceptance, a copy of the
original purchase order accompany the original as an acknowledgment
copy that is signed and returned to the buyer. Some suppliers like to send
a separate acknowledgment to the buyer. In such case, the buyer should
check the accepted closely to check to see that the supplier not taken
exceptions to any provisions of the order. The purchasing department
responsibility for an order does not terminate with the making of a
satisfactory contract. Purchasing bears full responsibilities for the order
until the material is received and accepted.
Purchase Order Includes the Following Information

 Purchase Requisition identification – requisition date, requisition
number, requesting department and source- local/foreign
 Issue identification—supplier’s name, legal license
 Specific shipping destination – buyer’s company name
 Internal information – buyer name, inspector name
 Payment Term – FOB shipping point/destination
 Item’s No, Item’s identification, item’s description
 Unit quantity, unit price, total quantity and price
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 Delivery time
 Authorized signature
 Terms and conditions: designed to give legal protection to the buyer
on such matters as contract acceptance, delivery performance and
contract termination, shipment rejections, infringements, invoicing
and payment procedures.
The typical PO distribution procedure is as follows
 Copy 1 and copy 2 (the acknowledgement copy) are sent to the buyer.
Which indicate that the supplier’s acceptance of buyer’s offer
 Copy 3 informs the accounting department of the purchase, it is used
by accounting in checking and issuing payment for the seller’s invoice.
 Copy 4 advises the receiving department that it can expect to receive
shipment of the order on a particular date. Receiving uses its copy to
identify and check the incoming shipment.
 Copy 5 informs the user of the details of the order so he can plan his
work accordingly.
 Copy 6 remains in purchasing department open-order file and is often
used for purposes of order follow-up and expediting.
 Copy 7 becomes the buyer’s working document and is filed in
purchaser’s open-order file.
E.g. price, delivery date, discount, payment, mode of transportation, and

dispute resolution mechanisms.
Conditions may include specific instructions regarding price, delivery date,
discount, payment system, transportation term, warranty, etc.
E.g. 1. The cash discount period available to buyer shall commence on the
date of receipt of the merchandize or on the date of receipt of the invoice,
which ever may be the later.
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2. Any deliveries beyond the specified date and quantity will be rejected
without any precondition.
3. Payment for credit purchases will normally be made by 15 th of following
the month. Such guiding principles of a given contract stated by the party
can be changed or modified by the will of both parties; however, any change
or modification by either party without the knowledge of the other party may
cause invalidation of a contract or rejection of an offer.
5) Follow up and Expediting the Order
Once the order is placed or accepted by the supplier the buying department
is expected to check the progress of the order. Following and expediting an
order requires some preconditions like large and critical purchase. This is
because follow upping and expediting are too costly and hence, the purchase
should justify the cost that is associated with follow upping. For that purpose
purchasers will follow-up or expedite the order already placed.
Follow–up: is checking and insuring the progress and delivery of an order at
the scheduled time by using honest and encouraging words or phrases,
through telephone, formal business letter and suppliers plant visit.
Unlike follow up, expediting needs the use of hard ship and threatening
words urge the supplier to deliver order on or before the delivery schedule,
like future business withdrawal or rejection of any delivery beyond the
original delivery schedule. Sometimes purchasing department want to
extend deliveries beyond the scheduled time through de-expediting. In short
follow up is the routine tracking of an order to assure that the vendor is able
to meet delivery promises. And expediting is a forceful follow up, meaning
the application of pressure on the vendor to make him/her either to meet the
original delivery promise or to deliver it ahead of schedule.
The purpose is:
1 To facilitate on time delivery of purchases
73

2 Identification of suppliers’ problems and then cooperate to

solve the problems.
6) Receiving and Inspection of Goods
Inspection is checking for a quantity of delivery and general condition of

shipment, holding the packing list and invoice sent from supplier and a copy
of purchase order to verify the delivered materials according to the order
placed. After materials shipments have been checked for the right quantity
the next task would be checking for quality of deliveries. Inspection for
quality can be made through different ways such as sampling (spot
checking), laboratory or testing tools for engineering and technical items. For
critical items in large and advanced industrial organizations, external
inspection professionals would be hired. Finally both receiving and inspection
section should prepare their respective report.
The bought items might be received by the store, the user department or the
receiving section and accompanied by different documents such as, advice
note, goods inward note, packing list, etc
 Advice note – is prepared by vendor and is designed to provide the
following information:
 Delivery date and time of shipment
 Quantity of items, etc
 Goods in ward note – issued by receiving section and used to
 Accounting section for payments
 Purchasing department regarding the receipt of the goods
 Store section to take the material in to storage
 Packing slip – when a supplier ships material, he includes in the
shipping container a packing slip which itemizes and describes the
contents of the shipment. The receiving clerk uses this packing slip in
conjunction with his copy of the purchase order to verify that the
74

correct material has been received.

After a shipment has been inspected for quantity and for general condition of
the material, the receiving clerk prepares a receiving report. The report may
include overage, damage, shortages and possible recommendations. Copies
of the receiving report are typically distributed as follows.
 Copy 1 is used by the purchasing department in closing out its working

file of the order.
 Copy 2 is used by the accounting department in receiving the order for
payment.
 Copy 3 is sent to the user as a notification that the material has arrived
 Copy 4 is retained in the receiving department’s operating record file.
7) Clearing the Invoice and Payment
An invoice is a document that has purchase order number and itemized price
for a given article. As a formal working system, buyers are supposed to be
claimed for payment by an invoice. There are, however, two contraception
arguments as whether the purchasing department or accounting department
has to check and clear the invoice.
This procedure may involve a simultaneous review of the purchase order and
receiving report and the invoice.
 The argument that favor purchasing department has to check and

clear the invoice are in a position that it is the purchasing department
which has the knowhow of the order placed.
Procedure to clear the invoice by purchasing department
After being adjusted for any correction the original invoice would be sent to
the accounting department that will be kept until authorize comes from
purchasing department. When the receiving department sends receiving
report ratifying those goods is received, purchasing compares the receiving
75

report and the copy of the invoice. If the receiving report and the purchase
invoice indicate similar information purchasing department compare them
with inspection report. It is after all these steps that purchasing report to the
accounting departmentt as an authorization for effecting payment.
 The other argument that favors, clearances to be made by

accounting department are in line with the notion that the task is
primarily accounting.
Procedures for clearing invoice by accounting department

There are two possibilities.
1. The supplier directly sends all invoices to accounting department of
the buying firm. The accounting department will check the correctness
and completeness of the invoice by comparing with the information in
the purchase order. If there is no discrepancy then accounting will
finally settle the payment.
2. If there is a variation in information in the invoice and the purchase

order, then, the invoice will be sent to purchasing for correction. In
case purchasing department examines any inconsistence, the invoice
will be sent back to supplier for recheck.
However, there may be some problems that create inconsistency among the
documents that help for effecting payment. These are delivery of damaged
materials, undesired materials, delivery of materials more than or short of
order/ required. Each of these different problems can be identified or
recognized at different stages.
For instance: delivery of damaged materials and delivery of quantities more

than required would be recognized at received section, where as delivery of
undesired of qualities and expired items for chemical items would be
recognized at inspection stage. Such discrepancies may cause dispute
76

between buyer and seller therefore, accurate and clear instructions or clause
has to be written on the purchase order or on the contract document
regarding the risk taker in case materials get damaged while in transit.
In addition, the clause should contain what could be made when the supplier
delivers undesired quantity and quality. On the other hand, there has to be
one representative from the supplier who should take part in receiving and
inspection process to present an eye evident. The existence of such
instructions and guidelines helps for making immediate decisions and
alleviating undesired disputes between buyers and seller. Moreover, such
contract instructions help to solve problems associated with discrepancy of
purchase invoice, purchase order inspection report, receiving report, which
helps to effect payment.
8) Close the Order

The finance unit after checking the availability of all the documents related
to that specific purchase and verifying the right amount is received settles
the payment to the supplier and the order by then is closed.
Closing simply entails a consolidation of all documents and correspondence

relevant to the order; the completed order is then filed in the closed-order
file.
Activity: 3
1. What do you know regarding the different types of records that
maintained in purchasing department?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
______________________________________________________________________.
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5.2. Maintenance of Purchasing Records

Purchasing department is responsible to maintain records that are believed
to be important, as per the policy of the organization.
The file of purchasing department contains an endless flow of operating
data. Despite its higher volume, much of this information can be useless in
daily operation unless it is organized in a manner which makes it readily
accessible. To make purchasing records accessible both for the departments
operation and for any external body the following separate documents need
to be kept. Recording system of every purchasing department may vary due
to their unique needs; however, there are some basic types of records which
purchasing departments should establish for their effective operation.
Records may be prepared for completed and under process, purchasing and
for other information of supplies, contracts and the like.
Some of these are:
 A record of open orders
 A record of close orders
 Purchasing log
 Commodity record
 Supplier record
 Contact record
 Special tool record
A. Record of Open Orders: This record is opened by the name of the
supplier and indexed alphabetically. Purchase order in each supplier
file is arranged in an ascending numerical order. Each order record
should contain the purchasing requisition, copy of the order, the
returned acknowledge information, follow-up data and all relevant
notes of correspondence, competitive bids, etc. some firms keep bids
and purchase requisitions in their own separate record, but they are
cross indexed for reference purpose.
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B. Records of Closed Orders: This record is simply a historical record of

all completed purchases. It serves as a reference when questions arise
on past orders, and when information needed to plan for future for how
long such record would be kept could not be uniform. It is difficult to
generalize some firms retain them for three to seven years. In the case
of governmental offices they are kept for an indefinite period of time.
Retaining closed records very long would be costly. When needed to
keep long firms, after supplier records and commodity received are
properly maintained, few made and high-value orders would be
retained more than four years volume of purchasing from various
suppliers etc.
C. Purchase Log: It is an ongoing summarized record of purchase

orders. It is arranged in numerical sequence of purchase orders issued
for suppliers. The log contains order number, supplier’s name,
description of the material purchased, value of the order, and status of
the order. It serves as a short cut reference from which summarized
data can be extracted such as number of purchase orders, rush orders,
small orders volume of purchases from various suppliers etc.
D. Commodity Record: Showing the description of all purchase of each

major commodity or item with full reference to necessary engineering
drawings and specifications; a list of approved supplies and their price
lists, and competitive quotations. Commodity record is a vital file of
materials data which helps of make efficient mass production
purchasing. It contains each major material and services purchased
repetitively, and their description and references such as drawings and
specification filed elsewhere.
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Other information includes in the records are list of approved potential

suppliers and their price schedules. When complete purchase history is
needed to be dept in the record those points described in purchased
log and closed orders could be included, however, firms must weigh
the value of the information they want to keep in the record against
the cost of transcribing it.
Supplier record (vendor history file): vendor history file with a separate
card for each supplier showing his address, telephone number, the
names of personnel to contact on specific matters of inquiry. It
provides quick information about the suppliers. A separate record
would be maintained for each supplier. Also, added are selling terms,
delivery and quality performance annual volume of purchases from
each supplier.
E. Contract Record: Consolidation of all contracts in a separate file

creates an immediate access to all contact documents, if the number
of contacts is very large summarizing in a list to provide an easy view
of the contacts and their expiration date.
F. Special Tool Record: Such a record is not the need of all firms. It
helps for those firms who purchase items requiring special tool does
manufacture. By maintaining a record of special tools purchaser can
summarize a quick reference of the tools owned, their age, location
and special characteristics.
5.3. Handling ‘Rush Orders’

Every department executive tries to develop an orderly and systematic
pattern of operation that efficiently utilizes the resource of that department.
However, sometime there may be undesired event that create obstacles to
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the orderly patterned working procedure of purchasing department.

 Rush orders are an urgent orders released from the user department to
fill an emergency requirements. The emergency case may be resulted
due to the following reasons.
1. negligence of the user department in correctly identifying its
requirements
2. in-appropriate inventory counting and wrongly reporting inventories
available in store
3. Unforeseen changes in market demand and production schedule of the
buying organization, and changes in style or technology.
Rush orders are by any means negatively affect the purchasing department
and the whole organization in terms of money and time. Due to
 Errors may be committed in processing rush orders which results
undesirable cost.
 Since rush orders add burden on the supplier, as a means of
compensation supplier would charge higher price than normal
order, deny discounts and additional services.
 Rush orders also increase administration costs like telephone,
postages paper work.
Based on justification that user department provides rush orders divided in
to two
A. The real rush order: this is justifiable or reasonable orders that
result due to unforeseen changes in market condition and style or
technological change, which is beyond the capacity off the user
department. Therefore, rush order is tolerable
B. The so-called rush orders: these are unjustifiable or
unreasonable orders that occur due to the negligent working nature
of the user department, warehouse operations and production
planners of the organization.
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Due to the undesired cost incurred in accomplishing purchasing activities

through frequent rush orders, now a days, most organization are applying
different mechanisms to discourage the use of rush order. Among these:
 Purchasing department has to work in coordination with user, ware
house and production department so as tom eliminate the use of
RO from the very beginning.
 Forcing the user department to seek approval from top level
manager for every RO
 Leaving certain amount of services charge on the user department,
those come up with frequent rush orders.
5.4. Handling Small Order

Small orders are perennial problem in every organization and a serious
problem. Examination of a typical company’s purchase order file reveals that
a sizable percentage or sometimes up to 80% of its purchase involves an
expenditure of less than $250.
However, this purchase constitutes a small percentage or seldom more than

10% of the firms’ annual dollar expenditure. No manager want to devote
more buying and clerical effort to the expenditure of less than 10% of his/her
fund than to expenditure of the other 90% because small order is costly to
buyer and seller like it. In general small purchase is not advisable for any
organization.
Small orders are orders of having low monetary value items which placed
frequently and make an organization to incur more paper and related cost.
Small order items are ordered in small quantity from time to time. If handling
small order is applied within the organization the purchaser must use the
following systems in so as to be successful:-
1 Centralize store systems
2 Telephone order system
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3 Electronic/computer ordering system

4 Petty cash system
5 Suppliers store system
6 Suppliers delivery system
Centralized Store System

A store system is the first approach typically used to reduce the volume of
small-order purchasing activity. When experience shows that the same
supply items are ordered in small quantities time after time, the logical
solution is to order these items in larger quantities and place them in a
centralized inventory for withdrawal as needed.
Telephone Order System
Most companies now use a telephone ordering system to reduce the

paperwork associated with small-order purchasing. Under this system, when
the purchasing department receives a requisition, it does not prepare a
formal purchase order. In lieu of PO, the order is placed by telephone
conversation and is recorded on the requisition. When the material is
received as ordered, the accounting department issues payment on the basis
of the purchase requisition.
Electronic/Computer Ordering Systems
A number of electronic communication systems currently are available to

transmit material purchase requests without writing or talking on the
telephone. For example, “Computers Talking Computers” – is now a reality in
a small number of firms across the country. Hence, if the two computers are
linked together, either the buyer’s production scheduling or his inventory
control programs can enter orders directly into the supplier’s order input
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system. An intermediate step used by some firms is to transmit the order to

the supplier’s computer by means of an on-line terminal in the buyer’s office.
Petty Cash System
Most firms today use a petty cash fund for making small purchases. For this
purpose many firms define “Small” as 1,000 Br to 5,000Br. Petty cash
system is to buy minor items and pay for them from a petty cash fund, in lieu
of buying them through the conventional purchasing system.
Summery
 Business and non-business organizations perform activities that range

from minor task to large projects with significant investment in terms
of money, time and level of effort to be made. Likewise, purchasing
department has a number of tasks to be done with in prescribed steps
or procedures. Procedures are detailed outlines of a specific action to
be taken to accomplish a given task, within the guide lines of any
applicable policy. Generally, procurement procedures and the
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document they utilize serve for two fundamental purposes within

organization
1. They provide the frame work and direction for accomplishing the
supply and materials managing activities effectively and
efficiently.
2. They provide the means for processing information input from
outside the department to produce output communication
needed
by individuals in other departments to do their jobs in a
coordinated and timely manner.
 Even though purchasing procedures differ from organization to
organization, the value and types of materials to be bought, the
following steps constitutes the typical Purchasing Cycle:
1. Recognize, define, and describe the need
2. Transmission of the need
3. Selection of source of supply and evaluation of suppliers
4. Prepare and placement the purchase order
5. Follow up and expediting the order
6. Receive and inspect the material
7. Clearance of the invoice and payment to supplier
8. Closed the Order
 Purchasing department is responsible to maintain records that are
believed to be important, as per the policy of the organization.
Recording system of every purchasing department may vary due to
their unique needs; however, there are some basic types of records
which purchasing departments should establish for their effective
operation. Some of these records are record of open orders, record of
close orders, purchasing log, commodity record, supplier record,
contact record, and special tool record.
 Rush orders are an urgent orders released from the user department to
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fill an emergency requirements, whereas, Small orders are orders of

having low monetary value items which placed frequently and make an
organization to incur more paper and related cost.
Study Questions
1. State the difference between a purchase requisition and purchase
order?
2. Describe the four objectives the properly designed procedures should
accomplish?
3. List and discuss each step in purchasing cycle?
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4. Distinguish the different purchasing related records

5. Discuss the importance and limitation of rush order and small order
handlings.
CHAPTER SIX
MATERIALS SPECIFICATION AND STANDARDIZATION
LEARNING OBJECTIVE
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After successfully completing this chapter, learners should able to:
 Define the term material specification.

 Familiar with different approach in developing specifications.
 Describe the importance of correct specification.
 Identify the forms of specification.
 Elaborate material standardization.
Introduction
Specifications and standardization are a prerequisite to good purchasing.

Quite often whether a purchase contract will be performed successfully is
not determined at the time the contract is written, rather it is
determined at the time the specification are written. Many firms pay a “
far and reasonable” price material however, they do not always pay the
“ right: price . the right price is paid only after all reasonable efforts to
improve the materials specification have been exhausted. This chapter
discussed the important aspects of specifications and standardization and
their impact on good purchasing.
Activity: 1
1. Define material specification using your own words.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
6.1 What is Materials Specification?
Specifications are the detailed descriptions of the material parts and

components used in making a product. Hence, they are the descriptions that
tell the seller exactly what the buyer wants to purchase. Because they
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impinge extensively on the operations of engineering, Production, and

purchasing optimum specifications contribute to the profit performance of all
these departments.
When specifications are fixed, the final design of the product to be sold is
also fixed, when the final design is fixed the product’s competitive stance
and its profit potential are also fixed. Hence developing proper
specification is an important management task. The task is difficult because
it involved many variables, including the problem of conflicting human
sensitivities. Many departments are capable of contributing to design
however, they frequently are thwarted form fully doing so because of
conflicting views before the optimum in design can be achieved, these
major conflicting views must be reconciled. For example, to gain a
competitive advantage, the marketing department normally desires
feature in a product that are nonstandard and unique. Engineering
sometimes desires features of design excellence that contribute little to
sales potential, and may complicate the manufacturing process.
Production to achieve its goal o flow unit costs favors material that are
easy to work and designs which result in the smallest possible number of
items in the production line. Such natural departmental difference
regarding design problems can be resolved only by perceptive and skillful
management.
Reduced costs usually result in increased profits. Direct attempts to reduce

labor costs normally result in strong counter pressures. Labor unions and
individual workers are innately suspicious of attempt to save money by
reducing labor costs. Hence, when an attempts in made to reduce these
costs. Regardless of its justification labor troubles often follow. Costs
reduction in the design are sometimes also generates opposition, but
such opposition if any generally is much less serve consequently by
imaginative and creative thinking, costs in this area typically can be
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reduced more easily than in any other area of industrial management.

This is why the design area is an extremely fruitful field for management
cooperation and coordination among engineering production and purchasing.
6.2. Writing the Specification
After the design of a product is determine, the next step is to translate the
individual part and material specifications in to written form. The need for
clarity and precision of expressions is important in all business
communications. Nowhere, is it more important than in the communication
emanating from purchase contracts.
Optimal performance in all department engineering, purchasing,

manufacturing, production Control, inspection, store, and marketing is
contingent on goods specifications. To meet the need of all departments, a
specification must satisfy the following requirements:
1. Engineering and marketing requirements for functional characteristics

chemical properties, dimensions, etc.
2. Manufacturing requirements for working of materials.
3. Inspection’s requirements to test the materials for compliance with the
specifications.
4. Stores’ needs to receive, store, and issue the material economically.
5. Production control’s requirement to schedule the material
economically.
6. Purchaser ability to procure material without difficulty and with
adequate completion from reliable sources of supply.
7. Production controls and purchasing ability to substitute materials when
such action becomes necessary.
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8. The total firm’s requirement of suitable quality at the lowest overall

cost
9. The total firm’s requirement to use commercial and industrial standard
materials whenever possible, and to establish company standards in all
other cases where non standard material is use d repetitively.
6.3 Importance of Correct Specification
The cost impact of materials alone clearly dictates that their selection should
be a part of product design. Many materials costs are firmly engineered into
a product’s specifications during the design stage, long before requisitions
are submitted to the purchasing department. If materials costs are to be
totally controlled, the design stage is the point at which control must be
initiated. The design stage is the first (sometimes the only) point at which
numerous costs can be reduced and controlled. If costs can be, but are not
reduce at this point, it is possible that they will be built into the product
permanently and will be forever hidden in the firm’s cost accounting records.
They will show up on the firm’s profit and loss statement, as a loss; rather,
they will continue indefinitely as an unnecessary and undetected profit
drain. Markets, materials, and methods are constantly changing; hence, a
second look to modify, simply, or improve specifications will always be
necessary, justified, and profitable. However, it is at the time of the original
design that the greatest dollar saving from both specifications and
standardization are possible.
Preparing specifications for a product involves four major considerations:
1) Design considerations of function

2) Marketing considerations of consumer acceptance
3) Manufacturing considerations of economical production
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4) Procurement considerations of markets, materials availability, and

cost
As previously pointed out, it is not uncommon for these considerations to
conflict with one another. Consequently, top management must provide the
encouragement and direction that will motivate all departments to cooperate
and seek a company solution, rather than departmental solutions. A design
capable of solving the functional problem perfectly might very well present
difficult production problems of machinery or fabricating. A design could
function well and be easy to produce, but present insoluble problems of
materials procurement and pricing. All too frequently a product design is
functionally sound, production is economical, and procurement is effective-
but the consumer does not want to buy the product. Example, some years
ago a large automobile manufacturer built a car that was superbly
engineered and very economical to operate. These were the two qualities
the manufacturer thought the consumer wanted most. This turned out to be
an erroneous assumption. Because the car lacked some of the style features
of its competitors, it did not sell well, and the manufacturer lost almost half
its previous share of the total automobile market.
Conflicts of departmental interest are seldom interests are seldom as grave

as the extremes just cited. Although department managers do disagree
occasionally, compromises can usually be worked out when the various
aspects of the problem are understood and the organizational mechanism for
the resolution of such problems has been established. Unfortunately, it
appears that either industry in general, does not understand problem fully,
or its solution suffers from limited direction from top management.
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How Balance Specifications Are Developed
Too often design engineers and production engineers resolve between the
selves all four of the major considerations of specifications preparation,
without consulting purchasing or the other concerned departments. This is
regrettable because professional engineers seldom have the commercial
experience and the market information required to resolve the procurement
considerations of specifications. In their attempts to do so, they frequently
develop stringent specifications that do not provide sufficient latitude to
allow effective competition. This is indeed a costly practice for design
engineers to pursue.
When specification conflicts arise, final authority for the decision should rest
with the department having responsibility for the product’s performance.
This is usually the design engineering department. This is not a just able
reason. However, for engineering unnecessarily to subordinate the design
considerations of manufacturing, procurement, and marketing.
From a company viewpoint the right specifications are those that blend the
requirements of all departments. Only such specifications can satisfy the
goals of top management-i.e., increased sales decreased costs, and the
added corporate security which ensue form an increasingly strong
competitive position.
To develop specifications that properly balance product quality

characteristics and product cost. Management use coordinates the firm’s
technical and business sills. Three approaches can be used: (I) the formal
committee approach. (2) The informal approach and (3) the purchasing
coordinators approach.
Formal Committee Approach–This approach recognizes that a good

specification is a compromise of basic objectives. A specification review
committee, therefore, is established, with representatives (as appropriate)
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from design engineering. Production, engineering, Purchasing, marketing,

production (in product design is proposed, all members of the committee
receive copies of all drawings, basic materials, and specifications. No design
becomes final until it is approved by the committee. One electronics firm
estimates that it saves over $ 850,000 annually by using a purchasing–
engineering team to evaluate new specification in this way.
Informal Approach: This approach emphasizes the concept of a buyer’s

responsibility challenge material requests. At the same time, top
management urges designers to request advice from buyers and work with
them on all items that may involve commercial considerations. Emphasis at
all times is placed on person to person communication and cooperation
between individual buyers and designers. Using this approach, a company
oriented, cost conscious attitude is developed at the grass-roots level
throughout the organization.
Purchasing Coordinator Approach: This approach entails creating one or

more positions in the purchasing department for individuals to serve in a
troubleshooting, liaison capacity with the design department. Typically, the
purchasing coordinator spends most of his or her time in the engineering
department reviewing design work just as soon as it comes off the drawing
boards. The coordinator searches for potential purchasing problems in an
attempt to forestall them before they become serious. The purchasing
coordinator approach is the most highly structured, as well as the most
expensive, of the three approaches to purchasing–engineering coordination.
It is also the most effective. Therefore, it should be used whenever
coordination problems stemming from the technical nature of a firm’s
product or from its size justify the cost.
The reader should not infer from this discussion any intent to derogate the
work of the design engineer. None is intended often for reasons of policy
tradition or expediency, the design engineer is required to make decisions
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alone that could be made more effectively in collaboration with others.

Nevertheless, millions of dollars are lost annually through the adoption of
unnecessarily stringent specifications at the design stage.
Activity: 2
1. Before discussing the forms/types of specification, mention of the
forms you know before.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
6.4. Forms of Specifications
A) Market Grades
Grading is a method of determining the quality of commodities. Grades
are a position in scale of qualities and the grade of a commodity is
determined by comparing that product with pre-established agreed
upon standards. Grading is generally limited to natural products such
as lumber, wheat, food products, cotton, coffee, tobacco, hide, etc. The
value of grading as a description of quality depends on the accuracy
with which the grades can be established and the ease with they can
be recognized upon inspection. There are for example, thirteen grades
of cotton, each of which must be determined from an examination of
individual samples. Hence inspection is critically important in buying
many materials by market grade.
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B) Trade/Brand Names
When manufacturers develop and market a new product, they must
decide whether or not to brand is. Branding or differentiating a product
is generally done to gain repeat sales, protect the product against
substitutes, maintain price stability, and simplify sales promotion. The
primary reason most manufacturers brand their products is to obtain
repeat sales. Consumers develop a preference for brands. Therefore,
branded products can generally be sold at higher prices than
unbranded products of similar quality.
Brand-name products are among the simplest to describe on a
purchase order. Thus, they save purchasing time and reduce
purchasing expense. An inspection expense is also low for branded
products. The only inspection required is sight verification of the brand
labels. The brand is the quality ordered. The higher prices usually paid
for name brands thus are offset to some extent by reduce description
and inspection costs.
The statement is often made that when a buyer purchases by brand
mane he eliminates competition by limiting himself to a single source
of supply. If a buyer had to limit his purchases to a single brand from a
single source, this would represent a major disadvantage of purchasing
by brand name. In fact, however, there are very few situations in which
only one brand is acceptable for a given purpose.
Limitation of a Brand Name

 A material that is bought under a brand name is higher in terms of price
compared to those without brand name.
 It tends to exclude other suppliers with similar products. These
limitations can be minimized by ordering those materials based on the
purpose for which the materials are intended for. For example OMO or
equivalent.
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 There is lack of consistent quality unless the manufacturer has a good

production and quality control mechanism.
C) Commercial Standards
Recurring needs for the same materials have led industry and
government to develop commercial standards for these materials. A
Commercial standard is nothing more than a complete description of
the item standardized. The description includes the quality of the
material and the quality of workmanship that should be used in
manufacturing the item. It also includes a method for testing both
materials and workmanship. Commercial standard are a cornerstone
of the mass production system; therefore, they are important to
efficient purchasing and to our standard of living.
All nuts, bolts, pipes, and electric items that are made to standard
specification can be expected to fit all standard application, regardless
of who manufactured the item. Materials ordered by standardized
specification leave no doubt on the part of either the buyer or the
seller as to what is required. Standard specifications have been
prepared for money goods in commercial trade. National trade
association, national engineering societies, the federal government,
and national testing societies all contribute to the development of
standard specifications and standard methods of testing. Commercial
standards are applicable to raw materials fabricated materials;
individual parts and components and subassemblies.
Purchasing by commercial standards is somewhat similar to
purchasing by brand name. In both methods, the description of what
is wanted can be set forth accurately and easily. With the expectation
of proprietary products most widely used items are standard in
nature; hence, they are highly competitive and readily available at
reasonable prices. There are many users of standard products;
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therefore manufacturers who make them can safely scheduled long,

low-cost production runs for inventory. They do not need specific sales
commitments before production. They know that when needed the
materials will be ordered under this specification. Inspection is more
expensive for materials purchased by brand. Commercially standard
products require periodic checking in addition to sight identification to
assure buyers that they are getting the quality specified.
Commercially standard items should be used whenever possible.
They contribute to the simplification of design, purchasing procedures,
inventory management, and cost reduction. Copies of standard
specifications can be obtained from a number of government, trade
association, and testing association sources. In fact, the easiest way
to get a particular specification is to ask a manufacturer to provide a
copy of the standard specification of the materials or product that he
recommends for the buyers intended need.
Advantage of Commercial Standard

 They are cheaper than those purchased without commercial
standards.
 Materials like bolts, nuts and electrical supplies that are produced
per specification can fit to standard application, irrespective of
where they are made
 Avoids misunderstanding (leaves no room between the buyer or
the seller). They have the same understanding as to quality of the
material.
One limitation of Commercial standard is that its inspection cost is
high; it is very hard to inspect all of the materials ordered and
received, because it should be checked against commercial
standards.
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D) Physical/Chemical Specification
Not all items and materials used in industry are covered by
standard specifications or brands. For many items, therefore, a
large number of buying firms prepared their own specifications. By
so doing, these buyers broaden their field of competition. All
manufacturers capable of making item describe in the buyer’s
specification are potential suppliers.
By preparing its own Specifications a company can often avoid the
premium prices of brands and the sole-source problems of
patented, copyrighted, and proprietary products. When preparing
its own specifications, a company should attempt to make them as
close as possible to industry standards.
Specifications are detailed descriptions of the general features/
characteristics of a particular item that are used to define a specific
product quality. These are listing of materials, components used in
making a product. It is verbal and/or quantitative description. It is
one means of communication between the buyer and the sellers.
The materials under this category may not be specified by market
grads, trade/brand name or it may not be standardized to be
specified. Hence, it could be described by physical/chemical
property.
Advantages
Describing quality by physical/chemical specification, on organization can
save premium prices that would be paid on branded materials.
Here, these materials could have a unique feature as compared to those
materials available in the market. Therefore, these special order products
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may have additional prices to be produced. Hence addition or deletion is

possible.
Limitations
 The buyer can assume complete responsibility as far as it is made as

per specifications.
 Require special inspection by comparing with the specification of those
materials received.
Physical specification is a detailed physical condition, sizes or dimensions in

measurable things. Chemical specification involves specifying the products in
terms of chemical composition and it explains the products reaction to
exposure.
E) Performance Specification
Performance Specification, in theory,
theory, is the perfect method of
describing quality. It describes an item in words in terms of what the
item is required to perform. This type of description is used
extensively in buying highly technical military and space products. For
example, the product wanted could be a missile capable of being
launched from a submarine a designated speed, range, and accuracy.
Suppliers are told only the performance that is required. Though
performance is specified in precise detail, they are not told how the
product should be manufactured or what materials should be used in
its manufacture.
Industry uses performance specifications expensive, complicated
machines and machine tools. Today more production machines are
replaced because of technological obsolescence than because of
wear. Therefore, in buying such a machine a firm should make every
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effort to obtain the ultimate in technological advancement. Often this

can be done best by using performance specifications can be
expensive. To reduce and control the expense, buyers should write
descriptions as possible.
Advantages
 Ease of preparing specification
 Assurance of obtaining the precise performance described
 Inclusion of all applicable new developments.
Potential Disadvantages
 In appropriate use;
use; users choose these because it is easy and they
tend to overuse.
 Poor supplier selection;
selection; it is not known in advanced from what
materials it have been made and the supplier may not technologically
capable unless he is honest.
 Unfair pricing;
pricing; Overhanging of prices
F) Materials and Methods of Manufacturers Specification

This type of description is at the opposite end of the spectrum relative
to performance specifications. When this method used, prospective
vendors are instructed precisely as to the specific materials to be used
and how they are to be processed.
Here the buyer dictates the supplier, by telling what type of materials is
required, what type of technology we need for our process of
production, etc. In this case the buyer is assumed to have full
knowledge of technological progress. Material specification describes
the material from which the product is made such as plastic made,
wood made or metal etc…
Material and method-of-manufacturing specifications are used
primarily by the armed service and the department of energy. These
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specifications are used most appropriately in that situation where

technically sophisticated buyers in large companies deal with small
supplier having limited research and development.
Advantages
 Widest competition is possible
 Good pricing is assured
Disadvantages
 It puts great responsibility on the buyer.
 It can deny a company the latest advancements in both technological
developments and manufacturing process.
 Expenses to prepare and expensive to inspect for compliance.
G) Engineering Design and Prints

Engineering Design and Prints method are often used in conjunction
with other methods of quality description. Specially, precise shape,
dimensions, and spatial relationships are required; drawings are the
most accurate method of describing what is wanted. It is applicable
to the purchase of construction, electronic, and electrical assemblies,
machine parts etc…
Advantages
 They are accurate and precise.
 They are the most practical way of describing mechanical items
requiring extremely close technologies.
 They permit wide competition.
 They clearly establish the standards for inspection.
Disadvantage
 High cost that is associated with the design and drafting work of the
item required.
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H) Combination Method
When any one of these methods is not adequate to describe a material
that is required, a combination of these methods is necessary to be
used. Regardless of the method or methods used to describe quality
only the minimum quality needed for the product to perform the
function intended should be specified.
6.5. What is Materials Standardization?

In business practice, the concept of standardization is applied in two
different areas. The first concerned with standardization of things –their size,
shape, color, physical properties, chemical properties, performance
characteristics, etc. this usage of the standardization concept, this frequently
called “industrial standardization. The second application deals with the
managerial aspect of business activity- standardizing such as operating
practices, procedures, and system. This type of standardization, frequently
termed as “managerial standardization.
Industrial standardization can be define as the process of establishing

agreement upon uniform identifications for definite characteristics of quality,
design, performance, quantity, service, etc. A uniform identification that is
agreed upon is called a standard.
There are different levels of standard
 Company standard
 National Standard – Ethiopian Standard (ES), American Standard (AS)
 International standard—ISO
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Summery
 Specifications and standardization are a prerequisite to good

purchasing. Quite often whether a purchase contract will be
performed successfully is not determined at the time the contract
is written, rather it is determined at the time the specification are
written. Specifications are the detailed descriptions of the material
parts and components used in making a product. Whereas,
standardization process of establishing agreement upon uniform
identifications for definite characteristics of quality, design,
performance, quantity, service, etc.
 After the design of a product is determine, the next step is to translate
the individual part and material specifications in to written form. The
need for clarity and precision of expressions is important in all business
communications.
 The cost impact of materials alone clearly dictates that their selection
should be a part of product design. Many materials costs are firmly
engineered into a product’s specifications during the design stage,
long before requisitions are submitted to the purchasing department.
The design stage is the first (sometimes the only) point at which
numerous costs can be reduced and controlled.
 To develop specifications that properly balance product quality
characteristics and product cost. Management use coordinates the
firm’s technical and business sills. Three approaches can be used: (I)
the formal committee approach. (2) The informal approach and (3) the
purchasing coordinators approach.
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 Forms of Specifications are market grades, brand or trade names,

commercial standards, physical/chemical, performance, material and
methods-of-manufacturing, engineering drawings, and combination of
these mentioned.
Study Questions
1. What is material specification?

2. What are the requirements a specification must satisfy to meet the
need of all departments, in the organization.
3. Mention the important considerations in preparing specifications for a
product.
4. Which departments are involved specification review committees
under formal committee Approach?
5. Discuss the different types of specification.
6. List and explain the types of standardization.
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CHAPTER SEVEN
SELECTION OF SUPPLIERS
LEARNING OBJECTIVES
At the end of this chapter, students will be able to:
 Describe the benefits of maintaining good supplier relationship

 Explain the process of supplier selection.
 Recognize the advantage of local buying.
 Understand suppliers' performance evaluation
Introduction
Selecting capable suppliers is one of purchasing managers most important

responsibility. If the supplier is selected, then competitive pricing, reliable
quality, on-time delivery, good technical service, and other goals of
purchasing are more likely achieved. After a competent supplier is selected
however, the buyer has work to do. A good supplier must be assisted,
rewarded, and motivated. And by making premedical evaluations inefficient
suppliers should be eliminated and anew efficient should be developed.
Running a high quality business operation is quite impossible without having

satisfactory suppliers. And this dream can be true through effective and
efficient function of purchasing for its responsible to establish and maintain a
satisfactory group of suppliers. Purchasing is responsible in selecting capable
106

suppliers to achieve competitive price, reliable quality, on time delivery,

good technical service and other at most opportunities to be exploited.
Periodical evaluation of suppliers should be made to screen-out inefficient
suppliers and replaced by effective ones.
Activity: 1
1. What do you think the importance of having good relationship with
suppliers?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
______________________________________________________________________.
7.1. Benefits of Maintaining Good Supplier Relationship
The laws of good business demand the need of a dependable supplier. It is in

the interests of business that you have a dependable supplier chain and
more importantly develop a good and mutually beneficial working
relationship with your supplier. The keywords to developing a relationship
with your supplier are knowledge, communication and expectations.
In today’s world of e-commerce, speed and accuracy are often the standards
that set pace in the buyer-supplier relationship and therefore it becomes all
the more important that this relationship be forged keeping in mind equal
benefits for both the parties involved. A good supplier the initiative in
suggesting better ways of serving customer and attempts to find new ways
of developing products and services which will allow customers to perform
their operations more economically. The good supplier warns ahead of time
107

of materials shortages, strikes and anything else that may affect the buyers
operation. It will remain competitive on continuing basis. The art of good
purchasing department is therefore, to find and keep top suppliers over time.
Good source of supply are one assurance of good quality production today,
and progressive thinking and planning is a further assurance of improved
quality tomorrow. Good source of supply, therefore, are important company
asset –like customer good will. A Company develops customer good will by
selling acceptable products at fair price, supported by a good service with
the customers’ interest–in mind. It develops suppliers’ good will by being
open, impartial, and scrupulously fair in all of its dealing with its suppliers.
A company’s purchasing department should motivate is suppliers to

participate in a mutual advantage of continuing relationship. Good will
between a company and its suppliers need to be just as carefully cultivated
and just a jealously guarded so that many costly errors can be avoided.
The essence of purchasing process is the rational selection of sources of
supply. In selecting sources of supply the purchase officer makes decision
that influences not only his firm’s economic success but livelihood of the
supplier and the efficiency of the entire economy. The following are a few
headers that will help you in creating a good working relationship with your
supplier:
Know your supplier: This is crucial to building a good relationship with your
supplier. Meet your supplier face to face, this gives you as well as the
supplier the perfect opportunity to understand each other personally as well
as professionally in addition to understanding each other’s needs both from
the supplier’s side as well as the buyer’s side.
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It is vital that you know how your supplier works as you will be using his
services for your business. Meet your account handlers and make sure that
they are available to contact at all times.
Placing orders: One of the biggest problems that both buyers and suppliers
face is with respect to placing orders. An order which is placed in time gives
the supplier sufficient time to meet the deadline.
Analyzing your forecast sales in advance and knowing your supply needs can
be very helpful when it comes to predicting and meeting supply deadlines.
Sharing this forecast with your supplier will keep him informed well in
advance and prepared.
Advance payment and clearing of dues: One of the key factors in

maintaining a good relationship with your supplier is the prompt payment of
bills and dues. This will motivate the supplier to work harder to keep up to
your business demands as well keep him happy. Even if you have to make
advance payments, make sure that there are no delays from your end. The
supplier in turn will ensure that there are no delays on his end as well.
What’s in it for me: An excellent way to reap the best from your
association with your suppliers is by making sure that your business is
beneficial and important to him. If you can make your business worth his
while, then the supplier will work harder to step up to your supply demands.
This in turn may also lead to a long term partnership with mutually beneficial
deals on both sides. If you come across a business deal which can be
beneficial to him, pass it on or recommend him. He will be inclined to return
the favor when an opportunity presents itself.
Open and clear communications: Probably the most vital link to a good
relationship with your supplier is open and clear communications. If you have
any specific demands or concerns it is vital that you convey them to your
109

supplier. Likewise be informed of any developments and expansions your

supplier may be taking on which may have an effect on your business. Draw
up and finalize contracts as and when and if needed to steer clear of any
miscommunications on both sides.
In conclusion one must remember that the relationship between the supplier
and the buyer is one of trust and dependability governed by a common
purpose of monetary and commercial gains. The relationship with supplier
which in turn affects the business world as well as the end customers.
7.2. Process of Supplier Selection
Knowledge of sources is a primary qualification for any effective buyer. The

procedure of source selection involves the preparation of an exhaustive list
of prospective suppliers and the successive elimination from this list on
various grounds until the number has been reduced to the one or few to be
favored with the business.
The process is therefore one on searching and sorting–searching for all likely
suppliers and then sorting for the ones with whom to do business.
Preparing a Prospective Supplier List
The first step in the process of selecting a supplier is to prepare a complete

list of prospective suppliers. The following information sources should prove
helpful to a buyer in establishing a list of potential suppliers.
1. Supplier information purchasing file log books

2. Supplier catalog
3. Trade exhibition
4. Visits to supplier plant
5. Trade journals
6. Telephone directors(the yellow pages)
110

7. Filing of mailing pieces–posts

8. Sales personnel
9. Advertisements
10. Visits from suppliers
11. Trade directories
12. Other purchasing department/people and
7.3. Local Buying
Local purchasing is a preference to buy locally produced goods and services

over those produced more distantly. It is very often abbreviated as a positive
goal 'buy local' to parallel the phrase think globally, act locally common in
green politics.
On the national level, the equivalent of local purchasing is import

substitution, the deliberate industrial policy or agricultural policy of replacing
goods or services produced on the far side of a national border with those
produced on the near side, i.e. in the same country or trade bloc.
Historically, there have been so many incentives to buy locally that no one
had to make any kind of point to do so, but with current market conditions, it
is often cheaper to buy distantly produced goods, despite the added costs in
terms of packaging, transport, inspection, retail facilities, etc.. As such, one
must now often take explicit action if one wants to purchase locally produced
goods.
These market conditions are based on externalized costs, argues local

economy writer, Examples of externalized costs include the price of war,
111

asthma, or climate change, which are not typically included in the cost of a
gallon of fuel, for instance.
Despite these externalized costs, support for local farmers is growing as

consumers are re-introduced to more centralized agriculture within their own
community. Purchasing locally can be broadly defined, so that it does not
necessarily apply to merely buying from the crop production field but can
also be applicable to local economic investment. This means that
international/inter-state trade is still maintained but perhaps the products
are packaged by local distributors and sold in community markets. In this
way, money is still finding its way back into the local economy.
Agricultural alternatives are being sought, and have manifested themselves

in the form of farmers’ markets, farmed goods sold through the community
cooperatives, urban gardens, and even school programs that endorse
community agriculture.
7.3.1. Rationale for Local Purchasing
Advocates often suggest local purchasing as a form of moral purchasing.

Local purchasing is often claimed to be better for the environment and better
for working conditions.
The first potential moral benefit is environmental: Bringing goods from afar
generally requires using more energy than transporting goods locally, and
some environmental advocates see this as a serious environmental threat.
Transportation contributes to environmental contamination in addition to the
pollution caused by chemical inputs in the growing phase. Of course, locally
produced goods are not always more energy-efficient; local agriculture or
manufacturing may rely on heavy inputs (e.g. industrial agriculture) or
energy-inefficient machinery and/or transportation systems. However, small-
scale growers tend to be more environmentally friendly because industrial-
112

sized agriculture uses genetically modified crops, monoculture production,

and chemical fertilizer intensive processes to grow crops—practices that
local farmers typically avoid.
The second potential benefit is creating better working conditions.

Nonetheless, while diverting purchasing from developing countries to local
farmers helps build the local economy, it can lead to worse conditions for
poor farmers in developing countries because it removes potential buyers
from the market.
The goal of localization is not necessarily to eradicate globalization; rather, it

is to reduce unnecessary transport and to strengthen and diversify
community economies. This calls for condensation of agriculture and
supports the idea that local farmers are capable of sustaining a community.
Activity:2
1. Identify source of information for potential suppliers.
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
2. What is the reason behind to local buying?
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
________________________________________________________________________
_______________________________________________________________________.
113

7.3.2. Benefits of Buying from Local
Shopping Locally Helps Boost Local Economy and Support

Communities
Competition from large national chains has put countless independent-

owned business out of practical in recent years. Since the economic
downturn, consumers are continually hunting for bargains that will make
their pennies go further. But shopping locally helps to have money in many
ways and local stores are often cheaper, and close at hand, allowing
customers to save on their purchase as well as transport and parking
charges. Here, are more reasons why shopping at a locally owned and
operated independent sellers is good for economy and the local community.
Stimulates Local Economy and Helps Other Business
Independent merchant’s retailers rely greatly on the custom of local

residents. Buying locally allows them to stay in business while investing back
in to community. As local business owners generally trade with other local
business such as manufacturers and suppliers they often help support one
another while ensuring that their monies stay in local community. Very often
the survival of many local businesses dependent upon that of local sellers.
Local privately-owned business like the dentists, opticians, hair salons within
the vicinity of an independent seller store has are likely to be affected if
customers shop less frequently as money spent in local stores has a direct
impact on the local economy. Customers who shop locally help to preserve
local jobs and encourage entrepreneurial skills which to the welfare of the
local economy.
Encourages Local Investments and Creates Employment
Independent shop owners value local residents and appreciate their custom.
As such they are much more likely to sponsor local events and invest in
114

community projects than national chains that have to go through their

hierarchy of power in order to get productive results of the community. Local
business tend to grow with their communities and as they need to employ
more people from delivery drives to window cleaners and workers. So
shopping more at the locally-run store will bring more revenue to the
business which will then lead to a sound investment to expand the business
and in turn create more jobs for local residents.
Positive Impact on the Environment
Unlike national chains which sell stock from all over the world, local stores
usually obtain their stock from local suppliers and procedures. Selling local
products generally involved little transportation of the goods which means
there will be less air pollution. And those concerned about food miles will
discover that food products obtain locally will be fresher and more nutritious
than those which have traveled thousands of miles to reach the store
shelves. From a much greener standpoint, shopping locally also to protect
the environment since local stores are closer and there is sometimes no
need to drive which results in less carbon footprints.
Develops a Strong Community Bond
Independent retailers are essential are in building a strong unity in the

community which makes it a pleasant place for every to live in. they identify
customers’ needs and delivery and are likely to respond to their requests for
specific products much more efficiently than bigger retailers that have to go
through the rigmarole of surveys and market research.
Consumers play a vital part in helping independent shop owners to survive

the brutal price wars often instigated by giant store chains. Local stores tend
to be much cheaper than their bigger counterparts when taking into account
all the costs- like fuel, parking, and bus or taxi fares-involved in getting to
115

and from bigger yet often isolated shops. Shopping locally would allow local
stores to survive and ensure that they stay in the neighborhood.
7.4. Suppliers’ performance Evaluation
After the list of possible suppliers has been compiled, the next step is to
evaluate performance of each supplier so that the list may be narrowed
down to the predetermined number with whom the buyer chooses to place
her/his business.
It is not always easy to evaluate potential suppliers because it often requires

an extensive amount of time and resources. There are several types of rating
system as to price, quality, delivery time, service, etc based on statistically
measurable criteria. In evaluating potential sources the most common
factors are stated below.
 Reliability
The most obvious factor is the quality capability of the vendor. Stability
and reputability are also other factors to consider in rating the
reliability of the vendor. Financial stability and strength are also
indictors of good management and reliable competitive ability. The
financial strength and weakness of a supplier obviously affect its
capability to respond to the needs of customers.
 Technical Capability
The capability of the supplier to provide engineering and design
assistance should be evaluated. The stage of supplier’s technological
development and his interest in keeping up with current methods are
also consideration affecting service. The inspection methods and the
quality control standards maintained by the prospective supplier are
also important in evaluating service. Since assurance of supply means
not only that the goods will be delivered, but also that they will be in
116

usable condition, it is important that these two criteria inspection and

quality control- be carefully checked before the choice of supplier is
made.
A closely related consideration that bears on supplier service is the

“housekeeping” or plant-maintenance standard carried out by the
supplier. A supplier who is careful and thorough in his plant
maintenance practices is likely to suffer from a minimum number of
production disruptions resulting from machinery breakdowns and
similar mishaps. Since production disruptions frequently lead to delays
in shipments to customers, they decrease the assurance of supply
which is an important consideration in service.
 Delivery performance
This refers to the ability of the potential supplier to provide materials
on the scheduled time. It also includes the availability of stocks locally
or at short notice to effect emergency orders. A consideration of the
location of the supplier is also important. Because, shipments from a
supplier located at a great distance from the buyer’s plant are subject
to more and greater risks of interruption such as accidents, strikes, and
floods, because of the distance and time involved in transportation. At
the same time, the possibility of using substitute modes of
transportation is lessened as distance increases.
 Service
Good service by the supplier is found to reduce the buyer’s workload,
increase the usefulness or availability of the product, and diminish the
uncertainty associated with buying decision. It includes both presale
services such as credit facilities, warranties and discounts; post sale
117

services installations and training of personnel, maintenance,

transportation service and other technical assistance.
 Financial Stability
If a supplier cannot meet obligations due to financial problems, your

own reputation with customers may suffer. There are agencies that can
help you investigate supplier credit history. You can also run supplier
verification report to see if this company is a real business.
 Quality and Continuous Improvement
Ultimately the quality of your product is directly impacted by the level

of product quality provided by your suppliers. Given the variety of
product offerings on the market, this parameter is relative to your own
quality standards. You can start by ordering a sample from a supplier
in question. But your much better option is to order a factory audit or
product inspection service.
 Competitive Pricing
Pricing of products or services when compared with other potential

suppliers, you might not have enough information about other
suppliers but you can certainly review several options using supplier
directories or by working with sourcing agents with full representation
of local suppliers.
 Labor Relations
Another possible inference with the continuity of production in a
supplier’s plant may originate with the workers themselves. These
stoppages may be in the form of strikes or slowdowns and are the
byproduct of the labor relations of the supplier. To a considerable
118

extent, the possibility of the leadership of the union associated with

the plant.
Activity: 3
1. What do you know about the objective methods of evaluating
suppliers?
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
__________________________________________________________________.
7.4.1. Supplier’s Evaluation Methods
Usually the most important measurement of a supplier’s service is his record

of performance in previous transactions. The standard of actual performance
is tangible and concrete, where as the other yardsticks measure
performance only by inference and often very tentatively. In recent years
increasing attention has been directed to determining objective standards
and procedures to evaluate and compare existing suppliers.
Three evaluation techniques have been developed these are:
A. categorical methods
B. Weighted Point method
C. Cost ratio method
A. The Categorical Method
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The categorical plan is the least precise of the evaluating techniques. It

relies heavily on the experience and ability of the individual buyer.
Essentially it consists of a procedure whereby the buyer keeps a record of
all vendors and their products. After establishing a list of factors for
evaluation purpose, the buyer assigns a grade indicating performance in
each area. A marketing system of plus, minus, or neutral is usually used.
In addition evaluating lists are given to all departments involved with the
supplier merchandise; such as the quality control, production, and
receiving departments. At periodic evaluation meetings the buyer
discusses the ratings with representatives of these departments. Later,
those suppliers composite high or low rating may be notified and future
business allocated accordingly.
Although this system is non-quantitative, it does provide a means of

systematic record keeping of performance criteria. It is also inexpensive
and requires a minimum of performance data. However, it relies heavily
on the memory and judgment of the individual doing the rating, and the
possibility exists that rating will become a routine chore performance with
a minimum of critical thought.
B. The weighted Point Method

In this method the number of factors such as the objectives of the
organization, its product and economic conditions of the organization are
included. The relative worth of these factors as compared to each other
will give a composite performance index. The relative worth of these
factors varies from products to products, organization to organization.
The following are the maximum but average points for the best performance.
Factor Average Points
A. Quality 35
120

B. Price 30
C. Delivery 20
D. Service 15
Total 100
The points are allocated based on the nature of the products for example, for
toys quantity is less important but the attraction and price are of main
considerations while for air craft components quality aspect is more
important as compared to price.
Note
This method is used for suppliers who have past relations with the firm
because it take past records in to consideration.
Example
Assume that an organization has chosen the following evaluation criteria

along with their relative weights as a basis in the evaluation process.
Criteria for evaluation Relative Weights
Quality of shipment 40
Accuracy of delivery premises 30
Frequency of cost – reduction suggestion 20
Price 10
100
The organization has also set acceptable and unacceptable rang for the
composite rating where at least 85% is excellent, 70-84% is acceptable and
121

60% or less is unacceptable. The following hypothetical performance figures

also provided about three suppliers or vendors.
Vendo Total Percentag Cost Quality of Price

r Shipment e of reduction good (in Birr)
shipment suggestio shipment
Received
Arrived on n
schedule
A 100 80 20% 90% 40
B 60 90 20% 80% 50
C 50 100 60% 70% 60
Given the above information which of the vendor stands best? Use the
weighted point method.
Solution
The composite rating comparison will be as follows:
Vendo Quality % of Cost Price rating Com

r Rating shipment reduction % x 10pts posit
(% of Quality arrived on rating % x e

time x 20 pts) ratin
x 40 pts)
30pts) g
A 0.9 x 40 = 0.8 x 30 = 0.2 x 20 = 1.0 x 10 74

36 24 4 =10
B 0.8 x 40 = 0.9 x 30 = 0.2 x 20 = 0.8 x 10 = 71
122

32 27 4 8
C 0.7 x 40 = 1.0 x 30 = 0.2 x 20 = .67 x 10 = 76.7

28 30 12 6.7
Note:
 The quality rating can be obtained by multiplying the percentage of

quality shipment by the weight of quality given in the evaluation
criteria.
Example:- The quality of good shipment for vendor A is 90% so the
quality rating will be 90% x 40 (weight of quality ) = 36 point out of 40
points
 The delivery rating and cost reduction rating will also be computed like
the quality rating.
 The computation of price rating involves two steps.
Step 1-
1- Develop the percentage for the different unit prices as
follow
Average price per unit Percentage
40 100 % (because it is the lowest

price)
50 80%
60 67%
We can develop the percentages by dividing the lowest price by the

prices offered by the vendors.
Therefore A = 40/40 = 100%
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B = 40/50 = 80%
C = 40/60 = 67%
Step 2-
2- Multiply these rates by the weight of price.
Based on the above analysis vendor C is selected as best supplier

with the overall highest point of 76.7
C. The Cost–Ratio method

In this method a list of supplier’s service is established in relation to the
price. In this method the objective is to evaluate the suppliers on the basis
of proceeding considerations. Here the highest the ratio of costs to the value
of shipment, the lower is the chance of selection for the supplier and the
lower the rating for a suppler. The cost categories that may be used in the
evaluation process will depend upon the type of firm or products.
We should identify elements which express quality, delivery, service and

price in order to evaluate supplier by finding the cost ratio of each factor.
i.e.
1. Quality–cost ratio = Total Quality Cost x 100
Total Dollar/birr of Purchase
2. Delivery cost ratio = Total Delivery Cost x 100
Total Shipment
3. Price Ratio = Total lowest Price x 100
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Actual Price
4. Service cost Ratio- In this case we need to establish a norm or

standard of service requirements and then we can
evaluate the supplier to see whether they fall above
or below the standard. Finally we should relate it to
the quoted price.
How to integrate the service ratio to the cost-ratio method?
In order to integrate the service ratio to the cost ratio method we may apply
the following procedure;
1. Determine the important subjective service factors & assign numerical

weights to each factor according to its importance to the buying firm.
2. Establish a premium over quoted price that the total subject service
package worth.
3. Determine an acceptable norm.
4. Rate the suppliers according to the service factors.
5. Determine by what percentage the supplier being rated is above or
below the acceptable norm.
6. Apply this percentage to the total value of the total service package to
determine the service-cost ratio.
Example:
Suppose you are a purchasing head of a company & you are required to
select the best supplier from among four suppliers named Mr. A, Mr. B, Mr. C
& Mr. D by evaluating their last year performance. Factors of analysis
include quality, delivery, service & price. Given the following data on
supplier performance, forward your proposal to higher officials using the
cost- ratio method.
Delivery Costs:
(Birr)
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A B C D
Telephone Call 400 100 200 300
Telegrams 475 275 425 200
Expediting 875 300 975 750
Premium shipment 750 225 900 950
Miscellaneous 500 300 700 600
Total Delivery Cost 3000 1200 3200 2800
Data related to Quality
(Birr)
A B C D
Visited Vendor Plants 300 500 400 200
Sample approval 400 700 800 600
Incoming Inspection 100 275 250 225
Manufacturing Losses 0 100 325 700
Reworking Cost 0 425 450 400
Value of rejects parts 200 1600 975 675
Total Delivery Cost 1000 3600 3200 2800
Service Rating
(Service Point)
Factor of Evaluation Maximum Point A B C D
A. Financial Stability 20 20 18 15 15
126

B. Field Service 25 20 21 15 12
C. Labor Relation 10 8 10 10 8
D. Geographical Location 15 10 15 6 0
E. Flexibility in Providing the
Item with in short period 5 5 5 3 5
F. Expansion Capacity of
the supplier 10 10 8 7 9
G. Warranty Provision 10 8 10 8 0
H. Miscellaneous 5 3 4 0 0
100 84 91 56 49
Assume that the service rating is 60 points and the maximum value of
service package is 20% of price.
Additional Information
The total value of shipment (purchase) & the quoted prices are given as
follows.
Vendor Total Value of Purchase Quoted Price
A 100,000 Br. 85
B 120,000 Br. 86
C 80,000 Br. 82
A 140,000 Br. 83
127

Given the above data, which supplier is the best based on the cost-Ratio
method.
Solution:
1. Compute the Quality Cost Ratio (QCR) as
QCR = Total Quality Cost
Total Value of Shipment
Supplier QCR
A (1,000/100,000) x 100 1%
B (3,600/120,000) x 100 3%
C (3,200/80,000) x 100 4%
D (2,800/140,000) x 100 2%
2. Compute Delivery Cost Ratio (DCR) as
DCR = Total Delivery Cost
Total Value of Shipment
Supplier DCR
A (3,000/100,000) x 100 3%
B (1,200/120,000) x 100 1%
C (3,200/80,000) x 100 4%
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D (2,800/140,000) x 100 2%
3. Calculate the Service Cost - Ratio (SCR)
Supplier Present rating SCR (% rating x Value of Service)
A 84 (84/60)100 = 140-100 = 40% x20 = 8%
B 91 (91/60)100 = 151.6-100=51.6%x20 = 10.3%
C 56 (56/60)100 = 93.3-100 = -6.7%x20 = -1.33%

D 49 (49/60)100 = 81.6-100 = -18.3% x 20 = -
3.67%
N.B. The acceptable service rating is 60 points & the service package is
valued at 20% of price. In order to calculate SCR, first determine the
percentage by which the rated supplier is above or below the acceptable
norm. For example, for supplier A the percentage is 40% which means the
supplier A is 40% above the acceptable norm. Then apply this percentage to
the total value of the service package to determine the SCR.
A positive sign of SCR indicates advantages. i.e. they will reduce quoted
price & a negative sign indicates under performance. i.e. they will increase
the quoted price.
Finally combine QCR, DCR SCR with the quoted price to determine the
vendors Net Cost.
1 2 3 4
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Supplie QC DC SCR Total Quot Net adjusted price

r R% R% % Cost ed
adjust Price
ed
A 1 3 -8 -4 85 85+(85x.04) = 81.6
B 3 1 - -6.33 86 86+(86x-0.063)=
10.3 80.56
3
C 4 4 1.33 9.33 82 82+(82x0.0933)=

89.6
D 2 2 3.67 7.67 83 83+(83x0.0761)=8

9.
37
Conclusion- The best candidate is B, Next is A, 3rd D and 4th C.
Summery
 Selecting capable suppliers is one of purchasing managers most

important responsibility. If the supplier is selected, then competitive
pricing, reliable quality, on-time delivery, good technical service, and
other goals of purchasing are more likely achieved. After a competent
130

supplier is selected however, the buyer has work to do. A good supplier
must be assisted, rewarded, and motivated.
 In today’s world of e-commerce, speed and accuracy are often the
standards that set pace in the buyer-supplier relationship and
therefore it becomes all the more important that this relationship be
forged keeping in mind equal benefits for both the parties involved.
 The essence of purchasing process is the rational selection of sources

of supply. In selecting sources of supply the purchase officer makes
decision that influences not only his firm’s economic success but
livelihood of the supplier and the efficiency of the entire economy. The
following are a few headers that will help you in creating a good
working relationship with your supplier: Know your supplier, placing
orders, advance payment and clearing of dues, what’s in it for me, and
open and clear communications.
 Knowledge of sources is a primary qualification for any effective buyer.

The procedure of source selection involves the preparation of an
exhaustive list of prospective suppliers and the successive elimination
from this list on various grounds until the number has been reduced to
the one or few to be favored with the business.
 Local purchasing is a preference to buy locally produced goods and

services over those produced more distantly. It is very often
abbreviated as a positive goal 'buy local' to parallel the phrase think
globally, act locally common in green politics. On the national level, the
equivalent of local purchasing is import substitution, the deliberate
industrial policy or agricultural policy of replacing goods or services
produced on the far side of a national border with those produced on
the near side, i.e. in the same country or trade bloc.
 After the list of possible suppliers has been compiled, the next step is
section and evaluates performance of each supplier so that the list
131

may be narrowed down to the predetermined number with whom the

buyer chooses to place her/his business. Now we can apply both
qualitative (subjective) approach and quantitative approaches. The
subjective evaluation approach compares suppliers based on the
suppliers’ ability to provide the desired quality and quantity, price,
Reliability Technical Capability Delivery performance Financial Stability
Quality and Continuous improvement Labor Relations and services of
the suppliers. The objective (quantitative) approach starts with
identifying the evaluation criteria and quantifying them. Here there
are three methods of quantitative evaluation methods. These are
categorical methods, weighted
eighted point method, and cost ratio method.
Self Exercise Questions
1. Mention and discuss mechanize in creating a good working relationship

with your supplier.
2. Write possible sources information which helpful to a buyer in
establishing a list of potential suppliers.
3. Specify the reasons for local buying and benefits of local buying.
132

4. Elaborate the goal of localization buying.

5. Discuss both the subjective evaluation approach and the objective
(quantitative) approach of suppliers’ evaluation methods..
Text:
 Doblelr, D. and Burt, D. (1996): Purchasing and Supply

management (6thed.) McGraw Hill Publishing Co.: New Delhi.
Required Reference
133

 Baily, Peter, (1985) Purchasing Systems and Records, 2nd ed.,

Biddles Ltd, Gower Publishing Company Ltd.
 Burt N. David, Donald W. Dobler and Stephen L. Starling, (2003):
World Class Supply Management: The Key to Supply Chain
Management, 7th ed., Tata McGraw-Hill pub. Co., Delhi,
 Gopalakrishnan, P. (1981): Purchasing and Materials

management. McGraw Hill publishing Co.: New Delhi.
 N. K. Nair (2005): Purchasing and Materials management. Vikas

publishing house pvt ltd.
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Applications, 8th ed. Prentice-Hall Inc., Englewood Cliffs, N.J.,
 Richard Lamming and Andrew Cox.( 1999): Strategic Procurement
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Principle of Purchasing I

After successfully completing this chapter, students should be able

 Define the term “purchasing”

 Compare and contrast purchasing with procurement

 Indentify basic importance and objectives of purchasing

 Identify the purchasing relation with other departments

1.1. Nature of Purchasing

No organization is self-sufficient. Every organization is in varying degrees,

In many organizations, materials form the largest single expenditure item.

Department of Logistic and Supply Chain Management

Purchasing is an organizational activity concerned with acquisition of

 Right quality. Quality has no meaning in purchasing except as it is

Quality frequently defined as “Fitness, merit, excellence”. The best

 Right quantity –refers to the quantity adequate enough to serve the

 Right Time-is making the materials available when it is required. It is

 increasing of operational cost e.g. wage

 Temporary lay off

 decline in profit & sale

Department of Logistic and Supply Chain Management

 laying behind planning horizon

 shift of customer to competitors, loss of

market share, etc

 Right price–is buying required quality and quantity material with

 Right source (supplier)–It is looking for right supplier that means

1.2. Purchasing Vs Procurement

The purchasing function comprises of essential the activities

The major activities are:

 Co-ordination with user department to identify purchase need

 Discussion with sales representatives

Department of Logistic and Supply Chain Management

 Identification of potential suppliers

 Conduct of market studies for important materials

 Negotiation with potential suppliers

 Administration of contracts and resolution of related problems

 Issuance of purchase orders

 Maintenance of a variety purchasing records

The procurement process or concept encompasses a wider range of

Specific activities usually included in the procurement process are:

 Participation in the development of material and service requirements

 Conduct of materials studies and management value analysis activities

 Conduct or more extensive materials market studies

 Conduct of all purchasing function activities

 Management of supplier quality

 Purchase of inbound transportation

 Management of investment recovery activities (salvage or surplus and

Department of Logistic and Supply Chain Management

In essence, procurement tends to be broader and more proactive, with some

1.3. Objectives of Purchasing

Objective of purchasing: the standard statement of overall objectives of the

A more specific statement of the overall goals of purchasing would include

1) Provide Uninterrupted Flow of Materials, Supplies, and

Stock outs of raw materials and production parts would shutdown an

Department of Logistic and Supply Chain Management

It involves an understanding of supplier’s cost structure, and then to

4) To keep Inventory Investment and Inventory Losses at a

The inventory level of materials/supplies that should be maintained at

Through proper buying, packaging and storing, it is also the

5) Maintain Adequate Quality Standards

To produce the desired produce or service, a certain quality level is