Materials Management:

PURCHASING

Dr. Vivekanand Ankush Pawar

Contents

● Introduction
● Purchasing
● Purchasing principles
● Purchasing Policies, Procedures and Practices
● Objectives of Purchasing
● Scope of Purchasing
● Responsibility and Limitations
● Sources of Supply
● Supplier Selection

Dr. Vivekanand Pawar 2

… Contents

● Supplier Evaluation
● Supplier Measurement
● Numerical – Supplier Rating
● Price forecasting
● Price-cost Analysis
● Negotiations
● Reciprocity
● Legal aspects of purchasing
● Purchase orders / contracts
● Method of buying- under certainty, under risk,
and under uncertainty
Dr. Vivekanand Pawar 3
Case 3 : A Critical Role of Purchasing at
Manitowoc
□ The importance of the purchasing department for the
rest of the company is well illustrated in the case of
Manitowoc. When the purchasing department is not able
to buy the raw materials for production, or the parts for
assembly the production department cannot do any work
and the customers will not be satisfied.

□ Once lowly bureaucrats, purchasing managers are

shifting onto the front lines. Robert Ward is one of them
and is in charge of purchasing for Manitowoc Co., one of
the world’s biggest crane makers. His job is to ensure an
unbroken flow of parts and materials from around the
globe, hunting industrial tires in China and scouring the
Midwest for giant bearings. And he has broad discretion
over Manitowoc’s operations to make sure critical
supplies aren’t held up.

4
Dr. Vivekanand Pawar
Case 3 : A Critical Role of Purchasing at
Manitowoc
□ “Buyers are the ones with the checkbook—and there’s a
huge power in that,” says Mr. Ward. Recently, he was in
France, agitated, and meeting with two Polish suppliers
that weren’t delivering all of the metal chassis they had
promised to Manitowoc’s big crane factory in Germany.
‘No chassis means no cranes’.

□ The president of one of the suppliers—who had just

driven 16 hours from Poland to meet with Mr. Ward and
other managers—announced unexpectedly that deliveries
could actually slow further in coming months. “I have a
lot of angry customers, because I have not been able to
deliver cranes,” said Mr. Ward, gazing at the Pole over
the top of his half-glasses.

5
Dr. Vivekanand Pawar
Case 3 : A Critical Role of Purchasing at
Manitowoc
□ Mr. Ward is one of a new breed of purchasing gurus who
have become a hot commodity in recent years. As more
companies globalize and outsource production, they need
a top-level point person who can manage these complex
relationships, navigate various foreign cultures, and be
willing to travel constantly.

□ Questions (Instruction : Answer the following

questions and submit it as Assignment No.3 by 3rd
September, 2020 (Thursday):

□ 1. Write down the case facts.

□ 2. Explain the critical role of purchasing at Manitowoc Co.

6
Dr. Vivekanand Pawar
Introduction

● Materials are the life blood of industry

● Materials must be available at the right time, in

the right quantity, at the right place, and the
right price

● Usually organization obtain materials from

outside sources

Dr. Vivekanand Pawar 7

… Introduction

Procurement
● The comprehensive function that
describes the activities and processes
performed to acquire good and services.
● Comprises of activities involved in
establishing requirements, sourcing such
as market research and vendor
evaluation and negotiation of contracts.
● Can also include the purchasing
activities required to order and receive
goods.
Dr. Vivekanand Pawar 8
… Introduction

● Procurement process can be divided into

five key steps

– Define the business need

– Develop the procurement strategy
– Supplier selection and evaluation
– Negotiation and award
– Induction and integration

Dr. Vivekanand Pawar 9

Purchasing

The process of ordering and receiving goods and

services
● Is a subset of the wider procurement process
● Generally refers to the processes involved in
ordering goods such as request, approval,
creation of a purchase order and the receipt of
goods

Dr. Vivekanand Pawar 10

… Purchasing

● Purchasing means acquiring good and services

from external agencies
● Purchasing is the first phase of materials
management
● Purchasing in a business environment, is one of
the most critical functions as it provides the
inputs required for the organization to be
converted into output
● Company costs & company profits are greatly
affected by materials as normally a
manufacturing organization spends nearly 50%
of its revenue in purchasing materials

Dr. Vivekanand Pawar 11

… Purchasing

● Purchase department is a unit of an

organization that performs the purchasing
function
● The purchase department – Is specialized and
centralized – Directed by an efficient manager
to achieve performance in an economical
manner
● The purpose of purchase department is to
arrange the supply of the materials, spare
parts, semi-finished goods and services,
required by the organization to produce the
desired product, from some agency or source
external to the organization
Dr. Vivekanand Pawar 12
Purchasing Policies, Procedures & Practices

Purchasing Policy
● Policy is determined by available finances
● Usually each organization formulates its
own policy whether in writing or not
● Written policy ensures that decisions are
consistent and gives authority to the
people handling purchases
● Policy must be stated unambiguously so
that it can be easily understood

Dr. Vivekanand Pawar 13

… Purchasing Policies, Procedures & Practices

Purchasing Policy
● There should be a clear statement about supply
sources
● eg. Whether local suppliers are preferred or not
● eg. Policy of maintaining multiple sources is
universal, since it provides a backup in case
one supplier fails
● eg. Government's policy to procure from
government sources
● eg. Sometimes in order to promote growth and
provide support against large industries,
governments also procure from small scale and
village industries.
Dr. Vivekanand Pawar 14
… Purchasing Policies, Procedures & Practices

Purchasing Procedures & Practices

● Specify the manner in which a purchase procedure is
executed
● Functions involved in execution
● Ascertain need
● Accurate statement of specifications, quality & quantity
● Transmission of the purchase requisition
● Analysis of respondents offers
● Negotiation with respondents
● Arrange for receipt, inspection and replacement of
defective supplies
● Invoice verification and payment
● Completion of documentation

Dr. Vivekanand Pawar 15

… Purchasing Policies, Procedures & Practices

Essentials of Scientific Buying ?

What to purchase ?
When to purchase ?
From where to purchase ?
How much to purchase ?
At what price to purchase

Dr. Vivekanand Pawar 16

… Purchasing Policies, Procedures & Practices

Basic principles of purchasing

● Buying the right quality

● Buying the right quantity
● Buying the right price
● Buying the right source
● Buying the right time and place

Dr. Vivekanand Pawar 17

Objectives of Purchasing

● Maintaining continuity of supply

● Maintenance of quality standards
● Avoidance of duplication, waste and
obsolescence
● Maintenance of the organization's
competitive position
● Maintenance of the organization's good
image
● Developing alternative sources of supply

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Scope of Purchasing

● Supplier approval process and

termination of business with suppliers

● Supplier performance evaluation

● Contract management

● Supplier development

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Responsibility and Limitations…
● Since purchasing is a support function, all purchases
require authorization – either formal or informal
● Authorization may be for a manufacturing quota for
a given period – Purchase manager is informed
about quota – Purchases are made at the discretion
of the purchase
● Authorization may be in the form of purchase
requisition
● For standard items in common and repetitive use,
purchase manager can make decisions and exercise
control based on his judgment for stocking in
advance
● Purchase managers' decisions are generally based on
experience, rate of usage, sales estimates
Dr. Vivekanand Pawar 20
… Responsibility and Limitations…

Centralized Purchasing
● Purchase of materials by a single
purchase department
● Purchasing responsibility delegated to a
specific department
● Department is headed and managed by a
purchasing manager
● Purchasing department purchases the
required materials for all the
departments and branches of the
organization
Dr. Vivekanand Pawar 21
… Responsibility and Limitations

Centralized Purchasing Advantages

● Bulk quantity of materials can be purchased at a low
price with favorable purchasing terms
● Service of an efficient, specialized and experienced
purchase executive can be obtained
● Economy in recording & systematic accounting of
materials
● Transportation costs can be reduced because bulk
quantity of materials purchased
● Avoids reckless purchases
● Reduces duplication of efforts ● Helps to maintain
uniformity in purchasing policies ● Helps to
minimize the investment on inventory

Dr. Vivekanand Pawar 22

… Responsibility and Limitations

Centralized Purchasing Disadvantages

● High initial investment has to be made in

purchasing
● Delay in receiving materials by other
departments
● Not suitable, if branches are located at different
geographical locations
● In case of an emergency, materials can not be
purchased from local suppliers
● Defective materials can not be replaced on a
timely basis
Dr. Vivekanand Pawar 23
… Responsibility and Limitations
Decentralized Purchasing

● Purchasing materials by all departments

and branches independently to fulfill
their needs
● There is no one purchasing manager who
has the right to purchase materials for
all departments and divisions
● Drawbacks of centralized purchasing can
be overcome by decentralized
purchasing system
Dr. Vivekanand Pawar 24
… Responsibility and Limitations

Decentralized Purchasing Advantages

● Materials can be purchased by each

department locally as and when required
● Materials are purchased in right quantity
of right quality for each department
easily
● No heavy investment is required initially
● Purchase orders can be placed quickly
● Replacement of defective materials
takes little time

Dr. Vivekanand Pawar 25

… Responsibility and Limitations
Decentralized Purchasing Disadvantages

● Organization losses the benefit of a bulk

purchase
● Specialized knowledge may be lacking in
purchasing staff
● Higher chances of over and under-purchasing of
materials
● Fewer chances of effective control of materials
● Lack of proper co-operation and co-ordination
among various departments

Dr. Vivekanand Pawar 26

… Responsibility and Limitations

● Two of the important responsibilities

of the purchase department
– To select the right source of supply
– To develop new suppliers
● Supplier development involves
– Supplier Selection
– Supplier Evaluation
– Supplier Measurement

Dr. Vivekanand Pawar 27

Sources of Supply
● Selection of the right source of supply
is an important factor for obtaining
the desired quality, quantity, price
and service
● Types of suppliers
– Manufacturers
– Distributors / Wholesalers / Agents –
Stockists / Dealers

Dr. Vivekanand Pawar 28

… Sources of Supply
Types of Suppliers Manufacturers

● Companies that research, develop and actually

produce the finished product ready for
purchase
● Manufacturers are the source of the supply chain
● Distributors, wholesalers, resellers and retailers
who purchase goods from manufacturers
benefit from the cheapest prices because no
other intermediaries have added their margin
to cost of the goods yet

Dr. Vivekanand Pawar 29

… Sources of Supply
Types of Suppliers Manufacturers

● More dependable with regards to

delivery, post-sales services
● Usually there is a restriction on MOQ
● For regular & large value purchases,
contract arrangements with
manufacturers are advantageous

Dr. Vivekanand Pawar 30

… Sources of Supply
□ Types of Suppliers Distributors / Wholesalers
/ Agents

● Have distribution rights of products manufactured by

others
● Usually buy in bulk from several manufacturers
● They warehouse the goods for reselling to smaller
local distributors, wholesalers and retailers
● They may also supply larger quantities to
organizations or government departments directly
● Certain manufacturers sell their products only
through distributors / agents, leaving the buyer
with no choice but to purchase from the distributors
/ agent
Dr. Vivekanand Pawar 31
… Sources of Supply
Types of Suppliers Stockists / Dealers

● Stock and sell the products of others

● Prices are often higher than those of the
manufacturers as the stockists add their
inventory carrying cost and profits to the prices
● Generally sell smaller quantities
● Often are able to offer immediate delivery of a
variety of items as they usually stock products
of several manufacturers

Dr. Vivekanand Pawar 32

Supplier Selection
Sourcing

● The process of finding potential

suppliers of goods or services Types
of Sourcing
● Sole Sourcing
● Multiple Sourcing
● Single Sourcing

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… Supplier Selection
Types of Sourcing Sole Sourcing
● Only one supplier is available for the
required material
● Such a case may arise on account of a
monopoly conditions or patents or
technical specifications or location or
quotas
● Organization has no option but to
purchase from the sole supplier

Dr. Vivekanand Pawar 34

… Supplier Selection
Types of Sourcing Multiple Sourcing
● Organization purchases the same item
from more than one supplier
Advantages
● On account of competition prices maybe
lower, better service and continuity of
supply
Disadvantages
● Tendency towards an adversarial
relationship between supplier and
customer
Dr. Vivekanand Pawar 35
… Supplier Selection
Types of Sourcing

Single Sourcing
● Sometimes organizations make a
planned decision to source an item
from one supplier even though
multiple sources are available
● Goal is to establish a long-term
partnership

Dr. Vivekanand Pawar 36

… Supplier Selection
Factors considered for selecting potential
suppliers
● Technical Ability
● Manufacturing Capability
● Reliability
● After-sales Service
● Supplier Location
● JIT Capability
● Other Factors
● Price
Dr. Vivekanand Pawar 37
… Supplier Selection
Factors considered for selecting potential suppliers
● Relation between buyer and seller is crucial
● Ideally the relationship will be on-going with a
mutual dependency
● Supplier can rely on future business and buyer
will have an assured supply of quality
materials, technical support and scope for
product improvement
● Communication between buyer and seller must
be open so that both parties understand each
others problems and work towards mutually
suitable solutions
Dr. Vivekanand Pawar 38
... Supplier Selection
Supplier Selection Sources Suppliers can be
identified from the following sources:
● Internal company staff
● Colleagues
● Sales representatives
● Trade journals
● Supplier & commodity directories
● Yellow pages
● Trade intermediaries
● Government agencies

Dr. Vivekanand Pawar 39

... Supplier Selection
Supplier Selection Sources Suppliers can be
identified from the following sources:

● Chambers of commerce
● Brochures & catalogs
● Samples
● Visit to suppliers
● Mail advertisements
● Trade exhibitions
● Newspapers
● Trade associations
● Internet search engines and company websites
Dr. Vivekanand Pawar 40
Case 4: How the Purchasing
Function Supports the Corporate
Strategy at Volkswagen AG
□ The Volkswagen Group (VW Group), one of the
largest automotive companies in the world,
does not write a corporate mission or vision
statement, the group defines strategies and
goals for a time period of about five years. On
Volkswagen’s homepage the `Group Strategy
2018´ can be found that was written in 2013,
and which defines four key aims of the group
for these five years. The first one is “to develop
technologies to become a world leader in
customer satisfaction and quality” (Volkswagen
Aktiengesellschaft, 2013).
Dr. Vivekanand Pawar 41
Case 4: How the Purchasing
Function Supports the Corporate
Strategy at Volkswagen AG
□ The following three goals include “increase unit sales”,
“long-term return on sales […] of 8% to ensure the
Group’s solid financial position” and “to be the most
attractive employer in the automotive industry”
(Volkswagen Aktiengesellschaft, 2013). After defining
the goals, the corporation also gives directions on how to
achieve the goals, for example the VW Group stresses
out to concentrate on environmentally friendly actions.
These four aims and the following guideline on how to
achieve these aims are the fundament of the strategies
of all departments. In this case, for example, the
purchasing function supports the corporate strategy by
concentrating on a continuous development of
technologies with the help of the sourcing strategy.

Dr. Vivekanand Pawar 42

 Case 4: How the Purchasing
Function Supports the Corporate
Strategy at Volkswagen AG
□ Furthermore, the purchasing department is asked to
concentrate on sustainable and environmentally friendly
product parts for the manufacturing department.

□ By following this strategy, the purchasing department

allows the corporation to increase the brand image in
society as well as to strengthen their market position.
This can be supported by the research of Kumper,
Teichman and Timpernagel (2012), who state in their
study that profitability can only be achieved through
sustainable strategies. Therefore, the purchasing
department adds value to the corporation by aligning
their management approaches to the overall strategy.
□

Dr. Vivekanand Pawar 43

 Case 4: How the Purchasing
Function Supports the Corporate
Strategy at Volkswagen AG
□ Questions (Instruction : Answer the following
questions and submit it as Assignment No.4 by 10th
September, 2020 (Thursday):

□ 1. Write down the case facts.

□ 2. How the purchasing department has supported the

Corporate Strategy at Volkswagen AG ?

Dr. Vivekanand Pawar 44

Supplier Evaluation
● After identifying potential sources,
purchase manager must shortlist
suppliers by evaluating potential
suppliers.
● Some factors in evaluating suppliers
are quantitative while some are
qualitative.
● Often ranking method is used as it
combines both qualitative and
quantitative factors.

Dr. Vivekanand Pawar 45

... Supplier Evaluation

● Usually suppliers are evaluated on the

basis of – Price – Delivery time
schedules – Quality – Customer service
● The above can be broken down into
different variables shown below & a
supplier evaluation form can be
prepared
● A supplier can be rated with respect to
variables shown in figure 1

Dr. Vivekanand Pawar 46

... Supplier Evaluation

Dr. Vivekanand Pawar 47

... Supplier Measurement
● After preliminary screening and selection, a trial
order is placed with the supplier.
● After execution of trial order, it is necessary for
the buyer to rate the supplier as the suppliers'
performance in meeting quality, delivery and
price standards set by the buyer need to be
systematically assessed.
● Supplier rating systems or supplier evaluation
forms based on ranking method can be
deployed for this purpose.

Dr. Vivekanand Pawar 48

Numerical Supplier Rating

Dr. Vivekanand Pawar 49

… Numerical Supplier Rating

Dr. Vivekanand Pawar 50

… Numerical Supplier Rating

Dr. Vivekanand Pawar 51

… Numerical Supplier Rating

Dr. Vivekanand Pawar 52

Price Forecasting
● A vital activity of materials management is
forecasting requirements of various materials
and their prices.
● Based on these forecasts materials budget, cash
flows, inventory levels, product costing are
derived.
● Sudden changes in prices must be anticipated
● However often, without any observable
environmental causes, prices do rise.
● Hence prices must be forecast using statistical
techniques.

Dr. Vivekanand Pawar 53

… Price Forecasting
Techniques
● Thumb Rule for Price Forecasting
● Time Series
– Extrapolation of Same Price Series
– Relation with another Price Series Thumb Rule
for Price Forecasting
● General practice in many organizations – use a
10% annual rise in price as a basis for price
forecast
● Suitable for an economy where-in inflation is
steady

Dr. Vivekanand Pawar 54

… Price Forecasting
Techniques
● Often prices vary randomly both within one
year and between years and the prices can be
predicted using statistical techniques
Extrapolation of Same Price Series
● Methods are based on time series – Moving
Averages – Exponential Smoothing
● Application of the above methods is the same as
demand forecasting or materials requirement
forecasting

Dr. Vivekanand Pawar 55

… Price Forecasting
Techniques Extrapolation of Same Price
Series Moving Averages
● Requires preservation of data which
becomes tedious if period over which
average is taken is large
● Giving equal weight-age to all data is
not appropriate

Dr. Vivekanand Pawar 56

… Price Forecasting
Techniques
Extrapolation of Same Price Series
Exponential Smoothing Method
● Tendency to produce forecasts that lag
behind the actual trend
● Fails to produce accurate forecasts if the
data has cyclical or seasonal variations
● Does not handle trend very well
● Forecasts generated are sensitive to the
value of smoothing constant α

Dr. Vivekanand Pawar 57

… Price Forecasting
Techniques Relation with another
price series
● Price of an item can be forecast based on
price of its principle raw material
● e.g. Price of linseed oil is based on price
of raw linseed
● Price of required item is derived using
liner regression
● e.g. Linseed oil price is forecast based on
the linear relationship between price of
linseed and linseed
Dr. Vivekanand Pawar 58
Price – Cost Analysis
● Purchase managers strive to get the best value
for each procurement
● Purchase managers must ensure that the price
being paid by the organization is fair and
reasonable
● Accomplished through Price - Cost Analysis
● However price is subject to many influences
apart from costs and profits
● When there is stiff competition between buyer &
seller, price structure gets distorted

Dr. Vivekanand Pawar 59

… Price – Cost Analysis
Price Analysis
● Is effective when applied to products that
can be contrasted to other, “similar”
procurement
● Goal is to assess whether a price is
reasonable, and this depends on the
type of market in which the supplier
operates
● Performing a price analysis typically
involves checking out historical prices,
market prices and published prices
Dr. Vivekanand Pawar 60
… Price – Cost Analysis
Cost Analysis
● Is more complex than price analysis
● Is useful when a price quote cannot be
accessed from the manufacturer
directly and the procurement is not
easily comparable to others or is
considered “unique”
● Additionally, when producing an item
internally, this method maybe applied

Dr. Vivekanand Pawar 61

… Price – Cost Analysis
□ Involves evaluating direct (traceable)
and indirect (all other non-direct
expenses) costs

□ ● Cost – Furnishes only the

bottom-level in price-setting – Above
that there is profit, competition
among suppliers, number of
prospective customers

Dr. Vivekanand Pawar 62

Negotiations
● A discussion between a buyer and a
seller with a view to reach an agreement
● Negotiations are considered very
important in the buying process
● Help foster good buyer – seller
relationship
● Usually a major reason for negotiations is
to reach price agreements, though in
case of branded cataloged products, this
may not be the reason

Dr. Vivekanand Pawar 63

… Negotiations

● Important reasons for resorting to

negotiations before entering into an
agreement
– Price
– Delivery
– Quality and / or performance
characteristics
– Other specific requirements

Dr. Vivekanand Pawar 64

Reciprocity
● Reciprocity – Means reciprocal
dealings between a buyer and seller –
Is a special case of buyer and seller
relationship
● Involves a policy decision of buying
from another party, the latter in turn
buying from the former
● A policy decision taken by top
management rather than purchase
and sales department
Dr. Vivekanand Pawar 65
… Reciprocity
● In practice procedure becomes complex
● Studies show that purchase managers dislike
reciprocity as it reduces chances of obtaining
competitive prices.
● Often results in buying from the organization's
customers without compensating benefits which in
effect raises costs – i.e. the organization pays more
and receives less.
● Can only be justified if profits made from the sales to
the customer outweigh other considerations.
● Guiding factor – overall benefit of the buying
organization.
● Reciprocity must be practiced within limits of
economic soundness and purchasing ethics.
Dr. Vivekanand Pawar 66
Legal Aspects of Purchasing
● All purchase orders signed by the designated
authority on behalf of the organization legally
binds the organization.
● Creates a contractual relationship between the
buyer & seller as per terms and conditions
mentioned in the purchase order.
● The purchase order is therefore a legally binding
contract.
● Mere economic soundness is not enough to fulfill
the contract and may other factors relevant to
the goods / service being purchased should
also be fulfilled.

Dr. Vivekanand Pawar 67

… Legal Aspects of Purchasing

● Purchase or sale of goods is governed by the law

of the land falling under the purview of laws
such as law of contract, sale of good act, laws
relating to carriage and to some extent laws of
insurance
● Purchase department should be aware of the
legalities of relevant laws involved, so as to avoid
litigation
● Due to complicated nature of the above, the
purchase department should avail of professional
legal advice

Dr. Vivekanand Pawar 68

… Legal Aspects of Purchasing

Law of Agency
● Part of business law
● Creates a legally binding relationship
between
– the agent – designated authorities
(employees) of the purchase department
– and
– the principal – the organization on whose
behalf contracts are negotiated and signed
by the agent

Dr. Vivekanand Pawar 69

… Legal Aspects of Purchasing

Law of Agency
● Branch of law separates and regulates
the relationship between
– Agents and principals (internal
relationship) – known as the principal –
agent relationship
– Agents and third parties with whom
agents deal on behalf of their principals
(external relationship); and
– Principals and third parties when the
agents deal with them
Dr. Vivekanand Pawar 70
… Legal Aspects of Purchasing
□ Law of Agency
● Relationship between the principal and agent
and the apparent authority of an agent to act
on behalf of the principal, creates the legal
relationship between the organization & an
outsider
● A seller has the right to rely on the agent's
apparent authority & assume the status of the
agency has been established by authorization
from the employer
● Approval by employer for performance of
required acts is sufficient evidence that
authority exists
Dr. Vivekanand Pawar 71
… Legal Aspects of Purchasing
Law of Contract
● Provides the legal framework within
which purchase and supply of goods
& services may be executed between
two or more parties
● A contract is an agreement having a
lawful object entered into voluntarily
by two or more parties each of whom
intends to create one or more legal
obligation between them

Dr. Vivekanand Pawar 72

… Legal Aspects of Purchasing

Law of Contract
● Elements of a contract
– An offer is made for providing some goods
/services and acceptance of the offer
– Consideration or obligation for providing the
stated goods / services
– The above to be made by competent persons
having the legal capacity to exchange
consideration and to create mutuality of
obligation
□ – Purpose of the contract should be lawful

Dr. Vivekanand Pawar 73

… Legal Aspects of Purchasing

Law of Contract
● A contract becomes valid only when the offer is
accepted by providing a purchase order
● If the supplier points out any discrepancy, or
variation from the original order, this
constitutes a new counteroffer and must be
cknowledged by the buyer to constitute a valid
contract
● Obligation is imposed on both the parties
● Unilateral contracts are not enforceable by law
● Unpriced purchase orders or without specified
delivery schedules should be avoided for the same
□ reasons Dr. Vivekanand Pawar 74
… Legal Aspects of Purchasing

□ Legal Status of Buyer

● Most legal problems arise in
connection with the
following basic areas of conflict
– Price, payment and other terms
– Quality
– Delivery
– Other legal problems

Dr. Vivekanand Pawar 75

… Legal Aspects of Purchasing

Legal Status of Buyer

● If the agent acts outside his actual authority, but within
what can be reasonably inferred
– Supplier can generally hold the buyer's organization
liable for such action
– Supplier can also sue the buyer personally for
actions beyond the limit of his actual authority
● If the agent exceeds both his actual authority &
apparent authority
– Supplier cannot hold the agent's organization liable
for such an action
Supplier can only hold the agent personally liable for
such an action

Dr. Vivekanand Pawar 76

… Legal Aspects of Purchasing

Price, Payment and other terms

Cost-plus Contracts
● Neither the buyer nor the seller know the cost of
the item to be supplied
● In such a case the contract specifies a fixed fee
or profit
● e.g. procurement of cutting edge space /
military /nuclear equipment which are
pre-production

Dr. Vivekanand Pawar 77

… Legal Aspects of Purchasing
Price, Payment and other terms
Open-price Contracts
● Neither the buyer nor the seller wish to be
bound by a fixed price
● e.g. prices of commodities are often governed
by forces of demand and supply
● Suppliers usually charge at the prevailing
market price at the time of delivery
● Buyers should avoid such contracts as they limit
the buyers choice for price determination

Dr. Vivekanand Pawar 78

… Legal Aspects of Purchasing
Price, Payment and other terms
Escalator Contracts
● Contracts for supplies that cover a long
duration, usually over the life cycle of the
product
● Such contracts have price escalation clauses, in
anticipation of rise in price of materials
● Usually price escalations are negotiated and
resolved
● To prevent any future conflict, the formula for
escalation should be predetermined and based on
reliable economic information and not on
seller's estimate of costs
Dr. Vivekanand Pawar 79
… Legal Aspects of Purchasing
Warranties and Conditions
● Could be either expressed or implied
– Implied in an act of selling
● Seller has the right to sell – goods are
not stolen
●Goods sold have to work
●When sale is preceded by the supply of a
sample it is implied that the goods supplied
are as per sample

Dr. Vivekanand Pawar 80

… Legal Aspects of Purchasing

Warranties and Conditions

– Express warranties
● Specific performance of the materials
supplied, often made by the supplier
● If the buyer is not made aware of such
express warranties, the law will hold the
seller responsible
●Wherever it conflicts with an implied
warranty, an express warranty overrides an
implied warranty

Dr. Vivekanand Pawar 81

… Legal Aspects of Purchasing

Warranties and Conditions

● Courts of law when settling disputes
take into consideration, knowledge
and conduct of a buyer and seller as
well as circumstances
● In general if a buyer acts in good faith
and had no indications of changes to
implied warranty, the seller will be
held liable by the law

Dr. Vivekanand Pawar 82

… Legal Aspects of Purchasing

Right to Inspection
● Buyer has the right to inspect goods to
determine their conformation to the terms of
supply
● If goods haven't been inspected earlier, buyer
can do so after receiving the goods
● Right to inspection is only for a limited and
reasonable period of time
● The reason-ability of the period has to be
specified in the contract, else in case of a dispute,
the court will decide the condition of
reason-ability

Dr. Vivekanand Pawar 83

… Legal Aspects of Purchasing

Right to Rejection
● Rejection of received goods can be done if
quality, specification quantity or other terms of
the contract are not satisfied
● If excess quantities are received either the
whole or excess quantity can be rejected
● Buyer is not obliged by law to return material
supplied which does not conform to the terms
of the contract, however must inform the
supplier about this intent
● If the seller is not informed nor are the
materials returned within a reasonable time,
buyer is obligated to pay for the materials
84
Dr. Vivekanand Pawar
… Legal Aspects of Purchasing

Terms of Payment
● Terms of payments can range from a simple
100% advance to complicated schedules based
on performance / progress of the supply /
Manufacture

● Suppliers often offer trade or cash discounts for

prompt payment

● Buyer must make sure that such trade or cash

discounts are mentioned in the terms of payments

Dr. Vivekanand Pawar 85

… Legal Aspects of Purchasing

Free on Board [F. O. B.] Contracts

● Means goods are to be supplied at the buyers
plant or shipping point
● The responsibility of transportation should be
clearly specified in the contract
● Transport charges either in part or in whole may
be borne either by the buyer or the seller
● e.g. delivery to the nearest transporter (road /
rail / port) maybe borne by seller and the balance
cost from that point to the buyer's plant are borne
by the buyer

Dr. Vivekanand Pawar 86

… Legal Aspects of Purchasing

Free on Board [F. O. B.] Contracts

● If the goods are damaged in-transit,
the supplier negotiates a claim with
the carrier not the buyer
● Buyer gets the title of the goods only
when they are finally delivered either
at the shipping point or at the buyer's
plant, as the case maybe

Dr. Vivekanand Pawar 87

… Legal Aspects of Purchasing
Free on Rail [F. O. R.] Contracts
● AKA Free on Truck [F.O.T.]
● Seller is required to deliver the goods on board
the rail
● When term & conditions state delivery at
rail-head, if not stated otherwise,
transportation charges are generally borne by
buyer else transportation charges are borne by
seller
● Once goods are put on board rail
– Ownership of the goods passes to the buyer and
they are at the risk of the buyer
– Buyer is responsible for the freight, insurance
and subsequent expense
Dr. Vivekanand Pawar 88
… Legal Aspects of Purchasing

Cost, Insurance and Freight [CIF] Contract

● Require the seller to procure transport insurance
against risk of loss or damage of goods
● The seller must contract with the insurer and
pay the insurance premium
● Insurance is generally more important in
international shipping than domestic shipping
● If good are damaged in-transit, buyer negotiates
a claim with the carrier
● Generally cost of freight & insurance is included
in the seller's price

Dr. Vivekanand Pawar 89

… Legal Aspects of Purchasing
Delivery
● If the seller fails to deliver as per the agreed
date, or fails to perform some act (e.g.
installation and commissioning) after delivery,
it is deemed as a breach of contract and the
buyer may cancel the order

Breach and Cancellation

● On cancellation of order due to breach of
contract, if the buyer has suffered losses due to
the breach, the buyer can sue for damages.

Dr. Vivekanand Pawar 90

… Legal Aspects of Purchasing

Damages
● The buyer or seller can also commit acts prior to
date of delivery that can be considered as a
breach of contract

● Depending on who caused the breach, the other

party can claim damages to the extent of loss
Suffered

● If the breach is caused due to a natural calamity

or circumstances beyond control (e.g. fire, social
disturbances), neither can sue for damages
Dr. Vivekanand Pawar 91
… Legal Aspects of Purchasing
□ Damages
● If the buyer purchases from another supplier,
damages are restricted to difference in contract
price and the new procurement price

● Termination clauses in the contract specify

– The procedures to be followed e.g. arbitration
– Limits of claims e.g. quantum of loss to the
Buyer

● If the contracts specifies a penalty, then Indian

courts will award the penalty
Dr. Vivekanand Pawar 92
… Legal Aspects of Purchasing

Honest Mistakes
● Occasionally an inadvertent mistake may occur
in concluding a contract

● If the other party had no previous knowledge of

the mistake, only the circumstances can
determine whether the contract is valid, void or
Voidable

● If the other party had previous knowledge of the

mistake, the contract is voidable at the knowledge
of the other party
Dr. Vivekanand Pawar 93
… Legal Aspects of Purchasing

Legal Problems – Infringement of Patent

● A buyer has no way of knowing if a supplier is
violating some patent

● If the buyer purchases such infringing goods, the

buyer is liable to the original patent holder

● Particularly true for electronics and IT products

● To protect themselves, buyers should incorporate a

clause that causes the seller to indemnify the buyer
in case of such an infringement

Dr. Vivekanand Pawar 94

Purchase Requisitions
Purchase Requisitions
● Purchases have to be made as per requisitions
received from
● Store-keeper for all standard materials for
replenishment or
● Planning department for special purchases for
non-stock items
● Requisitions are generally counter-signed by
works / production manager and the drawing,
design, R & D, planning department
● Requisitions specify quality, quantity, type etc of
material required to be purchased
Dr. Vivekanand Pawar 95
… Purchase Requisitions
Purchase Requisitions
● Purchase requisitions are generally made
in triplicate
– Copy 1 – Passed to buyer
– Copy 2 – Sent to planning department
– Copy 3 – Retained in stores office
● On receipt of the purchase requisition,
the purchase process starts
● Purchases without duly authorized
requisitions are not permitted

Dr. Vivekanand Pawar 96

Purchase Orders / Contracts
Purchase Order
Definition
A commercial document and first official offer
issued by a buyer to a seller, indicating types,
quantities, and agreed prices for products /
services the seller will provide to the buyer

● Sending a purchase order to a supplier

constitutes a legal offer to buy products / services

● Acceptance of a purchase order by a seller forms

a contract between the buyer and the seller

Dr. Vivekanand Pawar 97

… Purchase Orders / Contracts
Purchase Order
● A purchase order is generally issued in
triplicate
– Copy 1 [Original copy] – Sent to supplier
– Copy 2 – Sent to receiving store-keeper
– Copy 3 – Retained with purchase
department
● Reflects the importance and legal impact
of any document with reference to
purchase of goods / services

Dr. Vivekanand Pawar 98

… Purchase Orders / Contracts

Purchase Order
● Since it is not easy to negotiate the purchase order
and the terms & conditions, the O & T&C have to be
formulated in a manner that covers any probable
risk, in almost the same way a contract is done
● The reverse side of the purchase order usually
contains general terms & conditions such as
shortage, breakage, spoilage, suppliers warranties,
damages in case of failure to supply etc
● Except for forward contract purchases, necessary
formalities such as inviting quotes, tenders etc
need to be carried out & processed

Dr. Vivekanand Pawar 99

… Purchase Orders / Contracts
Purchase Order
Forward Contracts
● AKA Open-end or Blanket Purchase Orders
● In consultation & with approval of higher
management, forward contracts are made or
purchase of large quantity of materials which are
regularly needed
● Contracts are negotiated for a fixed period with
delivery dates, quantities and prices open
● Repetitive orders go directly to the supplier without
being processed by the purchase department
● A record of orders issued and deliveries made is
maintained

Dr. Vivekanand Pawar 100

Method of buying – under certainty, under
risk and under uncertainty

Primary task of materials manager – to decide on

the acquisition of necessary raw materials and
supplies to support orderly production at the
lowest ultimate cost
● Purchase decisions are decision-making
problems
● Depending upon available information decision
making problems can be classified into
– Certainty
– Risk
– Uncertainty

Dr. Vivekanand Pawar 101

… Method of buying – under certainty,
under risk, and under uncertainty

Dr. Vivekanand Pawar 102

… Method of buying – under certainty,
under risk, and under uncertainty

Dr. Vivekanand Pawar 103

… Method of buying – under certainty,
under risk, and under uncertainty
Under Certainty
● Decision outcomes are known and the values of
the outcome are certain
● Task of the decision maker is to compute the
optimal alternative or outcome based on an
optimization criteria
● e.g. if the optimization criteria is least cost and
two different sources of materials are being
considered, which appear to be equal in value,
one costing 20% less than the other, then all other
things being equal, decision would be purchase
from the less expensive source

Dr. Vivekanand Pawar 104

… Method of buying – under certainty,
under risk, and under uncertainty

Under Certainty
● However decision making under certainty is rare
as all things are rarely equal
● Liner programming is a technique for finding an
optimal solution under certainty
Under Risk
● Decision needs to be made for a condition for
which outcome is not known with certainty
● All possible outcomes must be listed,
probabilities must be assigned to each outcome
and payoff for each outcome must be
computed
Dr. Vivekanand Pawar 105
… Method of buying – under certainty,
under risk, and under uncertainty

Under Uncertainty
● Outcomes are known but probabilities are not known
● Such situations arise when information of various
occurrences is neither available nor is it possible to
estimate the probability of each of these
occurrences
● Situation is generally encountered when buying a
new product, procuring from a new source and
speculative purchases
● Under situations decisions can be taken based on
several different criteria
● Application of criteria depends on the attitude of the
decision maker

Dr. Vivekanand Pawar 106

… Method of buying – under certainty,
under risk, and under uncertainty

Under Uncertainty
Criteria
● Pessimistic Approach
– Maximin
– Miniimax
● Optimistic Approach
– Maximax
– Minimin
● Laplace [Insufficient criterion]
● Hurwictz [Criterion of realism]
● Minimax Regret

Dr. Vivekanand Pawar 107

Case 5: Procurement of plastic
parts at Sony‐Ericsson

□ Sony‐Ericsson purchases their plastic parts for

mobile phones. The text derives from an
interview with Fredrik Ohlin, commodity team
leader for plastic parts, at Sony‐Ericsson. The
following section will give a brief introduction to
the company and their operations this will be
followed by a description of the purchasing
process of plastic parts.

Dr. Vivekanand Pawar 108

Case 5: Procurement of plastic
parts at Sony‐Ericsson
□ Sony‐Ericsson Multimedia Communications is a
global provider of mobile multimedia devices,
including mobile phones, accessories, and PC
cards. The company was established in 2001
by the telecommunication provider Ericsson
and consumer electronic provider Sony.
Sony‐Ericsson undertakes product research,
design and development, manufacturing,
marketing, sales, distribution and customer
services. The Global management office is
based in London, and R&D is in Sweden, UK,
France, Netherlands, India, Japan, China and
the US. (Sony Ericsson, 2008)

Dr. Vivekanand Pawar 109

Case 5: Procurement of plastic
parts at Sony‐Ericsson
□ Sony Ericsson has a purchasing organization
divided into two parts where one part is
strategic and the other one is project based.
The project based organization part is
co-located with the development units and
intends to meet and serve the needs of the
development units. The first stages of the
product development are performed in‐house
without any cooperation within the suppliers.
However, once the product reaches the final
stages of the development joint development
projects are initialized. (Ohlin, 2008)

Dr. Vivekanand Pawar 110

Case 5: Procurement of plastic
parts at Sony‐Ericsson

□ In every project, there is one or several person

responsible for a certain commodity type. The
number of commodity located to each
purchaser is based on the strategic importance
and the constraints related to the product. If a
purchased product is considered to be of a
more simple nature, a purchaser can be
responsible for supporting several projects with
that commodity. (Ohlin, 2008)

Dr. Vivekanand Pawar 111

Case 5: Procurement of plastic
parts at Sony‐Ericsson

□ The plastic purchasing section at Sony‐Ericsson

does not have any general approach or model
for setting up supply strategies. The persons
responsible for each commodity group create
their own supply strategies based on the
specific situation. The department in question
does not use any standardized portfolio model
which can be applied for all product categories.
Further on, there is no specified strategy of
model for analyzing supply markets when
searching for new suppliers. (Ohlin, 2008)

Dr. Vivekanand Pawar 112

Case 5: Procurement of plastic
parts at Sony‐Ericsson
□ In most cases the traditional purchasing procedure is not
applied at Sony Ericsson. In a traditional purchasing
procedure, the purchasing process begins with the
company determining product specifications which is
followed by a supplier selection and a contracting.
However, in Sony Ericsson’s case, an unspecified
proposal is sent out without any product specifications.
Sony Ericsson uses its market position to delay the final
specification of the product until late in the process. This
allows Sony Ericsson and the supplier to have a longer
development phase before specifying the final product.
□ Further on, by using its company strength this way,
Sony Ericsson can postpone price discussions until late in
the process where they have a much better bargaining
situation.

Dr. Vivekanand Pawar 113

Case 5: Procurement of plastic
parts at Sony‐Ericsson
□ Sony Ericsson use a rating model for existing suppliers’
abilities based on past experiences. Suppliers are
selected based on past experiences, knowledge,
suitability, and production capacity. There are a number
of abilities as being especially suitable as supplier
characteristics; ability to produce various technologies
in‐house, amount of support from supplier during
development project, and price. Quality is mentioned
being a parameter which is very hard to measure and is
often based on past experience of the supplier.
Sony‐Ericsson is in its turn evaluated by the suppliers on
a yearly basis. Factors that are evaluated are mostly
from a performance point of view rather than evaluation
of “soft” values.

Dr. Vivekanand Pawar 114

 Case 5: Procurement of plastic
parts at Sony‐Ericsson
□ Questions (Instruction : Answer the following
questions and submit it as Assignment No.5 by 17th
September, 2020 (Thursday):

1. Write down the case facts.

2. “The plastic purchasing section at Sony‐Ericsson does
not have any general approach or model for setting up
supply strategies.” Explain.
3. Explain the supplier evaluation and selection process at
Sony‐Ericsson.

Dr. Vivekanand Pawar 115

 Dr. Vivekanand Pawar 116
116
10/1/2020