The need for acquiring materials or assets for an organization is fundamental to their business operations. Creating strategies and methods to procure the best materials at the most cost efficient ways and to maintain the same can be only put to practice with a dedicated procurement and purchasing functions. The terms purchasing and procurement are often interchanged, but they do differ in scope. Procurement is much wider term and it is a strategic element when compared to purchasing. Purchasing is the functional part of procuring materials for the organization.
“Procurement can be broadly defined as all the planning, analyzing and measures taken to acquire goods and services required to run the organization smoothly.” Procurement can be of two types direct and indirect. Direct procurement involves the acquisition of raw materials and goods required for production. Indirect procurement involves the acquisition of maintenance, repairs and operating supplies.
Procurement and purchasing together is responsible in fulfilling the input needs of the organization. The history of procurement dates back to the times of Egyptians. During that time, the Egyptians for their huge pyramid projects tracked the supply of building materials and workers. In modern era, procurement gained importance with the industrial revolution. Procurement dates back before 1900’s when purchasing was independent function in railroad organizations. Later during the world war era purchasing gained more importance as obtaining raw materials was more important.
“ Purchasing can be defined as the activity of acquiring goods and services to meet the goals of organization”. Purchasing can also be divided into direct and indirect. Direct purchasing involves the method of paying cash or money directly and getting the goods. Indirect purchasing is when the purchasing is done with a third party involved.
The need for purchasing and procurement
Procurement is an essential management for an organization. The depth of procurement varies according to the business functions of the organization. Every organization has procurement planning before they setup their physical assets. Service sector like banks also focus on procurement function to reduce costs in its operating expense. Organizations have internal procurement and external procurement. Procurement is linked with the strategy making of an organization.
Purchasing on the other hand is responsible for the day-to-day supply of materials. The role of the purchasing department is * To provide all materials, supplies, tools, equipment, and services required for the organization’s operations * To secure materials, supplies, equipment, and services at the lowest possible cost. * To furnish members of management with timely information. * Building, organizing, and maintaining formal lists of potential suppliers. * Ensuring continuity of supply through coordinated planning, scheduling and contracts. * Assuring good quality of raw materials
* Documenting purchasing actions
The process of procurement
Defining business needs: The requirements and needs of the organization should be analyzed and understood. The future needs, and current needs of the company to operate the firm.
Develop the procurement strategy: Depending on the business and function of the organization there would be a wide range of solutions and approach’s for a business organization. The firms would do market research and come up with the best strategy and to move forward to select supplier.
Supplier evaluation and selection: After market research and establishing procurement approach the firms will go by to select the supplier carefully by weighing on the key criteria’s
Negotiation and award of contract: Organizations take up detailed negotiation with the supplier. The terms and conditions of delivery and return, the invoice process and terms of payment will all be discussed.
Induction and Integration: The delivery orders are delivered only after the contract is signed. Both the parties understand the whole process and any service needed should be agreed upon.
The key purchasing process steps
Request to purchase: identifying the business need. Like what to buy, when to buy, how much to buy. This is a request sent internally within a company to obtain purchased goods and services.
Supplier selection: identifying the suitable supplier according to the firms needs based on price and time.
Purchase order: this order is a document whereby buyer states the specifications, quantity, time, and other obligations to the seller. The purchasing department raises purchasing order and sends it to the supplier.
Order Fulfillment: The suppliers either procures or manufactures the goods and is dispatched.
Goods receipt: the goods are received and checked to ensure that they are matched with what was ordered and whether it is of the right quality.
Supplier invoice/ payment: the supplier sends in the invoice for the order and is processed by the finance department for payment.
2.Procurement as a strategic function
Procurement is an integral part of corporate performance and is given greater importance than ever by the senior management. Procurement includes sourcing, purchasing and covers all activities from identifying potential suppliers through to delivery from suppliers to the users. Procurement department needs a strong support from the top-level management. Using of new technology have always favored in purchasing decisions. But not all companies have achieved positive results due to the neglect from top-level management. As mentioned earlier procurement is a strategic function. An organization uses different methods to have a good procurement function.
Procurement in a broader sense includes the entire process by which all the
classes of resources like the people; materials, facilities and services are obtained. In an organization creating procurement strategy is the major step before deciding about purchasing. This involves identifying the needs of the organization and defining whether the materials are to be procured via in-house production or external procurement. The next step is to form a procurement strategy in deciding from whom the materials should be obtained. The supplier selection and management is a strategic decision, as these decisions are not periodically changed.
2.1 Supplier selection
Effective supplier selection process assures the success of an organization in a highly competitive environment. “Six sigma DMAIC” methods can improve the supplier selection process. By applying DMAIC methods to supplier selection process along with Six-sigma an organization can improve the supplier base with regard to quality, cost and service function. The supplier selection is based on certain criteria’s They are:
– – Cost,
Well it is not possible to find a supplier with all the qualities. But the firm should be focused on finding the best possible supplier available there. Firms often use cross functional team for supplier selection. The present suppliers are monitored by their past and present performances. New suppliers are evaluated by their strength, capacity, financial security etc. A firm should not rely one very few suppliers. Having a big supplier base is beneficial in certain industry as there will be more options. Analytic Network Process (APN) and fuzzy TOPSIS method can also help in supplier selection and decision making whereby suppliers are weighted based on criteria’s and ranked by the team.
2.2 Supplier base management
To have a better competitive advantage over other competitors an organization should better manage their supplier base. Procurement strategy heavily relies on supplier base and how they are managed. Managing a big supplier base and treating every supplier equally is not an easy task. Organizations always try to keep a competitive environment among their supplier base to get the maximum benefit out of their suppliers. To have a good relationship with suppliers firms often tend to involve them more in the production this is called Early Supplier Involvement.
Early supplier Involvement is a practice that brings together one or more suppliers to the product design team early in the product development process. By bringing suppliers firms can utilize their expertise and help the buyer to create a better product. This type strategy can be widely seen in automobile industry where manufactures often work with their suppliers producing brakes or engines performance kits to design a car and make it much competitive. Not always buyers get the level of service, which they expect, from the supplier. There will be differences like quality of the products, time of delivery, prices of the suppliers etc. to shorten these gaps of buyer expectations and supplier output.
Buyers tend to do Supplier Development. To develop the supplier base, organizations can form cross-functional supplier development teams to monitor and negotiate with suppliers to improve. Firms also identify the critical suppliers and try to improve them or look for other sources. Organizations can bridge the gap between present and desired supplier performance by identifying the situation and working together to develop them. Using Kraljic portfolio where items are divided into leverage items, strategic items, non critical items and bottle neck items and then preparing different strategic plans for each.
Scania a world leading manufacture of trailers, buses and marine engines very well uses the Kraljic approach.
The procurement team also focuses on creating supplier associations. Supplier Associations are mutually benefiting group of company’s most important suppliers. Supplier associations help organizations to develop awareness, education and implement programs designed to help their suppliers perform better. Supplier association otherwise known as kyoryoku Kai has been successfully implemented by Toyota to manage their supplier base. Supplier associations help the buyer to develop small suppliers and also create trust among all the suppliers.
2.3 Supplier relationship
While forming the procurement strategy firms clearly understand the kinds of relationship that is required to maintain with their suppliers. Supplier relations help organizations to strategically plan, manage and interact with supplier’s in order to uncover and realize new value and reduce risk. The form of relationship is based on how much the buyer wants to engage with the supplier. According to Andrew Cox model. The supplier relation is based on the asset specificity where low specificity leads to arms length relation and higher specificity will lead to strategic alliances or mergers with the supplier.
An organization based on its interests, needs or goals can opt to have any kind of relationship with its suppliers. It can be an arms length relation, partnerships or core competency relationship. As Hakansson described in his IMP model relationships derive after many episodes, Episodes of transactions. A firm looks at a relation more strategically if they are to work together for a long period of time. This turns out in case of single sourcing. A good relation with suppliers in procuring materials adds to the competitive advantage of the organization.
2.4 Vendor Managed Inventory is famous business model in which the buyer and supplier comes to a mutual agreement which determines the inventory levels, fill rates and costs. This kind of arrangement improves the supply chain by reducing inventory levels and eliminating stock outs. This type of procurement strategy is very successfully used by Wal-Mart.
Procurement sees everything in a bigger picture and all these help the firms to manage their suppliers in a better way so as to have a better purchasing than their competitors.
Purchasing is more technical function. Purchasing puts into practice the whole procurement strategy. Purchasing is defined as “ to buy materials of right quality, in the right quantity from the right source delivered to the right place at the right time at the right price.” The purchasing function in an organization has set of guidelines and rules for operation. This is defined by the top-level management and formed when the whole procurement strategy is formed.
3.1The objectives of purchasing
The objectives or goals are known as 5R’s
Right price: right price is determined by allowing reasonable profit for the supplier and insisting and helping to reduce cost.
Right quality: in an item purchased should ensure to mutually accepted standard by supplier and customer at the time of finalizing the purchase order.
Right place: this is where the item is going to enter the value stream. The purchasing team should be able to bring it at the right place or else there is no value for the product.
Right time: materials required for the internal or final customers should schedule and reached at right time.
Purchasing starts with request to purchase and ends with supplier invoice payment. The purchasing department has different strategies to fulfill these processes. Nowadays the entire purchasing process is done through online thus eliminating paper and other complex procedures involved. Its called E-Purchasing and E-procurement. E procurement simplifies the purchasing function. Earlier organizations needed to invest highly in procuring the software and other hardware to implement this strategy. Today companies can opt for hosted e-procurement that are pay as you go. These are on demand technology providers such as salesforce.com and perfect commerce.
E procurement should be integrated with the ERP and MRP systems so that the back end financial, accounts payable department etc. are all easily connected. This also allows the firms to easily access the information and also to analyze the records. With electronic purchase all the purchases of the firm goes through the E procurement system. The purchasing department can ensure that buying complies with negotiated contracts. This system also reduces the purchasing cycle time by 75% Purchasing is responsible for the timely availability of materials of achieving the goals of the organization. Firms in certain industries like information technology like Dell keeps their inventory levels low.
To attain such low level inventory levels purchasing uses Just in Time strategy. This purchasing technique helps in reducing cost and maintains a lean supply chain. But using JIT is as risky as the benefits of it. This was experienced by Toyota in 1997. A small fire caused their brake production to halt. This in turn caused the whole production line to shut down due to the lack of brakes. An estimated 15million dollar worth sales was lost by Toyota.
Creating a quality product starts with purchasing quality materials. Purchasing is responsible for this. Purchasing department works closely with manufacturing to understand the needs and performance of their own function. Purchasing maintains a steady inflow of materials. They organize and maintain records of past transactions. Over last few years more importance is being given to Procure to pay process. Procure to pay focuses on automation of the purchasing function which not only benefits the purchasing but also other departments like finance where they get all the details of recent transactions. The accuracy of information and visibility is other key factor. This also reduces the processing cost and time. Purchasing techniques are almost the same followed by other organization. New technologies are adopted by organizations to make the process smooth and more efficient.
There are two Types of Purchasing, centralized and decentralized buying. Centralized: purchasing means buying and managing purchases from one location for all locations within an organization. This can also be run by a central location. Buying into a distribution warehouse that feeds smaller warehouses. This is called a hub and spoke system. In a Centralized purchasing all the orders are brought together and a bulk purchasing is done. In order to take advantage of volume pricing, the district purchases items in Bulk. Vendors typically require that the district take delivery of the items in mass. These bulk purchases are stored in the warehouse until the sites request the items.
This type of purchasing also saves time since the purchasing department has resource to reduce time to research products. Decentralized purchasing: is the opposite where each plant or office buys what it needs. The buyer buys from a list of suppliers approved buy the purchasing department. This type of purchasing reduces the waiting time in waiting for the central procurement team to supply. However in this type of purchasing organization looses the benefits of bulk buying.
“Procurement” a strategic function paves way to procedures and guidelines for the purchasing. This research shows how organizations use different procurement strategies, which also constitutes as a competitive advantage for them in the race to make products that win the high competitive markets. Purchasing clearly is only associated with the transactional part and all other functions associated with it. Even though the terms procurement and purchasing are widely used interchangeably and often mistaken to be the same.
For an organization it is their procurement strategy that defines what they do and how their work creates more value and profits to them. Purchasing on the other hand facilitates the smooth process of transactions between the buyer and seller. From another point of view procurement can be seen as a road that’s laid out and purchasing as a vehicle which rides through it with all the traffic rules and regulation. In this highly competitive environment where consumer power drives the way organizations work procurement is what differentiates them and gives competitive advantage when it comes to acquiring materials.
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