THE PURCHASING MANAGEMENT FUNCTION

6. THE PURCHASING MANAGEMENT FUNCTION

LEARNING OUTCOMES: After you have read this topic you should be able to:

 Explain other concepts or approaches to the provision of materials to a business  Discuss the role and importance of the purchasing function in the success and efficiency of a

business  Describe certain management aids at the disposal of the purchasing manager  Discuss the purchasing function and the nature of purchasing activities in a business perspective

6.1. PURCHASING IN PERSPECTIVE

The purchasing function is that function that satisfies the business’s needs in the most effective way (lower prices)

The activities of the purchasing function

 Select suppliers  Purchase and arrange for the transport of materials to the business  Decide what prices to accept  Determine quantity and quality of materials/services  Expedite and receive materials  Control warehousing and inventory holding

Purchasing management involves the planning, organising, leading and controlling of all activities relating to the purchase of materials and services from an external source aimed at increasing the business’s profitability. Purchasing managers use management aids to facilitate their task e.g. benchmarking, purchasing budgets, purchasing policy, and techniques include negotiation, purchasing research, price analysis and learning curves.

6.2. BROADENING THE PROVISION FUNCTION

 Materials management- combines all materials provision activities under one head- the materials manager. This eliminates the conflicting objectives of different materials provision activities by combining them under one person- (materials manager).

 Logistics Management- integrates all movement (transport) and warehousing activities, place of purchase (materials) - transformation process to the final consumer. Certain activities of purchasing, operations and materials managers are under logistics manager.

 Supply chain management- an extension of system approach (internal functions of the business

i.e. marketing, finance, production, human resources) are managed as an integrated fashion, the fashion, the flow of materials in all the linked organisations, from the raw product to the end i.e. marketing, finance, production, human resources) are managed as an integrated fashion, the fashion, the flow of materials in all the linked organisations, from the raw product to the end

Specific activities include information systems, purchasing product scheduling, orders, inventory management, warehousing, client services and recycling.

6.3. THE IMPORTANCE OF THE PURCHASING FUNCTION TO THE BUSINESS

Purchasing costs are the greatest expense to any business. It has been found that in retailing businesses approximately 90% of each rand is spent on purchases and 60% in manufacturing costs. Therefore purchasing costs is an area where cost savings can make a vital contribution to the profit of a business.

 Inventory Holding: Stock is held to prevent disruptions in the production or operational processes. The aim is to keep inventory levels low without risking an interruption in the operational process. The reason behind this is large sums of operating capital is tied up in inventory and could earn revenue if invested elsewhere. Effective purchasing management can eliminate inventory holding.

 Profit Leverage: This means that if purchasing costs constitute a major portion of the total costs of a business, a saving in purchasing costs has greater profit potential that a similar increase in sales e.g. 4% reduction in purchasing costs can make the same contribution to profitability as an increase of 20% in sales. The contribution of effective purchasing to profitability differs in each business.

 Contributions to the marketing of products: Purchasing materials of the right quality and price at the right time, manufacturers can offer final products in the right quantities at a competitive price of the right time in the market.

6.4. THE MANAGEMENT TASK OF THE PURCHASING MANAGER

 Purchasing planning-this means managing the purchase function for the future. Purchasing objectives and plans are drawn applying the resources (people, physical facilities and funds) to achieve these objectives. Purchasing planning must be conducted in consultation with other functional management areas (marketing, operational and financial). The following levels are essential in purchasing planning.

-Strategic level: Purchasing manager provides input to business planning. Involves long-term planning and includes elements such as purchasing research, availability forecasting and purchasing policy.

-Tactical or middle management level: covers medium term needs, budgeting, the purchasing system and organisation, purchasing methods negotiation, development of human resources etc.

-Operations level: short term and includes planning the tasks of expediting, keeping records and -Operations level: short term and includes planning the tasks of expediting, keeping records and

Purchasing objectives that can be derived from the business’s objectives Business Objectives

Purchasing Objectives

 To retain market share  To provide materials of the right quality in the correct  To move from the specialty market

quantities at a competitive price

to the general market  To seek new and larger suppliers and develop a new  To develop specific new products

materials flow system to handle larger quantities and a and services

greater variety items while keeping total inventory  To develop an overall production

volume as low as possible

capacity plan, including an overall  To seek or develop new suppliers make or buy

 To develop systems that integrate capacity planning  To initiate a cost reduction plan

together with a policy of make or buy  To standardise materials and reduce suppliers

The place of the purchasing department in the organisational structure Affected by 3 elements

Centralization or decentralization

 Centralized structure-allows for the standardization of purchases cost saving because of volume orders offered at discounts. Gives the business increased buying power lower prices negotiated.  Decentralization- suited to a business that has plants geographically dispersed, who supports local suppliers. Buyers have close contact with users and reaction time to the requests is quicker.  Combination of centralized and decentralized - the middle course. Centralization offers long- term contracts on behalf of the entire business. Decentralization provides the special needs and

small purchases of the plant.

Integration of purchasing and materials flows of activities Organisation of provision activities according to the materials management approach Figure 6.1

Director: Materials

Operations

Materials

Purchasing

Inventory

Materials

planning and

Systems

Manager

control

handling, and

control

Managers

Manager

operations

Manager manager

Internal organization of the purchasing department-organization- may comprise an informal structure in which buyers purchase any material/service, processing any queries on their desk. The buyer is responsible for all purchases from a specific supplier-in case of strategic materials. Can be divided into:

 Purchasing and negotiation- purchasing staff responsible for choosing suppliers  Follow-up and expediting-solving problems with suppliers  Administration-preparation and dispatch of purchasing documents, records etc.  Purchasing research- collection, analysis and classification of information whereby decisions are

made.  Inventory holding- warehousing and inventory  Disadvantage- staff becomes stereotyped and cannot develop further

Co-ordination with other functional management areas

The purchasing department has to operate in co-ordination with other departments to make an optimal contribution to the business. Finance, marketing and production are areas that are closely co-ordinate with the purchasing department.

Cross functional teams

This is meant to show the ability of the purchaser to work with groups and show leadership qualities. The following applications are identified:  Commodity sourcing strategy  Sourcing  Supplier evaluation  Supplier certification  New product development

Control in the purchasing department

Purchasing control ensures that purchasing objectives are pursued within acceptable and accepted standards or norms/guidelines.

-The assessment of purchasing management

Management performance should be evaluated like other activities as it influences overall job performance. Management is intangible and difficult to measure quantitatively.

-The assessment of purchasing activities

Aim of the purchasing department is to supply the business effectively with the right materials, quality and price. Certain criteria must be used to realize the effectiveness of the activities.  Price proficiency – comparing prices and determining discounts  Supplier’s performance-receiving late deliveries (no of time), rejected orders etc.  Timeliness – examining the rescheduling of orders, shortages etc.  Cost-saving- comparing cost with previous periods  Workload: orders and requisitions  Purchasing costs: expression of administrative purchasing costs as a percentage  Inventory holding: calculation of inventory turnover and enquiries into inventory losses and

obsolescence of stock  Relationship performance: survey or scrutiny of supplier turnover

 Relationship with other functional management areas: monitoring the replies to the requests of the purchasing function

6.5 THE PURCHASING CYCLE

The steps in purchasing cycle are divided into 3 categories:  The notification phase –the purchasing department is informed –need  The order phase-processes the order by acknowledging the documentation process  The post order phase- dealing with problems and making payments

Steps

 The development and description of a need  Choice of supplier  Determine prices  Placing an order/concluding a contract  Expediting and follow up  Receipt, inspection and discrepancies  Paying for the order  Closing the order

6.6 QUALITY DECISIONS AS A PURCHASING ACTIVITY The role of quality

3 factors are important  Quality  Supplier service  Price

Quality is the most important of the above. It forms an inseparable part of other purchasing activities.

6.7 DECIDING ON PURCHASING QUANTITIES The need for inventory holding

Marketing and production /operations budgets solely exist on estimates, and because of unreliable delivery and quality, inventory holding exists. Inventory is held in 2 reasons.

 To ensure that the operations process can continue without interruptions (shortage of materials)  To utilize cost savings

Implications of inventory positions Disadvantages

of

too much

Disadvantages of too little inventory inventory

 Operating capital is tied up  Higher unit prices as a result of smaller orders with the resultant opportunity

 More urgent with concomitant higher order and interest costs

and transport costs and strained relations with  Losses in terms of

suppliers

depreciation, obsolescence,  Cost of production or job interruptions and the damage and theft

accompanying strained relations with users or  Costs in terms of storage

marketers in the business

space (rental or interest),  Lost sales because of empty shelves in the more warehouse staff and

retailer and the resultant negative influence on equipment

and

bigger

its image

insurance premiums

Inventory costs

Inventory carrying costs- keeping inventory (storage, salaries, insurance) Inventory ordering costs-costs of placing an order Total inventory costs-sum total of inventory carrying costs

Inventory control systems

Inventory must be controlled so that optimal inventory level can be maintained, so that the best service can be offered at the lowest possible price (cost).  Systems of fixed order quantities- each time new inventory is required, a fixed quantity is

ordered.  The cyclical ordering system – inventory is checked and review at fixed intervals is a

supplemented by an order to bring the inventory level to a maximum.  Materials requirements planning system (MRF)- computer assisted system whose aim is to

maintain minimum inventory levels  Just-in-time (JIT)-a production scheduling system not an inventory system. Eliminates the holding

of inventory, suppliers are to deliver materials in time (when they are needed)

6.8 THE SELECTION OF SUPPLIERS

 Affirmative action- addressing the inequalities of the past, increasing pressure on South African businesses to give disadvantaged suppliers the opportunity to enter the market

 Materials or service not available-if a need or service is required and not available from the

market, a contract can be entered into with another supplier to provide the service/product  Normal performance appraisal – indicates supplier’s weakness, help to maintain long-term ties with suppliers.

6.9 PRICING DECISIONS

The best price: price is a decisive factor. Lowest price is not always the best. A buyer must obtain the highest value for the business. Prices must be reasonable and allow the purchaser to become

competitive in the market.

Preferences in price comparison

Purchasers adopt a policy of allocating a specified preference percentage to certain suppliers. In some instances, preferences are statutorily enforced. The purchasing policy may also be examined.

The influence of inflation

If suppliers request a price increase, they should substantiate it, and the buyer can conduct a cost of price analysis, to determine whether it is justified.

Factory influencing the scheduling of purchases

 Internally – business policy may present buyers from buying speculatively and not able to use bargain offers.

 Externally- concern market conditions and government regulations  Recessions- favourable buyers’ market, decrease in price because of decrease in demand.  Boom period- economic activities are high and demands increase

Market structures and the scheduling of purchases

Stable markets- buyers purchase materials to obtain optimum inventory of materials. Unstable markets- major price fluctuations in price and availability of materials Structured markets- facilitate international trade

Policies for purchasing at the right time

 Scheduling purchases according to needs  Advance purchasing  Speculative purchasing

 Minimum purchases

6.10 NEGOTIATIONS IN PURCHASING

Negotiation between buyer and seller requires a common understanding about the assignment and execution of the contract.

Negotiation is used mainly in cases where:

 Unique or complex materials are purchased for the first time  The supplier is in a strong position in the market  There are few suppliers in the market  There is price collusion between suppliers  A buying transaction is accomplished by a service or maintenance contract  Price increases are requested

TOPIC 7