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M&DC Purchasing & Supply Chain: Material Management

 

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Purchasing

 

Contents

  • Purchasing is the “process of buying.” Many assume purchasing is solely the responsibility of the purchasing department. However, the function is much broader and, if it is carried out effectively, all departments in the company are involved. Obtaining the right material, in the right quantities, with the right delivery (time and place), from the right source, and at the right price are all purchasing functions.

  • Choosing the right material requires input from the marketing, engineering, manufacturing, and purchasing departments. Quantities and delivery of finished goods are established by the needs of the marketplace. However, manufacturing plan-fling and control (MPC) must decide when to order which raw materials so that marketplace demands can be satisfied. Purchasing is then responsible for placing the orders and for ensuring that the goods arrive on time.

  • The purchasing department has the major responsibility for locating suitable sources of supply and for negotiating prices. Input from other departments is required in finding and evaluating sources of supply and to help the purchasing department in price negotiation. Purchasing. in its broad sense, is everyone’s business.

a. Purchasing and Profit Leverage

  • On the average, manufacturing firms spend about 50% of their sales dollar in the purchase of raw materials, components, and supplies. This gives the purchasing function tremendous potential to increase profits. As a simple example, suppose a firm spends 50% of its revenue on purchased goods and shows a net profit before taxes of 10%. For every $100 of sales, they receive $10 of profit and spend $50 on purchases. Other expenses are $40. For the moment, assume that all costs vary with sales. These figures are shown in the following as a simplified income statement:

                                   INCOME STATEMENT

                                Sales                                                  $100

                                Cost of Goods Sold

                                             Purchases            $50

                                             Other Expenses      40               90

                                                                                                        

                                 Profit Before Tax                                    $10

  • To increase profits by $1, a 10% increase in profits, sales must be increased to $110. Purchases and other expenses increase to $55 and $44. The following modified income statement shows these figures:

                                INCOME STATEMENT (SAI~ES INCREASE)                                  

                                   Sales                                                  $110

                                   Cost of Goods Sold

                                               Purchases              $55

                                               Other Expenses        44               99

                                                                                                           

                                    Profit Before Tax                                    $11

  • However, if the firm can reduce the cost of purchases from $50 to $49, a 2% reduction, it would gain the same 10% increase in profits. In this particular example, a 2% reduction in purchase cost has the same impact on profit as a 10% increase in sales.

                               INCOME STATEMENT (REDUCED PURCHASE COST)

                                     Sales                                                 $100

                                     Cost of Goods Sold

                                                Purchases               $49

                                                Other Expenses         40             89

                                                                                                          

                                      Profit Before Tax                                   $11

 

b. Purchasing Objectives

  • Purchasing is responsible for establishing the flow of materials into the firm, following up with the supplier, and expediting delivery. Missed deliveries can create havoc for manufacturing and sales, but purchasing can reduce problems for both areas, further adding to the profit.

  • The objectives of purchasing can be divided into four categories:

    • Obtaining goods and services of the required quantity and quality.

    • Obtaining goods and services at the lowest cost.

    • Ensuring the best possible service and prompt delivery by the supplier.

    • Developing and maintaining good supplier relations and developing potential suppliers.

    • To satisfy these objectives, some basic functions must be performed:

      • Determining purchasing specifications: right quality, right quantity, and right delivery (time and place).

      • Selecting supplier (right source).

      • Negotiating terms and conditions of purchase (right price).

      • Issuing and administration of purchase orders.

c. Purchasing Cycle

  • The purchasing cycle consists of the following steps:

  1. Receiving and analyzing purchase requisitions.

  2. Selecting suppliers. Finding potential suppliers, issuing requests for quotations, receiving and analyzing quotations, and selecting the right supplier.

  3. Determining the right price.

  4. Issuing purchase orders.

  5. Following up to assure delivery dates are met.

  6. Receiving and accepting goods.

  7. Approving supplier’s invoice for payment.

Receiving and analyzing purchase requisition.

  • Purchase requisitions start with the department or person who will be the ultimate user. In the material requirements planning environment, the planner releases a planned order authorizing the purchasing department to go ahead and process a purchase order. At a minimum, the purchase requisition contains the following information:

    • Identity of originator, signed approval, and account to which cost is assigned.

    • Material specification.

    • Quantity and unit of measure.

    • Required delivery date and place.

    • Any other supplemental information needed.

Selecting suppliers.

  • Identifying and selecting suppliers are important responsibilities of the purchasing department. For routine items or those that have not been purchased before, a list of approved suppliers is kept. If the item has not been purchased before or there is no acceptable supplier on file, a search must be made. If the order is of small value or for standard items, a supplier can probably be found in a catalogue, trade journal, or directory

Requesting quotations.

  • For major items, it is usually desirable to issue a request for quotation. This is a written inquiry that is sent to enough suppliers to be sure competitive and reliable quotations are received. It is not a sales order After the suppliers have completed and returned the quotations to the buyer, the quotations are analyzed for price, compliance to specification, terms and conditions of sale, delivery, and payment terms. For items where specifications can be accurately written, the choice is probably made on price, delivery, and terms of sale. For items where specifications cannot be accurately written, the items quoted will vary. The quotations must be evaluated for technical suitability. The final choice is a compromise between technical factors and price. Usually both the issuing and purchasing departments are involved in the decision.

Determining the right price.

  • This is the responsibility of the purchasing department and is closely tied to the selection of suppliers. The purchasing department is also responsible for price negotiation and will try to obtain the best price from the supplier. Price negotiation will be discussed in a later section of the chapter.

Issuing a purchase order.

  • A purchase order is a legal offer to purchase. Once accepted by the supplier, it becomes a legal contract for delivery of the goods according to the terms and conditions specified in the purchase agreement. The purchase order is prepared from the purchase requisition or the quotations and from any other additional information needed. A copy is sent to the supplier; copies are retained by purchasing and are also sent to other departments such as accounting, the originating department, and receiving.

Following up and delivery.

  • The supplier is responsible for delivering the items ordered on time. The purchasing department is responsible for ensuring that suppliers do deliver on time. If there is doubt that delivery dates can be met, purchasing must find out in time to take corrective action. This might involve expediting transportation, alternate sources of supply, working with the supplier to solve its problems, or rescheduling production.

  • The purchasing department is also responsible for working with the supplier on any changes in delivery requirements. Demand for items changes with time, and it may he necessary to expedite certain items or push delivery back on some others. The buyer must keep the supplier informed of the true requirements so that the supplier is able to provide what is wanted and when.

Receiving and accepting goods.

  • When the goods are received, the receiving department inspects the goods to be sure the correct ones have been sent, are in the right quantity, and have not been damaged in transit. Using their copy of the purchase order and the bill of lading supplied by the carrier, the receiving department then accepts the goods and writes up a receiving report noting any variance. If further inspection is required, such as by quality control, the goods are sent to quality control or held there for inspection. If the goods are received damaged. the receiving department will advise the purchasing department and hold the goods for further action. Provided the goods are in order and require no further inspection, they will be sent to the originating department or to inventory.

  • A copy of the receiving report is then sent to the purchasing department noting any variance or discrepancy from the purchase order. If the order is considered complete, the receiving department closes out its copy of the purchase order and advises the purchasing department. If it is not, the purchase order is held open awaiting completion. If the goods have also been inspected by the quality control department, they, too, will advise the purchasing department whether the goods have been accepted or not.

Approving supplier’s invoice for payment.

  • When the supplier’s invoice is received, there are three pieces of information that should agree: the purchase order, the receiving report, and the invoice. The items and the quantities should be the same on all; the prices, and extensions to prices, should be the same on the purchase order and the invoice. All discounts and terms of the original purchase order must be checked against the invoice. It is the job of the purchasing department to verify these and to resolve any differences. Once approved, the invoice is sent to accounts payable for payment.

  • The first concern of purchasing—what to buy—is not necessarily a simple decision. For example, someone deciding to buy a car should consider how the car will be used, how often, how much one is willing to pay, and so on. Only then can an individual specify the type of car needed to make the “best buy.” This section looks at the problems that organizations face when developing specifications of products and the types of specifications that may be used.

  • In purchasing an item or a service from a supplier, several factors are included in the package bought. These must be considered when specifications are being developed and can be divided into three broad categories:

    • Quantity requirements.

    • Price requirements.

    • Functional requirements.

a. Quantity Requirements

  • Market demand first determines the quantities needed. The quantity is important because it will be a factor in the way the product is designed, specified, and manufactured. For example, if the demand was for only one item, it would be designed to be made at least cost, or a suitable standard item would be selected. However, if the demand were for several thousand, the item would be designed to take advantage of economies of scale, thus satisfying the functional needs at a better price

b. Price Requirements

  • The price specification represents the economic value that the buyer puts on the item—the amount the individual is willing to pay. If the item is to be sold at a low price, the manufacturer will not want to pay a high price for a component part. The economic value placed on the item must relate to the use of the item and its anticipated selling price.

c. Functional Requirements

  • Functional specifications are concerned with the end use of the item and what the item is expected to do. By their very nature, functional specifications are the most important of all categories and govern the others.

  • In a sense, functional specifications are the most difficult to define. To be successful, they must satisfy the real need or purpose of an item. In many cases, the real need has both practical and aesthetic elements to it. A coat is meant to keep one warm, but under what circumstances does it do so and what other functions is it expected to perform? How cold must it get before one needs a coat? On what occasions will it be worn? Is it for working or dress wear? What color and style should it be? What emotional needs is it expected to fill? In the same way, we can ask what practical and aesthetic needs a door handle or side-view mirror on a car is expected to satisfy.

d. Functional specifications and quality.

  • Functional specifications are intimately tied to the quality of a product or service. Everyone knows, or thinks he or she knows, what quality is, but there are several misconceptions about what it is and what it is not. Ask someone what is meant by quality, and you will get replies such as, “The best there is,” “Perfection,” “Degree of excellence,” and “Very good.” All sound great but do not mean very much.

  • There are many definitions of quality, but they all center on the idea of user satisfaction. On this basis, it can be said that an item has the required quality if it satisfies the needs of the user.

  • There are four phases to providing user satisfaction:

    1. Quality and product planning.

    2. Quality and product design.

    3. Quality and manufacturing.

    4. Quality and use.

  • Product planning is involved with decisions about which products and services a company is to market. It must decide the market segment to be served, the product features and quality level expected by that market, the price, and the expected sales volume. The basic quality level is thus specified by senior management according to their understanding of the needs and wants of the marketplace. The success of the product depends on how well they do this.

  • The result of the firm’s market studies is a general specification of the product outlining the expected performance. appearance. price, and sales volume of the
    product. It is then the job of the product designer to build into the design of the product the quality level described in the general specification. If this is not properly done, the product may not be successful in the marketplace.

  • For manufactured products, it is the responsibility of manufacturing, as a minimum, to meet the specifications laid down by the product designer. If the item is bought, it is purchasing responsibility to make sure the supplier can provide the required quality level. For purchasing and manufacturing, quality means conforming to specifications or requirements.

  • To the final user, quality is related to his or her expectation of how the product should perform. Customers do not care why a product or service is defective. They expect satisfaction. If the product is what the customer wants, well designed, well made, and well serviced, the quality is satisfactory.

  • Functional specifications should define the quality level needed. They should describe all those characteristics of a product determined by its final use.

  • Function, quantity, service, and price are interrelated. It is difficult to specify one without consideration of the others, indeed, the final specification is a compromise of them all, and the successful specification is the best combination of the lot. However, functional specifications ultimately are the ones that drive the others. If the product does not perform adequately for the price, it will not sell.

  • Once authorization to process an order has been received, production activity control is responsible for planning and preparing its release to the shop floor. The order should be reviewed to be sure that the necessary tooling, material, and capacity are available. If they are not, the order cannot be completed and should not be released.

    1. By brand,

    2. By specification of physical and chemical characteristics, material and method of manufacture, and performance.

    3. By engineering drawings.

    4. Miscellaneous.

a. Description by Brand

  • The price specification represents the economic value that the buyer puts on the item—the amount the individual is willing to pay. If the item is to be sold at a low price, the manufacturer will not want to pay a high price for a component part. The economic value placed on the item must relate to the use of the item and its anticipated selling price.

    • Items are patented, or the process is secret.

    • The supplier has special expertise that the buyer does not have.

    • The quantity bought is so small that it is not worth the buyer’s effort to develop specifications.

    • The supplier, through advertising or direct sales effort, has created a preference on the Dart of the buyer’s customers or ct~ff

  • When buying by brand, the customer is relying on the reputation and integrity of the supplier. The assumption is that the supplier wishes to maintain the brand’s reputation and will maintain and guarantee the quality of the product so repeat purchases will give the buyer the same satisfaction.

  • Most of the objections to purchasing by brand center on cost. Branded items, as a group, usually have price levels that are higher than nonbranded items. It may be less costly to develop specifications for generic products than to rely on brands. The other major disadvantage to specifying by brand is that it restricts the number of potential suppliers and reduces competition. Consequently, the usual practice, when specifying by brand, is to ask for the item by brand name or equivalent. In theory, this allows for competition.

b. Description by Specification

  • There are several ways of describing a product, but they usually include one or more of the following. Whatever method is used, description by specification depends on the buyer describing in detail exactly what is wanted:

    • Physical and chemical characteristics. The buyer must define the physical and chemical properties of the materials wanted. Petroleum products, pharmaceuticals, and paints are often specified in this way.

    • Material and method of manufacture. Sometimes the method of manufacture determines the performance and use of a product. For example, hot- and cold-rolled steels are made differently and have different characteristics.

    • Pelfo?7nance. This method is used where the buyer is primarily concerned with what the item is required to do and is prepared to have the supplier decide how performance is to be attained. For example, a water pump might be specified as having to deliver so many gallons per minute. Performance specifications are relatively easy to prepare and take advantage of the supplier’s special knowledge.

  • Whatever the method of specification, there are several characteristics to description by specification:

    • To be useful, specifications must be carefully designed. if they are too loosely drawn, they may not provide a satisfactory product. If they are too detailed and elaborate, they are costly to develop, are difficult to inspect, and may discourage possible suppliers.

    • Specifications must allow for multiple sources and for competitive bidding.

    • If performance specifications are used, the buyer is assured that if the product does not give the desired results, the seller is responsible. They provide a standard for measuring and checking the materials supplied.

    • Not all items lend themselves to specification. For example, it may not be easy to specify color schemes or the appearance of an item.

    • An item described by specification may be no more suitable, and a great deal more expensive, than a supplier’s standard product.

    • If the specifications are set by the buyer, they may be expensive to develop. They will be used only where there is sufficient volume of purchases to warrant the cost or where it is not possible to describe what is wanted in any other way.

Sources of specifications.

  • There are two major sources of specifications:

    1. Buyer specifications.

    2. Standard specifications.

Buyer specifications.

  • Buyer-developed specifications are usually expensive and time-consuming to develop. Companies usually do not use this method unless there is no suitable standard specification available or unless the volume of work makes it economical to do so.

Standard specifications.

  • Standard specifications have been developed as a result of much study and effort by governmental and nongovernmental agencies. They usually apply to raw or semifinished products, component parts, or the composition of material. In many cases, they have become de facto standards used by consumers and by industry. When we buy motor oil for a car and ask for SAE 10W30, we are specifying a standard grade of motor oil established by the Society of Automotive Engineers. Most of the electrical products we buy are manufactured to Underwriters Laboratory (UL) standards. Steel and structural steel members are manufactured to standards set by the American Society of Mechanical Engineers.

  • There are several advantages to using standard specifications. First, they are widely known and accepted and, because of this, are readily available from most suppliers. Second, because they are widely accepted, manufactured, and sold, they are lower in price than nonstandard items. Finally, because they have been developed with input from a broad range of producers and users, they are usually adaptable to the needs of many purchasers.

  • Market grades are a type of standard specification usually set by the government and used for commodities and foodstuffs. When we buy eggs, we buy them by market grade—small, medium, or large.

c. Engineering Drawings

  • Engineering drawings describe in detail the exact configuration of the parts and the assembly. They also give information on such things as finishes, tolerances, and material to be used. These drawings are a major method of specifying what is wanted and are widely used because often there is no other way to describe the configuration of parts or the way they are to fit together. They are produced by the engineering design department and are expensive to produce, but give an exact description of the part required.

d. Miscellaneous

  • There are a variety of other methods of specification including the famous phrase, “Gimme one just like the last one.” Sometimes samples are used, for example, where colors or patterns are to be specified. Often a variety of methods can be used, and the buyer must select the best one.

  • The method of description is communication with the supplier. How well it is done will affect the success of the purchase and sometimes the price paid.

  • The objective of purchasing is to get all the right things together: quality, quantity, delivery, and price. Once the decision is made about what to buy, the selection of the right supplier is the next most important purchasing decision. A good supplier is one that has the technology to make the product to the required quality, has the capacity to make the quantities needed, and can run the business well enough to make a profit and still sell a product competitively.

a. Sourcing

  • There are three types of sourcing: sole, multiple, and single.

    1. Sole sourcing implies that only one supplier is available because of patents, technical specifications, raw material, location, and so forth.

    2. Multiple sourcing is the use of more than one supplier for an item. The potential advantages of multiple sourcing are that competition will result in lower price and better service and that there will be a continuity of supply. In practice there is a tendency toward an adversarial relationship between supplier and customer.

    3. Single sourcing is a planned decision by the organization to select one supplier for an item when several sources are available. It is intended to produce a long-term partnership. This aspect is discussed at more length in the section in Chapter 15 on supplier partnerships.

b. Factors in Selecting Suppliers

  • The previous section discussed the importance of function, quantity, service, and price specifications. These are what the supplier is expected to provide and are the basis for selection and evaluation. Considering this, there are several factors in selecting a supplier.

Technical ability.

  • Does the supplier have the technical ability to make or supply the product wanted? Does the supplier have a program of product development and improvement? Can the supplier assist in improving the products? These questions are important since, often, the buyer will depend upon the supplier to provide product improvements that will enhance or reduce the cost of the buyer’s products. Sometimes the supplier can suggest changes in product specification that will improve the product and reduce cost.

Manufacturing capability.

  • Manufacturing must be able to meet the specifications for the product consistently while producing as few defects as possible. This means that the supplier’s manufacturing facilities must be able to supply the quality and quantity of the products wanted. The supplier must have a good quality control program, competent and capable manufacturing personnel, and good manufacturing planning and control systems to ensure timely delivery. These are important in ensuring that the supplier can supply the quality and quantity wanted.

Reliability.

  • In selecting a supplier, it is desirable to pick one that is reputable, stable, and financially strong. If the relationship is to continue, there must be an atmosphere of mutual trust and assurance that the supplier is financially strong enough to stay in business.

After-sales service.

  • If the product is of a technical nature or likely to need replacement parts or technical support, the supplier must have a good after-sales service. This should include a good service organization and inventory of service parts.

Supplier location.

  • Sometimes it is desirable that the supplier be located near the buyer, or at least maintain an inventory locally. A close location helps shorten delivery times and means emergency shortages can he delivered quickly.

Other considerations.

  • Sometimes other factors such as credit terms, reciprocal business, and willingness of the supplier to hold inventory for the buyer should be considered.

Price.

  • The supplier should be able to provide competitive prices. This does not necessarily mean the lowest price. It is one that considers the ability of the supplier to provide the necessary goods in the quantity and quality wanted, at the time wanted, as well as any other services needed.

  • In a modern business environment, the type of relationship between the supplier and the buyer is crucial to both. Ideally, the relationship will be on-going with a mutual dependency. The supplier can rely on future business, and the buyer will have an assured supply of quality product, technical support, and product improvement. Communications between buyer and supplier must be open and full so both parties understand the problems of the other and can work together to solve problems to their mutual advantage. Thus, supplier selection and supplier relations are of the utmost importance.

c. Identifying Suppliers

  • One major responsibility of the purchasing department is to continue to research all available sources of supply. Some aids for identifying sources of supply follow:

    • Salespersons of the supplier company.

    • Catalogues.

    • Trade magazines.

    • Trade directories.

    • Information obtained by the salespeople of the buyer firm.

d. Final Selection of Supplier

  • Some factors in evaluating potential suppliers arc quantitative, and a dollar value can he put on them. Price is the obvious example. Other factors are qualitative and demand some judgment to determine them. These are usually set out in a descriptive fashion. The supplier’s technical competence might be an example.

  • The challenge is finding some method of combining these two major factors that will enable a buyer to pick the best supplier. One method is the ranking method, described next.

    1. Select those factors that must be considered in evaluating potential suppliers.

    2. Assign a weight to each factor. This weight determines the importance of the factor in relation to the other factors. Usually a scale of one to ten is used. If one factor is assigned a weight of five and another factor a weight of ten, the second factor is considered twice as important as the first.

    3. Rate the suppliers for each factor. This rating is not associated with the weight. Rather, suppliers are rated on their ability to meet the requirements of each factor. Again, usually a scale of one to ten is used.

    4. Rank the suppliers. For each supplier, the weight of each factor is multiplied by the supplier rating for that factor. For example, if a factor had a weight of 8 and a supplier was rated 3 for that factor, the ranking value for that factor would he 24. The supplier rankings are then added to produce a total ranking. The suppliers can then be listed by total ranking and the supplier with the highest ranking chosen.

  • Figure 7.1 shows an example of this method of selecting suppliers. Theoretically, supplier B, with the biggest total of 223, will be selected.

  • The ranking method is an attempt to quantify those things that are not quantified by nature. It attempts to put figures on subjective judgment. It is not a perfect method. but it forces the buying company to consider the relative importance of the various factors.

Factor

Weight

Rating of Ranking of

Suppliers Suppliers

Suppliers

 

A

B

C

D

A

B

C

D

Function

10

8

10

6

6

80

100

60

60

Cost

8

3

5

9

10

24

40

72

80

Service

8

9

4

5

7

72

32

40

56

Technical

 

 

 

 

 

 

 

 

 

Assistance

5

7

9

4

2

35

45

20

10

Credit

 

 

 

 

 

 

 

 

 

Terms

2

4

3

6

8

8

6

12

16

Total (rank of suppliers)

 

 

 

219

223

204

222

Figure 7.1 Supplier rating

5. Price Determination

  • Price is not the only factor in making purchasing decisions. However, all other things being equal, it is the most important. In the average manufacturing company, purchases account for about 50% of the cost of goods sold, and any savings made in purchase cost has a direct influence on profits.

  • However, remember that “you only get what you pay for.” The trick is to know what you want and not pay more than necessary. When a purchase is made, the buyer receives a package of function, quantity, service, and price characteristics that are suited to the individual’s needs. The idea of “best buy” is the mixture that serves the purpose best.

a. Basis for Pricing

  • The term “fair price” is sometimes used to describe what should be paid for an item. But what is a fair price? One answer is that it is the lowest price at which the item can be bought. However, there are other considerations, especially for repeat purchases where the buyer and seller want to establish a good working relationship. One definition of a fair price is one that is competitive, gives the seller a profit, and allows the buyer ultimately to sell at a profit. Sellers who charge too little to cover their costs will not stay in business. To survive, they may attempt to cut costs by reducing quality and service. In the end, both the buyer and seller must be satisfied.

  • Since we want to pay a fair price and no more, it is good to develop some basis for establishing what is a fair price.

  • Prices have an upper and a lower limit. The market decides the upper limit. What buyers are willing to pay is based on their perception of demand, supply, and their needs. The seller sets the lower limit. It is determined by the costs of manufacturing and selling the product and profit expectation. If buyers are to arrive at a fair price, they must develop an understanding of market demand and supply, competitive prices, and the methods of arriving at a cost.

  • One widely used method of analyzing costs is to break them down into fixed and variable costs. Fixed costs are costs incurred no matter the volume of sales. Examples are equipment depreciation, taxes, insurance, and administrative overhead. Variable costs are those directly associated with the amount produced or sold. Examples are direct labor, direct material, and commissions of the sales force.

 

Total cost = fixed cost + (variable cost per unit) (number of units)

                                                                              total cost

Unit (average) cost =                             .

                                     number of units

 

                                                                             fixed cost             

                                                                 =                                   + variable cost per unit

                                                                        number of units

 

  • Figure 7.2 shows the relationship of fixed and variable costs to sales volume and how revenue will behave. The sum of the fixed and variable costs is labeled total cost on the graph. The third line represents the sales revenue Where this line intercepts the total cost line, revenue equals total cost, and profit is zero. This is called the break-even point. When the volume is less than the break-even point, a loss is incurred; when the volume is greater, a profit is realized. The break-even point occurs where the revenue equals the total cost.

Revenue = total cost
(Price per unit )(number of units) fixed cost + (variable cost per unit) (number of units)

 

b. Example Problem

  • To make a particular component requires an overhead (fixed) cost of $5000 and a variable unit cost of $6.50 per unit. What is the total cost and the average cost of producing a lot of 1000? If the selling price is $15 per unit, what is the break-even point?

Answer

Total cost = $5000 + ($6.50 x $1000) = $11,500

Average cost = $11,500 ± 1000 = $11.50 per unit

Break-even point: Let X = number of units sold

$15X= $5000+ $6.5X

$8.50X = $5000

X = 588.2 units

  • Break-even occurs when 588.2 units are made and sold.

c. Price Negotiation

  • Prices can be negotiated if the buyer has the knowledge and the clout to do so. A small retailer probably has little of the latter, but a large buyer may have much. Through negotiation, the buyer and seller try to resolve conditions of purchase to the mutual benefit of both parties. Skill and careful planning are required for the negotiation to be successful. It also takes a great deal of time and effort, so the potential profit must justify the expense.

  • One important factor in the approach to negotiation is the type of product. There are four categories:

    1. Commodities. Commodities are materials such as copper, coal, wheat, meat, and metals. Price is set by market supply and demand and can fluctuate widely. Negotiation is concerned with contracts for future prices.

    2. Standard products. These items are provided by many suppliers. Since the items are standard and the choice of suppliers large, prices are determined on the basis of listed catalog prices. There is not much room for negotiation except for large purchases.

    3. Items of small value. These are items such as maintenance or cleaning supplies and represent purchases of such small value that price negotiation is of little purpose. The prime objective should be to keep the cost of ordering low. Firms will negotiate a contract with a supplier that can supply many items and set up a simple ordering system that reduces the cost of ordering.

    4. Made-to-order items. This category includes items made to specification or on which quotations from several sources are received. These can generally be negotiated.

  • The material in this chapter has described the traditional role and responsibilities of purchasing. This section will study the effect material requirements planning (MRP) has on the purchasing function and the changing role of purchasing.

  • Purchasing can be separated into two types of activities: procurement, and supplier scheduling and follow-up. Much of what has been covered in this chapter is in the area of procurement. Procurement includes the functions of establishing specifications, selecting suppliers, price determination, and negotiation. Supplier scheduling and follow-up is concerned with the release of orders to suppliers, working with suppliers to schedule delivery, and follow-up. The goals of supplier scheduling are the same as those of production activity control: to execute the master production schedule and the material requirements plan, ensure good use of resources, minimize work-in-process inventory, and to maintain the desired level of customer service.

a. Planner/buyer concept.

  • In a traditional system, the material requirements planner releases an order either to production activity control or to purchasing Purchasing issues purchase orders based on the material requirements plan. Production activity control prepares shop orders, schedules components into the work flow, and controls material progress through the plant. When plans change, as they invariably do, the production planner must advise the buyer of the change, and the buyer must advise the supplier. The production planner is in closer, more continuing contact with MRP and their frequently changing schedules than is the buyer. To improve the effectiveness of the planner/buyer activity, many companies have combined the two functions of buying and planning.

  • The planner’s job and the buyer’s job are combined into a single job done by one person. Planner/buyers do the material planning for the items under their control, communicate the schedules to their suppliers, follow up, resolve problems, and work with other planners and the master scheduler when delivery problems arise. The planner/buyer handles fewer components than either a planner or a buyer, but has the responsibilities of both. The planner/buyer is responsible for:

    • Determining material requirements.

    • Developing schedules.

    • Issuing shop orders.

    • Issuing material releases to suppliers.

    • Establishing delivery priorities.

    • Controlling orders in the factory and to suppliers.

    • Handling all the activities associated with the buying and production planning functions.

    • Maintaining close contact with supplier personnel.

  • Because the role of production planning and buying are combined, there is a smoother flow of information and material between the supplier and the factory. The planner/buyer has a keener knowledge of factory needs than the buyer does and can better coordinate the material flow with suppliers. At the same time, the planner! buyer is better able to match material requirements with supplier’s manufacturing ca¬pabilities and constraints.
     

b. Contract buying.

  • Usually a material requirements planning system generates frequent orders for relatively small quantities. This is particularly true for components that are ordered lot-for-lot. It is costly, inefficient, and sometimes impossible to issue a new purchase order for every weekly requirement. The alternative is to develop a long-term contract with a supplier and to authorize releases against the contract. Often the supplier is given a copy of the material requirements plan so they are aware of future demands. The buyer then issues a release against the schedule. This approach is efficient and cost effective but requires close coordination and communication with the supplier. Again, contract buying can be managed very well by a planner/buyer.

c. Supplier responsiveness and reliability.

  • Because material requirements often change, suppliers must be able to react quickly to change. They must be highly flexible and reliable so they can react quickly to changes in schedule

Contract buying

  • assures suppliers a given amount of business and commits them to allocating that amount of their capacity to the customer. Suppliers are more responsive to customer needs and can react quickly to changes in schedules. Because customers know the capacity will be available when needed, they can delay ordering until they are more sure of their requirements.

Close relationship with suppliers.

  • Contract buying and the need for supplier flexibility and reliability mean the buyer-supplier relationship must be close and cooperative. There must be excellent two-way communication, cooperation, and teamwork. Both parties have to understand their own and the other’s operations and problems.

  • The planner/buyer and the supplier counterpart (often the supplier’s production planner) must work on a weekly basis to ensure both parties are aware of any changes in material requirements or material availability.

Electronic data interchange (EDI).

  • Electronic data interchange (EDI) enables customers and suppliers to electronically exchange transaction information such as purchase orders, invoices, and material requirements planning information. This eliminates time-consuming paper work and facilitates easy communication between planner/buyers and suppliers.

Vendor-managed inventory.

  • In recent years there has been a growth in the purchasing approach known as vendor-managed inventory. In this concept, a supplier maintains an inventory of certain items in the customer facility. The supplier “owns” the inventory until the customer actually withdraws it for use, after which the customer then pays for that use. The customer does not have to order any of the inventory, as the supplier is responsible for maintaining an adequate supply in the facility for customer use. This approach is most commonly used for lower-value products that have a relatively standard design, such as fasteners, standard electrical equipment, etc.

Internet.

  • Internet technology has become the most quickly accepted communications medium ever. There are three variations of networks used: Internet, intranet, and extranet. The Internet is most commonly used and is open to the general public. The intranet is an internal net that is normally used within the boundaries of a company. It may stretch across many manufacturing sites or even countries. Much of the data shared in this environment is considered sensitive, and therefore access is usually limited to people within the company. Extranet is an intranet shared by two or more companies. Each participating company moves certain data outside of a private intranet to the extranet, making it available only to the companies sharing the extranet. (An example might be providing information to a supplier.)

  • Organizations that alter their perspective away from traditional purchasing toward supply chain management must recognize that their perspective toward managing the entire organization must also change. For instance, most organizations that have adopted a supply chain perspective find the following:

    • Their cost focus has altered dramatically. Often decisions are not based on just product price, but instead on total cost and value. This implies an integrated view of price, quality, serviceability, durability, and any other characteristic that the company places on total value. It also can include transportation, storage, and material handling costs. To accomplish this changed perspective, organizations have adopted techniques of process analysis, value stream analysis, and mutual (between the company and their suppliers) value analysis.

    • Decision making has changed from the “I say and you do” or a negotiated perspective with suppliers to one of “Let’s talk about the best way to handle this and make a mutually advantageous decision.” This also implies very long supplier contracts.

    • Information sharing has changed from simply giving out information about the order to the perspective of sharing some important information about the business itself.

    • Measurement systems look at all aspects of the supply chain and not just supplier performance.

    • There is a growth in electronic business (c-business). This implies using the Internet more for handling business information flows and transactions.
       

a. Savings Can Be Substantial.

  • There are many advantages associated with an effective supply chain perspective. Some of these savings include:

    • More effective product specification, allowing for efficient product substitutions and product specifications focused on fitness of use.

    • Better leveraging of volume discounts and supplier consolidation.

    • Long-term contracts with efficient communication systems, significantly reducing the administrative cost of ordering and order tracking.

    • More effective use of techniques such as electronic commerce, using credit cards for payments, and blanket ordering.