Chapter 2

1. Chapter 2 PURCHASING MANAGEMENT

2. Disclaimer • These slides do not replace the prescribed material. All prescribed material need to be studied for assignment and examination purposes • Some of the slide content is based on the 2015 Cengage Learning Instructor resources.

3. Chapter Outline • Introduction • A Brief History of Purchasing Terms • The Role of Supply Management in an Organization • The Purchasing Process • Sourcing Decisions – The Make or Buy Decision • Roles of Supply Base • Supplier Selection • How Many Suppliers to Use • Purchasing Organization • International Purchasing/Global Sourcing • Procurement for Government/Non-Profits Agencies 3

4. A Brief History of Purchasing • Purchasing is a key business function that is responsible for acquisition of required materials, services, and equipment. The acquisition of services is also called contracting. Considering the strategic role and additional skills and knowledge required for purchasing, the term supply management is often used to describe the expanded set of responsibilities of purchasing professionals. You can find a definition of supply management in the list of key terms in your tutorial letter 101 as well as in activity 3 of the MO001. It is important to note that in the government sector, purchasing is often referred to as procurement.

5. The Role of Supply Management in an Organisation The primary goals of purchasing are: • Ensure uninterrupted flows of raw materials at the lowest total cost, • Improve quality of the finished goods produced, and • Maximize customer satisfaction. Purchasing contributes to these objectives by: • Actively seeking better materials and reliable suppliers, • Work closely with and exploiting the expertise of strategic suppliers to improve quality and materials • Involving suppliers and purchasing personnel in new product design and development efforts.

6. The Role of Supply Management in an Organisation(Continued) The Financial Significance of Supply Management Profit-Leverage Effect The main aim of the profit leverage effect is to indicate that the same reduction in purchase spend will result in the same amount of profit increase (given that all other costs and expenses remain unchanged). Return on Assets (ROA) Effect The main aim of the return on investment effect is to determine how effective purchasing strategies resulting in lower purchase spend will affect the return on investment ratio. Note that a reduction in purchase spend will result in lower total assets (because of the lower raw material inventory). Inventory Turnover Effect The main aim of the inventory turnover effect is to determine how many times a firm’s inventory is utilised and replaced in one financial year.

7. The Purchasing Process – e-Procurement (Continued) Advantages of the e-Procurement System • Time savings • Cost savings • Accuracy • Real time • Mobility • Trackability • Management • Benefits to the suppliers

8. Small Value Purchase Orders Processing costs for small value purchases are minimisedthrough: • Procurement Credit Card/Corporate Purchasing Card (P-card) • Blanket or Open-End Purchase Orders • Blank Check Purchase Orders • Stockless Buying or System Contracting • Petty Cash • Standardization & Simplification of Materials & Components • Accumulating Small Orders to Create a Large Order • Using a Fixed Order Interval

9. Sourcing Decisions – The Make or Buy Decision Outsourcing: Buying materials and components from suppliers instead of making them in-house. The trend has moved toward outsourcing. Backward vertical integration: Refers to acquiring sources of supply Forward vertical integration : Refers to acquiring customer’s operations. The Make or Buy decision is a strategic decision

10. Sourcing Decisions – The Make or Buy Decision (Continued) Reasons for Buying or Outsourcing • Cost advantage • Insufficient capacity • Lack of expertise • Quality

11. Sourcing Decisions – The Make or Buy Decision (Continued) Reasons for Making • Protect proprietary technology • No competent supplier • Better quality control • Use existing idle capacity • Control of lead-time transportation, and warehousing cost • Lower cost

12. Sourcing Decisions – The Make or Buy Decision (Continued) If an organisation has decided to source a product from a suitable supplier, it is useful to employ the make-or-buy break-even analysis for computing the cost-effectiveness of such a sourcing decision. There are five assumptions underlying break-even analysis. They are highlighted below. 1. All costs involved can be classified under either fixed or variable costs. 2. Fixed cost remains the same within the range of analysis. • A linear variable cost relationship exists. • The fixed cost of the make option is higher because of initial capital investment in equipment. 5. The variable costs of the buy option are higher because of supplier profits.

13. Roles of Supply Base Supply Base -list of suppliers that a firm uses to acquire its materials, services, supplies, and equipment • Firms emphasize long-term strategic supplier alliances consolidating volume into one or fewer suppliers, resulting in a smaller supply base See video as part of this folder

14. Reasons Favoring Multiple Suppliers Need capacity Spread risk of supply interruption Create competition Information Dealing with special kinds of business How Many Suppliers to Use  Single-source (supplier rationalization)– This may be risky. Current trends favor fewer sources. Reasons Favoring a Single Supplier • To establish a good relationship • Less quality variability • Lower cost • Transportation economies • Proprietary product or process • Volume too small to split

15. Purchasing – Centralisedvs. Decentralised Purchasing Organizationis dependent on many factors, such as market conditions & types of materials required • CentralisedPurchasing- purchasing department located at the firm’s corporate office makes all the purchasing decisions • DecentralisedPurchasing - individual, local purchasing departments, such as plant level, make their own purchasing decisions

16. Advantages -Decentralization Closer knowledge of requirements Local sourcing Less bureaucracy Purchasing – Centralisedvs. Decentralised(Continued) Advantages - Centralization • Concentrated volume- • Avoid duplication • Specialization • Lower transportation costs • No competition within units • Common supply base