Chapter Three

1. Chapter Three Purchasing and Materials Management

2. Review of Chapter Two • 4-stage relationship development process: Essence of each stage Awareness – buyers & sellers engage in “arms-length” evaluations of potential partners; Exploration – interaction occurs and tentative associations may form; Expansion – increasing dependence between exchange partners. One party has made a successful request for adjustment & start to seek more from current partners; Commitment – partners adapt & resolve disputes internally in order to sustain the relationship. • Mechanisms to sustain strategic relationships House calls; trading places; managing dependence; supplier pledges; contracts and ownership

3. Learning Objectives • Understand the basics of supply chain management • Discuss the objectives of purchasing department • Explain ideas of “appropriate quality”, “EOQ” and “total cost of ownership” • Describe the processes that purchasing uses to evaluate vendors and their offering, as well as how the process varies depending on the organization’s experience • Recognize the major ethical issues facing purchasing agents and how they respond to those issues • Understand differences in government purchasing

4. Supply Chain Management • Supply chain management involves proactively planning and coordinating the flow of products, services, and information among connected firms focusing on creating and delivering value to end users. • The goal of SCM is purchasing and logistical efficiencies (The profit impact derived from purchasing and logistical efficiencies often outweighs that from market penetration). • Why has SCM “come to the forefront” in recent years? – Technological advancements and global competition have FORCED marketers to seek ways to improve marketing satisfactions (faster distribution /better pre/post sale service), shorten production times, and lower costs. These can be achieved by an efficient SCM.

5. The Objectives of Purchasing • Secure appropriate levels of the supply of the right product or service (Quantity) + • Secure the correct level ofquality (Quality) + • Secure the lowest total cost (Cost)

6. Quality: What is “appropriate” quality? Quality must be appropriate to consumer expectations, usage requirements, and/or mandated standards. Buying goods of “excessive” quality only increase cost. In other words, quality must be acceptable to the consumer AND sufficient to survive the environment and types of use/abuse it will face.

7. Quantity: What is “Economic Order Quantity”? EOQ is the quantity that minimizes both ordering and storing costs. A buyer should AVOID a PURE EOQ purchasing policy. One strategy of EOQ is forward buying. • The practice of purchasing larger quantities than are currently needed whenever discounts exceed carrying costs. • That means buy a lot more than they immediately need in order to get the cheaper price. • Forward buying will create a spike in sales and other production problems for the manufacturers.

8. Cost: What is the total cost of ownership? The total cost of ownership is the purchase price PLUS costs associated with installing, using, maintaining, insuring, supplying, and servicing the product. To determine the price, a company pays goes beyond the dollar cost: TOTAL COST = PURCHASE PRICE + DELIVERY + STORAGE + SERVICE Value analysis • Value analysis is a method of comparing the benefit, function, and cost of materials, components and work processes; • The objective is to reduce cost and/or improve purchasing design (quality, quantity and cost) • The procedure of the analysis is to compare what is currently being done with new alternatives being considered in terms of benefits received, functions of product, cost of materials and work process involved • The outcome is to win greater value for less cost

9. What Companies Really Pay for Ownership? • Cost of ownership goes beyond the price paid for a product • TOTAL COST OFOWNERSHIP = PRODUCT PRICE + DELIVERY + INSTALLATION + MAINTENANCE / REPAIR + POWER COSTS + SUPPLY COSTS + OPERATING COSTS + FINANCING

10. Value Analysis The objectives of value analysis: • Reduce costs and/or • Improve design What is New Currently Alternatives Being Done Being Considered COMPARE - Benefits received - Functions of product - Cost of materials - Work process involved OUTCOME: GREATER VALUE FOR LESS COST

11. Purchasing Philosophy Adversarial Purchasing Philosophy • A traditional purchasing philosophy • The firm utilizes several vendors for each product (just give any vendor a portion of its business) • Developed in order to increase competition among the buyers • Consequences: lower prices while increasing the level of service and attention paid to the account Partnership Purchasing or Preferred Supplier Systems • Seeks to maximize the benefits of collaboration • Makes a long-term commitment to a vendor • Purchasing partnerships are made with vendors who provide …

12. Purchasing partnerships are made with vendors who provide: • High-purchase-volume materials, components or strategic products • Information and training for effective product use • Services requiring specialized knowledge for cost reductions and/or performance • Materials unavailable elsewhere

13. Supplier Evaluation Buy-Grid Model – A general model of rational organizational decision making - Buy-phase model(go through 8 steps beginning with problem recognition, search, evaluate and select) - Buy-class model (the type of buying decision based on the experience of the buyer with a purchase of a particular product: new buys & straight rebuys & modified rebuys) Multiattribute Decision Making - Based on the idea that people compare products across features – weighted by importance - Assumptions: rationality and knowledgeable buyers - Can be used to evaluate potential suppliers and current suppliers as well

14. Step 8 Evaluation of product performance Step 7 Selection of an order procedure Step 6 Evaluation of proposals andselection of a supplier Step 5 Acquisition and analysis of proposals Step 4 Search for qualified suppliers Step 3 Development of detailed specifications Step 2 Definition of the product-type needed Step 1 Recognition of a need

15. Buy-class Model Type of buying decisions 1. New buys • Follow complete buying process (all steps taken) • Never purchase before • With emphasis on product definition & development of product specification 2. Straight rebuys (Automatic purchasing) • Require the least buying process steps to complete • Only two steps are required: need recognition & placing an order • Image advertising works 3. Modified rebuys • The same product or product type is being purchased • But most of the decision steps are still taken • Comparison advertising works

16. Trends in Purchasing • Reducing purchasing costs • Outsourcing in-house activities • The development of cross-functional teams • Increasing professionalism through certification programs and establishes a code of ethics

17. Trends in Purchasing One trend is reducing purchasing costs: • Cutback on employees through early retirement and layoffs • Reduce number of vendors/transactions – buying more in the same amount of time by buying more from the same vendors, reduce shopping around • Build relationships – increases the importance of developing strategic relationships with customers • Centralize purchasing activities – the concentration of purchasing within company headquarters for closer supervision and strategizing • Internet makes centralization easier to accomplish

18. Trends in Purchasing The second trend is outsource in-house activities • Outsourcing: the process of buying products/services from another firm, usually one that was previously created in-house. E.g., a company hires an ad agency to do all of its advertising, an exhibit company to handle all of its trade shows, and a marketing research firm to conduct all of its research. Then the company can focus on its core business. • Many things can be outsourced including training, manufacturing, processing activities and involve suppliers to help design new products or processes. • See make-or-buy decision analysis (depends on who provides best value for lowest cost)

19. Make-or-buy Decision Analysis UNACCEPTABLE RISK Retain Production and Provide Services ACCEPTABLE RISK Buy the Products, Components or Services

20. Trends in Purchasing The third trend is the development of cross-functional teams • Cross-functional teams: include members of various functional areas; include personnel from suppliers, company departments and customers • Take advantage of the different types of expertise • Factors lead to effective cross-functional teams: Appropriate leadership; Face-to-face communication; Continuity – in it for the long term; Top-level commitment to provide for key individuals’ full participation; Embracing diversity of experience, backgrounds, outlooks and corporate philosophy

21. Purchasing in Government • Government is the largest single buyer, the largest single employer, the largest single landlord. • Government often adjusts its purchasing to achieve social and/or political goals • Government often removes the profit motive and add the power to tax

22. Ethics in Purchasing • What is ethics? – Ethics are moral codes of conduct, rules for how someone should operate that can be followed as situations demand • Two basic dimensions guide ethical issues in purchasing: fairness (any competitor has equal opportunity to sell to the buyer and equal access to information from the buyer) and responsibility to the buying organization. • Two worrisome activities: gift giving and information access & use. • Why should any “for profit” firm be concerned with ethics? – any trade-off of short-term profits for long-term ethics is short-sighted. In the end, buyers will support those that have earned their trust and value their reputation.