MODULE: PROCUREMENT MANAGEMENT

LESSON2: Purchasing Research And Planning; Purchasing Cost Management

INTENDED LEARNING OUTCOMES

At the end of this module the students must be able to:

1. Understand the concept of purchasing research and planning.
2. Analyze the importance of purchasing research and planning.

Purchasing: it’s Meaning, Definition, Importance and Objectives!

Meaning and Definition:

Purchasing means procurement of goods and services from some external agencies. The object of
purchase department is to arrange the supply of materials, spare parts and services or semi-finished
goods, required by the organisation to produce the desired product, from some agency or source
outside the organisation.

The purchased items should be of specified quality in desired quantity available at the prescribed time
at a competitive price.

According to Walters, purchasing function means „the procurement by purchase of the proper
materials, machinery, equipment and supplies for stores used in the manufacture of a product
adopted to marketing in the proper quality and quantity at the proper time and at the lowest price,
consistent with quality desired.”

According to Westing, Fine and Zenz “Purchasing is a managerial activity that goes beyond the
simple act of buying. It includes research and development for the proper selection of materials and
sources, follow-up to ensure timely delivery; inspection to ensure both quantity and quality; to control
traffic, receiving, storekeeping and accounting operations related to purchases.”

Importance of Purchasing:
1. Purchasing function provides materials to the factory without which wheels of machines cannot
move.
2. A one percent saving in materials cost is equivalent to a 10 percent increase in turnover. Efficient
buying can achieve this.
3. Purchasing manager is the custodian of his firm‟s is purse as he spends more than 50 per cent of
his company‟s earnings on purchases.
4. Increasing proportion of one‟s requirements are now bought instead of being made as was the
practice in the earlier days. Buying, therefore, assumes significance.
5. Purchasing can contribute to import substitution and save foreign exchange.
6. Purchasing is the main factor in timely execution of industrial projects.
7. Materials management organisations that exist now have evolved out or purchasing departments.

Objectives of Purchasing:
The purchasing objective is sometimes understood as buying materials of the right quality, in the right
quantity, at the right time, at the right price, and from the right source. This is a broad generalisation,
indicating the scope of purchasing function, which involves policy decisions and analysis of various
alternative possibilities prior to their act of purchase.

The specific objectives of purchasing are:

1. To pay reasonably low prices for the best values obtainable, negotiating and executing all company
commitments.
2. To keep inventories as low as is consistent with maintaining production.
3. To develop satisfactory sources of supply and maintain good relations with them.
4. To secure good vendor performance including prompt deliveries and acceptable quality.
5. To locate new materials or products as required.
6. To develop good procedures, together with adequate controls and purchasing policy.
7. To implement such programmes as value analysis, cost analysis, and make-or-buy to reduce cost
of purchases.
8. To secure high caliber personnel and allow each to develop to his maximum ability.
9. To maintain as economical a department as is possible, commensurate with good performance.
10. To keep top management informed of material development which could affect company profit or
performance.
11. To achieve a high degree of co-operation and co-ordination with other departments in the
organisation.
What is the Importance of Research, Before Purchasing
Materials?
Purchasing research is the systematic design, collection, analysis and reporting of data and findings
relevant to a specific purchasing situation facing the company. (Koller P 2003).
This study focused on purchasing research as a tool for public procurement in the service industry. .
The aim of purchasing research is to ensure optimal decisions and improve profitability.

Areas of Purchasing Research:

The purchase department should be assigned the necessary authority and responsibility to administer
such controls as to buy the right quantity of the right quality at the right time at the right Prices from
the right supplier on right terms.

Research is possible in each of these areas. Transportation of materials is another area where large-
scale economies are possible and research can fruitfully contribute. Economic field has a great
bearing on purchase activities, and finally, the purchasing system and organization itself need to be
brought under research.

1. Quality:
One of the most important aspects to investigate into is to see whether one has not over specified the
specifications. One can make the specification ideal, but at the same time make it uneconomical too.
The specifications should be good enough for the purpose. They should be neither too rigid nor too
lax.
Another aspect is constant search of viable substitutes. If substitutes avoiding use of scarce raw
material can be found, they would reduce cost and improve availability. Due to the technological
innovations, new materials are appearing in the market at a breath-taking pace.

2. Quantity:
The quantity to be purchased has an important bearing on inventory management. The forecasts of
requirement have to be reasonably accurate to keep the inventory levels low without affecting the
service..
Forecasts may have to be corrected suitably for items with seasonal consumption or for items
showing a marked upward or downward trend. Further corrections have to be applied for factors such
as the law of supply and demand which will need detailed probing into possible raw material
shortages, possibility of strikes in industries, mean of transpiration, effect of governmental
regulations, import restrictions, etc.
Quantity discounts offered by the industry may affect the decision. In short, the behavioural pattern of
each item individually and in group has to be studied. If the number of items is large, ABC analysis
may be helpful.
3. Suppliers:
Vendors must be kept under close watch regarding their performance. Only such vendors who do not
fail in supplying good quality material, who deliver on time and whose prices are competitive, may be
retained on the approved list.
There must be a constant effort in locating new vendors for the supply of current or substitute
materials. Toward this end there should be a checklist of all present and potential suppliers showing
their present product lines, their financial position, their expansion programme and likely additions to
their product lines.
.
4. Time:
The best it to buy depends mainly on lead-time consideration a safety stock requirements. Any effort
put in to reduce lead-time is well worth it. Safety stock provision depends upon service
considerations. The higher the services level, greater will be the safety stock and, therefore, greater
the inventory holdings.
The best service level, bearing in mind the finances of the company, has to be determined for each
group of items based on the importance of the group and the nature of the group, e.g., vital, essential,
desirable, fast moving, slow moving etc.

5. Price:
Fostering competitive bidding can reduce prices. If current suppliers are not behind or form a ring,
negotiations may be resorted to and in this case the research team should prepare the required data.
If negotiations do not succeed, the research team must develop acceptable substitutes as a long-term
solution.
Value analysis may help in developing substitutes or deletion of time altogether. It may be analyzed if
making the items internally instead of buying would feasible. Impact of an impending government
budget may tend to raise prices. Purchases should, therefore, not be made too close to the budget
date. Certain indirect actors also affect prices.

The Importance of Purchase Planning

Effective purchase planning is essential to furthering the business and competitive interests of the
Postal Service. As such, it requires the coordination and cooperation of a number of organizations
and must address a number of topics.
The success of major purchases, which are those with the potential to impact these objectives,
should be planned for by a purchase team that fully reflects the strategic importance of the purchase,
and should involve the team's use of a wide range of supply chain business practices (such as
strategic sourcing, demand analysis, prequalification, supplier selection strategy, and resource
planning). The success of other purchases will not require the same level of investment, but will
require some degree of planning. In all cases, the effectiveness of the purchase planning will directly
affect the success of the purchase.
2.1.2 Preliminary Planning
Organizations normally plan their purchasing needs during the budget process. Because purchase
planning should involve everyone with a stake in the outcome, coordination between internal postal
business partners should begin as early as possible. Planning for high-dollar purchases should begin
in the concept-development phase and consider best value in relation to business strategy and total
cost of ownership. The goal of this preliminary planning is to define the Postal Service requirement to
be purchased.

2.1.3 Purchase Planning

2.1.3.a The Process. Purchase planning is the process of establishing objectives and tactics to obtain
the best value in a specific purchase. It is done by a purchase team made up of the Postal Service
business partners with an interest in the purchase, including the organization requesting the
purchase, the purchasing organization, and other organizations needed to help determine best value.
The contracting officer responsible for the purchase is the business leader of the purchase team, and
it is his or her responsibility to ensure that the team concentrates on purchase planning as part of an
overall business strategy. As business leader, the contracting officer should also ensure that the team
takes advantage of the most effective supply chain management business practices for a given
purchase. Customer satisfaction and business success should be the primary focus of purchase
planning as they will ultimately define best value in a purchase.

What Is the Total Cost of Ownership?

The total cost of ownership (TCO) is the purchase price of an asset plus the costs of operation.
Assessing the total cost of ownership represents taking a bigger picture look at what the product is
and what its value is over time.
When choosing among alternatives in a purchasing decision, buyers should look not just at an item's
short-term price, known as its purchase price, but also at its long-term price, which is its total cost of
ownership. The item with the lower total cost of ownership is the better value in the long run.

KEY TAKEAWAYS
• The total cost of ownership, or TCO, includes the purchase price of a particular asset, plus
operating costs over the asset's lifespan.
• Looking at the total cost of ownership is a way of assessing the long-term value of a purchase
to a company or individual.
• Corporations use the total cost of ownership as a means of analyzing business deals, while
individuals look at the total cost as a way of assessing potential purchases.
UNDERSTANDING TOTAL COST OF OWNERSHIP (TCO)
When you‟re looking at new equipment, have you ever felt like the initial cost is too high?
If you answered yes, you‟re not alone. The price tag can cause much confusion because it reflects
one small part of the big picture. Some sources say that the amount on the price tag represents less
than 10 percent of the total cost spent on a piece of equipment over its lifetime.
In fact, energy costs, maintenance, and repair fees are predicted to have at least five times more
relevance than the upfront cost. But, few consider these factors as part of the price during their
selection process.

HOW IS TOTAL COST OF OWNERSHIP CALCULATED?

TRY THE TCO FORMULA
The next time you are selecting new equipment, try using the total cost of ownership (TCO) formula:

I = INITIAL COST
The initial cost is the number that appears on the price tag. As previously stated, this is less than 10
percent of the Total Cost of Ownership (TCO).
O = OPERATION
Operation is the cost to install the pump, test the pump, train employees to run the pump, and the
cost of energy to operate the pump. If the pump is complicated to use, the cost of training will
increase.
M = MAINTENANCE
Maintenance includes the cost of regular repairs such as cleaning, inspecting, lubricating, and
adjusting the pump to make sure it is in optimal condition. This also includes reactive maintenance
when the equipment breaks down unexpectedly.
D = DOWNTIME
While you could include downtime along with the cost of maintenance, it is often so large that it
warrants its own category. Downtime involves the labor costs of employees whose work is delayed,
indirect labor costs from supervisors who address the issue, lost production, and lost customers from
inability to meet time expectations.
P = PRODUCTION
Two different pumps will likely have different levels of output, produce different qualities, and have
different environmental implications.
R = REMAINING VALUE
The remaining value has to do with the pump‟s longevity. How much will the pump be worth in 5 or 10
years? It can be a big difference.

This formula can sound a little overwhelming, but let‟s start simple.
I + M – R = TCO

For this example, we will start with three variables to compare two hypothetical pumps: Pump A and
Pump B. The variables chosen are initial cost (I), maintenance costs over 5 years (M), and the
remaining value after 5 years of depreciation (R).

• Pump A has an initial cost (I) of $10,000.

• Pump B has an initial cost (I) of $20,000, twice the upfront cost as Pump A.
Based on initial cost (I) alone, Pump A would be the clear choice. However, the TCO can tell us a lot
more about which option is best.

Pump A Pump B
Initial cost $ 10,000 $20,000
+ Maintenance $5,000 $2,000
- Remaining value $2,000 $10,000
= TCO$13,000 $12,000

The TCO of Pump B is less than Pump A even though its initial cost was twice as much. However,
the gap is only $1,000, which is a slight difference.

I + M + D – R = TCO
Now add a fourth variable, estimated downtime (D).
We will go with a conservative estimate and of $50,000 per hour, even though downtime will likely be
a lot more.
Pump A Pump B
Initial cost $10,000 $20,000
+ Maintenance $5,000 $2,000
+ Downtime $150,000 (3 hours at $50,000/hour) $50,000 (1 hour)
- Remaining value $2,000 $10,000
= TCO$163,000 $62,000

Since $163,000 – $62,000 = $101,000, pump B costs $101,000 less than Pump A. The price gap
becomes wider with every variable that you add, giving you a clear choice for cost value.
Introduction to Cost Efficiency
Meet Josh! Josh owns his own hunting business where customers can purchase hunting clothing and
equipment and try out their skills at an indoor shooting range. While business has always been good,
Josh is considering expanding a bit and offering classes for hunters of all skill levels.
In order to do so, Josh has to make sure his profits are substantial enough to support the new
expenses that will be incurred by maximizing his profits by deciding the best way to bring in more
clientele with the least amount of financial investment. In order for Josh to decide which incentive or
sales pitch he should pursue, he plans on evaluating each one for cost efficiency.
So what is cost efficiency? Well, it's used by firms to measure the worth, costs, or benefits of a
project, investment, or program. It is a way for a company to decide if a decision is worth the cost and
helps a company understand any benefits they might receive if they pursue a business venture. So
for Josh, he will need to know what each method to bring in customers will provide his company in
terms of benefits, and he will need to know what each method will cost.

What is Strategic Sourcing and Why Is It Important

There are few industries more dependent on a reliable supply of components than electronics
manufacturing. Every supply chain has its own model for the procurement of components, but just
because a business has always operated a certain way, this is not enough of a reason to continue to
do so. This is especially true when finances can be used more effectively. Here‟s how strategic
sourcing could help.

What is strategic sourcing?

Strategic sourcing is a holistic approach to developing channels of supply that considers all activities
within the procurement cycle to secure the best possible total cost, rather than just the lowest
purchase price for those goods.
Strategic sourcing allows businesses to consolidate their purchasing power to achieve the lowest
possible total cost of ownership and minimise risk to the supply chain. The approach is a long-term
process that is dependent on a continuous re-evaluation of the business‟s sourcing activities, analysis
of the market and aligning business goals and requirements with those of the suppliers.

The 7-step process of strategic sourcing

1. Profile the product category in as much detail as possible, including the spending patterns and
departments involved.
2. Analyse the market, identifying potential new suppliers, both local and global.
3. Develop a sourcing strategy based on the goals of the business, deciding where to buy whilst
minimising risk and cost.
4. Select the sourcing process by defining your request for proposal criteria for soliciting bids.
5. Negotiate with and select suppliers after reducing to only the valid bids.
6. Work with the new suppliers to integrate them into the existing processes, using the
communication plan to integrate improvements to specifications or processes.
7. Benchmark the current state of the category by tracking performance metrics and the
effectiveness of the sourcing plan. This leads back to step one as the marketplace evolves.

Why is strategic sourcing important?

Adopting strategic sourcing can bring significant benefits to businesses in the electronics
manufacturing industry, the most noticeable being cost savings. Sourcing suppliers with this method
and continuing to analyse the evolving market means that businesses can ensure they are always
achieving high cost savings.
This method also allows companies to align their component sourcing with their business goals,
which increases efficiency and minimises risk within the supply chain. The process of analysing
suppliers on more than just their initial product cost also means that these business goals can be
matched with the best possible suppliers in order to achieve them, creating high value at low cost.
 Activity

1. How important is Purchasing Research and Planning in Procurement Process?

Reference

 Amado, M., Ashton, K., Ashton, S., Bostwick, J., Clementes, G., Drysdale, J. Project
Management For Industrial Designers.
 N., Shaw, Felecia (1 October 2010). Retrieved 26 October 2016. The Power To
Procure: A Look Inside The City Of Austin Procurement Program.
 Hodges Silverstein, S,: Sager, T.: 2105. Legal Procurement Handbook (New York:
Buying Legal Council).
 Keith, B.; Vitasek, K.; Manrodt, K.; Kling, J.; 2016. Strategic Sourcing In The New
Economy: Harnessing The Potential Of Sourcing Business Models For Modern
Procurement.