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The acquisition of materials and assets is a fundamental necessity for any organization's business operations. Developing effective strategies and methods to procure the best materials at the most cost-efficient ways, as well as maintaining a consistent supply, is crucial for organizational success. This can only be achieved through dedicated procurement and purchasing functions. While the terms "purchasing" and "procurement" are often used interchangeably, they have distinct differences in scope and significance. Procurement is a broader and more strategic concept compared to purchasing, which is the functional aspect of procuring materials for the organization.
Procurement can be broadly defined as the comprehensive planning, analysis, and measures taken to acquire goods and services necessary for the smooth operation of an organization.
Procurement can be further categorized into two main types: direct procurement and indirect procurement. Direct procurement involves the acquisition of raw materials and goods required for production, while indirect procurement focuses on acquiring maintenance, repairs, and operating supplies.
The combined efforts of procurement and purchasing are responsible for fulfilling the input needs of the organization.
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The history of procurement can be traced back to ancient civilizations. For instance, the ancient Egyptians meticulously tracked the supply of building materials and labor for their monumental pyramid projects. In the modern era, procurement gained prominence with the advent of the industrial revolution. However, its roots extend even further, with purchasing as an independent function in railroad organizations dating back before the 1900s, gaining particular importance during the World War era due to the critical need for raw materials.
Purchasing is defined as the activity of acquiring goods and services to meet the organization's goals.
Similar to procurement, purchasing can also be categorized into direct and indirect purchasing. Direct purchasing involves a direct exchange of cash or money for goods, while indirect purchasing often involves a third party in the procurement process.
The origins of purchasing can be traced as far back as 2800 BC, evident in cuneiform clay tablets containing purchasing orders. Remarkably, it was only in the past two centuries that purchasing began to receive attention in trade books and textbooks. In 1832, Charles Babbage addressed purchasing in his book "On the Economy, Machinery, and Manufacturing." The first book exclusively dedicated to purchasing, titled "The Handling of Railway Supplies: The Purchase and Disposition," was published in 1887 by Marshall M. Kirkman. The first college textbook on purchasing was authorized by Howard T. Lewis of Harvard University in 1933.
Although interest in the purchasing and supply function began to gain momentum in the 20th century, it had already been recognized as an independent and essential function well before the 1900s. However, the growth of interest and attention to purchasing during the early 1900s was uneven. By 1915, several books on purchasing had emerged, and numerous articles had been published in trade journals, primarily in engineering publications.
Yet, before World War I (1914-1918), most firms primarily regarded the purchase function as a clerical activity. However, during the war, the ability to procure raw materials, supplies, and services to keep factories and mines operational became the three key determinants of organizational success. This shift in focus prompted a closer examination of organizational policies and procedures related to purchasing, and it subsequently emerged as a recognized management activity. Historically, management interest had primarily centered on research and development, marketing, finance, and operations, with purchasing often subordinated to these functions. However, managers increasingly became aware of its impact on the bottom line, rivaling the significance of other functions. It is with such insights that purchasing evolved through various stages.
Procurement is an essential management function for any organization, with its depth varying depending on the organization's specific business operations. Every organization engages in procurement planning as part of its initial setup, whether they are physical asset-based or service-oriented. Even sectors such as banking focus on procurement functions to minimize operating expenses and reduce costs. Procurement is intricately linked with an organization's strategic decision-making process.
On the other hand, purchasing is responsible for the day-to-day supply of materials required for an organization's seamless functioning. The primary objectives of the purchasing department include:
Effective procurement involves a well-defined process that encompasses various crucial steps:
The first step in the procurement process is to analyze and understand the requirements and needs of the organization. This involves a comprehensive examination of both current and future needs necessary to sustain the company's operations. These needs serve as the foundation upon which the procurement strategy is built.
Depending on the nature of the business and its specific functions, organizations must explore a wide range of solutions and approaches. This involves conducting market research to gain insights into the available options and to determine the best strategy moving forward. The strategy development phase is crucial in laying the groundwork for supplier selection.
Following market research and the establishment of a procurement approach, organizations proceed to carefully select their suppliers. This selection process involves a thorough evaluation of potential suppliers based on key criteria.
Organizations engage in detailed negotiations with chosen suppliers. During this phase, terms and conditions related to delivery, returns, invoicing processes, and payment terms are all meticulously discussed and agreed upon.
Once the contract is signed, the delivery of orders commences. Both parties involved in the procurement process, the organization and the supplier, gain a mutual understanding of the entire process. Any additional services or requirements are also agreed upon at this stage to ensure a seamless procurement process.
Within the broader procurement framework, the purchasing process consists of several critical steps:
This initial step involves identifying the specific business needs, including what items to purchase, when to make the purchases, and the quantities required. Requests to purchase are internally generated within a company to procure necessary goods and services.
Once the business needs are defined, the organization proceeds to identify suitable suppliers based on factors such as price and delivery time, among others.
A purchase order is a formal document that outlines the buyer's specifications, quantity requirements, delivery timelines, and other obligations to the seller. The purchasing department initiates and sends this purchase order to the selected supplier.
Upon receiving the purchase order, the chosen supplier either procures or manufactures the required goods and subsequently dispatches them to the buyer.
Upon the arrival of the goods, the organization verifies whether they match the specifications outlined in the purchase order and if they meet the required quality standards.
The supplier sends an invoice for the fulfilled order, which is then processed by the finance department for payment.
Procurement holds a pivotal role in corporate performance and is now more critical than ever, as recognized by senior management within organizations. The procurement process encompasses sourcing and purchasing, covering all activities from identifying potential suppliers to delivering goods and services to end-users. The success of the procurement department relies on strong support from top-level management. The integration of new technologies has greatly influenced purchasing decisions, although not all companies have achieved positive results, often due to the lack of attention from top-level management.
As previously mentioned, procurement is inherently a strategic function. Organizations employ various methods to establish effective procurement practices, with a broader perspective that encompasses all resources, including personnel, materials, facilities, and services. Creating a procurement strategy is a critical step before engaging in the purchasing process. This strategy involves identifying the organization's needs and determining whether materials should be procured through in-house production or external procurement. The subsequent step is the strategic selection of suppliers, a decision that is not subject to frequent changes.
An effective supplier selection process is paramount to an organization's success in a highly competitive environment. Implementing methodologies like "Six Sigma DMAIC" can enhance the supplier selection process, aligning it with Six Sigma principles to improve supplier quality, cost-effectiveness, and service efficiency. Supplier selection is typically based on several key criteria:
It's essential to note that finding a supplier that excels in all these criteria may not always be feasible. Organizations should instead strive to identify the best possible supplier available. Cross-functional teams are often employed in the supplier selection process. Existing suppliers are evaluated based on their past and present performances, while new suppliers are assessed in terms of their capacity, financial stability, and other relevant factors. Diversifying the supplier base is beneficial in certain industries, as it provides more options. Analytic Network Process (ANP) and fuzzy TOPSIS methods can aid in supplier selection and decision-making, enabling suppliers to be weighted based on specific criteria and ranked by the procurement team.
To gain a competitive advantage over rivals, organizations must effectively manage their supplier base. Procurement strategy heavily relies on supplier management. Managing a diverse supplier base while treating each supplier equitably presents its challenges. Organizations often foster a competitive environment among their suppliers to maximize benefits. Early Supplier Involvement is one such practice where suppliers are actively engaged in the product design process early in development. This collaboration allows firms to leverage supplier expertise and create superior products, as commonly seen in the automobile industry.
Notably, variations in product quality, delivery times, and pricing may exist among suppliers, potentially impacting the buyer's expectations. To bridge these gaps, buyers often engage in Supplier Development. This approach involves forming cross-functional teams to monitor and negotiate with suppliers to improve their performance. Firms also identify critical suppliers and seek to enhance their capabilities or explore alternative sources. The Kraljic portfolio model categorizes items into leverage, strategic, non-critical, and bottleneck items, allowing organizations to develop distinct strategic plans for each category. Scania, a world-leading manufacturer of trailers, buses, and marine engines, effectively utilizes the Kraljic approach.
When formulating a procurement strategy, organizations carefully consider the type of relationship they wish to maintain with their suppliers. Supplier relationships play a pivotal role in strategically planning, managing, and interacting with suppliers to unlock value and reduce risks. The nature of the relationship often depends on the degree of engagement desired by the buyer. According to the Andrew Cox model, supplier relations are contingent on asset specificity, with lower specificity leading to arms-length relationships and higher specificity resulting in strategic alliances or even mergers with suppliers.
Organizations can opt for different types of relationships with their suppliers based on their interests, needs, or goals. These relationships can range from arms-length relations to partnerships or core competency relationships. As per the IMP model by Hakansson, relationships evolve over time through multiple episodes of transactions. Organizations tend to adopt a more strategic approach when collaborating with suppliers for extended periods, such as in the case of single sourcing. Establishing strong relationships with suppliers in the procurement of materials contributes significantly to an organization's competitive advantage.
The Vendor Managed Inventory (VMI) business model is a collaborative arrangement in which the buyer and supplier mutually agree on inventory levels, fill rates, and associated costs. This collaborative approach enhances supply chain efficiency by reducing inventory levels and eliminating stockouts. This procurement strategy has been notably successful and is exemplified by Wal-Mart's effective implementation.
In conclusion, procurement encompasses a comprehensive view of organizational resources, and these strategies enable firms to manage their suppliers more effectively, ultimately achieving superior purchasing outcomes compared to their competitors.
Purchasing represents the technical execution of the entire procurement strategy. It is defined as the process of acquiring materials of the right quality, in the right quantity, from the right source, delivered to the right place, at the right time, and at the right price. The purchasing function within an organization operates according to a set of guidelines and rules, which are defined by top-level management and formulated as part of the overall procurement strategy.
The objectives of purchasing are often referred to as the "5R's," each representing a critical aspect of the purchasing function:
The purchasing process begins with the request to purchase and culminates with supplier invoice payment. To achieve these objectives, the purchasing department employs various strategies. In contemporary times, the entire purchasing process has transitioned to online platforms, eliminating the need for paper-based procedures. This approach, known as E-Purchasing and E-Procurement, simplifies the purchasing function. While organizations previously needed substantial investments in software and hardware to implement these strategies, today's companies can opt for hosted e-procurement solutions on a pay-as-you-go basis, offered by on-demand technology providers such as Salesforce.com and Perfect Commerce.
E-Procurement should ideally integrate seamlessly with Enterprise Resource Planning (ERP) and Material Requirements Planning (MRP) systems, facilitating the connection of backend functions like finance and accounts payable. This integration provides easy access to information and robust record analysis. With electronic purchasing, all of a firm's purchases are processed through the E-Procurement system, allowing the purchasing department to ensure compliance with negotiated contracts. Additionally, this system significantly reduces the purchasing cycle time by up to 75%. Purchasing plays a crucial role in ensuring the timely availability of materials, which is essential for achieving organizational goals. Some companies, especially those in information technology, such as Dell, maintain low inventory levels. To achieve such inventory efficiency, purchasing employs the Just-In-Time (JIT) strategy. While JIT can reduce costs and maintain a lean supply chain, it also carries risks. This was exemplified in 1997 when a small fire halted Toyota's brake production, causing a domino effect resulting in the shutdown of the entire production line due to the lack of brakes, leading to an estimated loss of $15 million in sales for Toyota.
Creating a quality product begins with purchasing quality materials, making the purchasing department directly responsible for this critical aspect. The purchasing department collaborates closely with manufacturing to understand the requirements and performance criteria of their functions. They maintain a steady flow of materials, organize and maintain records of past transactions, and in recent years, increased emphasis has been placed on the Procure-to-Pay process. Procure-to-Pay focuses on automating the purchasing function, benefiting not only purchasing but also other departments like finance, where they gain access to detailed transaction information. Improved accuracy of information and enhanced visibility are key factors in this process, which also reduces processing costs and time.
Purchasing techniques are relatively uniform across organizations, and new technologies are adopted to streamline and enhance efficiency. Two primary types of purchasing approaches are centralized and decentralized buying. In centralized purchasing, all purchases are managed from one location for all branches or locations within an organization. It can also be run from a central location, often buying into a distribution warehouse that supplies smaller warehouses, a model known as the hub and spoke system. Centralized purchasing leverages the combined orders of all branches to achieve volume pricing benefits. Typically, vendors require the district to accept mass deliveries, and these bulk purchases are stored in the warehouse until needed by the sites.
Decentralized purchasing, on the other hand, involves each plant or office buying what it needs, although the purchasing department maintains a list of approved suppliers. This approach reduces waiting times, as sites do not have to rely on the central procurement team to supply their needs. However, this method sacrifices the advantages of bulk purchasing.
In conclusion, procurement serves as the strategic foundation upon which purchasing operates. This research has highlighted how organizations employ diverse procurement strategies, ultimately providing them with a competitive edge in fiercely competitive markets. While procurement sets the strategic direction for an organization, purchasing executes the transactional aspects and associated functions. Although the terms "procurement" and "purchasing" are often used interchangeably and mistakenly considered synonymous, it is crucial to recognize that for an organization, it is the procurement strategy that defines its operations and the value it creates, leading to enhanced profits and competitive advantages. Purchasing, in contrast, acts as the vehicle that navigates this strategic road, adhering to all traffic rules and regulations. In today's hyper-competitive environment, where consumer influence shapes organizational operations, procurement emerges as the differentiator, providing organizations with a competitive advantage in acquiring essential materials.
Procurement and Purchasing in Organizational Management. (2016, Oct 12). Retrieved from https://studymoose.com/procurement-vs-purchasing-essay
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