PROCUREMENT MANAGEMENT NMIMS GLOBAL ACCESS SCHOOL FOR NMIMS | continuine epucationCOURSE DESIGN COMMITTEE Chief Academic Officer Dr Sanjeev Chaturvedi NMIMS Global Aceoss ~ School for Continuing Education TOC Reviewer Content Reviewer Ruchita Mishra Ruchita Mishra Visiting Faculty, NMIMS Global Visiting Faculty, NMIMS Global Access - School for Continuing Education, _ Access - School for Continuing Education. ‘Specialization : Procurement, Operations & Specializatfon : Froeurement, Operations & Supply Chain Management ‘Supply Chain Management Author: Murugesan Narayanaswamy Reviewed By: Ruchita Mishra Copyright: 2017 Publisher ISBN: 978-99-88052. Address 4495/7, Ansari Road, Daryaganj, New Delhi-110002 Oniy for [NMIMS Global Access - School for Continuing Education School Address ‘VL, Mehta Road, Vile Parle (W), Mumbai ~ 400 056, Ini 9CHAPTER NO. CHAPTER NAME PAGE NO. 1 Introduction to Procurement Management 1 2 Purchasing Operation and its Structure 29 3 Supplier Sourcing, Registration and Evaluation 50 4 Cost Management, Discounts and Negotiations 79 ‘Transportation and Delivery 11 6 Procurement of Capital Goods 137 7 E-procurement 167 8 Price 187 9 Purchasing Law and Ethics 209 10 Global Sourcing 229 a Case Studies 253 ieeePROCUREMENT MANAGEMENT URR uLUM Introduction to Procurement Management: Purchase procedure, Understanding negotiation, Inter face with other disciplines Purchasing manager's roles and responsibilities, Types of purchases, Purchasing and supply proce- dures ‘Types of requisitions- standard requisitions, traveling requisition and bill of materials, issuing an RFx- Request for quotation, request for proposal, request for bid terms Purchasing Operations and Structure: Purchase orders and payment, Blanket order, Open-end or ders, vendor managed inventory, stockless buying and MRO purchase, Open and closed tendering, Internal conflicts during purchasing operation Supplier Sourcing, Registration, and Evaluation: Spend analysis, Sourcing and supplier registration procedure, Supplier Evaluation and selection, Blacklisting of vendors Cost Management, Discounts and Negotiations: Total Cost of Ownership, Target pricing, Activ ty-Based Costing (ABC), Quantity discounts and supplier selection, Negotiation strategy and practices ‘Transportation and Delivery: FOB (Free on board) Terms, INCO (International commercial) terms, Documentation in freight shipments, Expediting and tracing shipments, Developing transportation and logistics strategy Capital Goods: The challenge of procuring capital assets, Sourcing and supply issues, Leasing Equip- ‘ment, Acquisition of technology E-procurement: Pricing and business strategies for E-procurement platform, E-marketplaces and on- line Catalogues, Online Auctions Price: Relation of cost to price, Government influence on pricing, Contract cancelation Purchasing Law and Ethic: chasing ethics Legal authority and personal liability of the purchasing manager, Pur- Global Soureing: Evaluating international suppliers, Intermediaries and countertradesINTRODUCTION TO PROCUREMENT MANAGEMENT CONTENTS Introduction 12 ‘Meaning of Procurement Management Self Assessment Questions Activity, 13 Purchase Procedure 13a ‘Understanding Negotiation 132 Interface with Stakeholders Self Assessmient Questions Activity, 14 Purchasing Manager — Roles and Responsibilities ‘Self Assessment Questions Activity, 1s ‘Types of Purchases Self Assessment Questions Activity, 16 Purchasing and Supply Procedures Self Assessment Questions Activity, uy ‘Types of Requisitions ata Standard Requisitions Lt ‘Travelling Purchase Requisition LT3 Bill of Materials (BOMs) Self Assessment Questions Activity, 18 Issuing an RFx Ls. Request for Quotation (RFQ) 182 Request for Proposal (RFP) 1.83 Request for Bid Terme Self Assessment Questions ActivityPRBS Tet Cer oY CONTENTS Summary. Descriptive Questions Answers and Hints ‘Suggested Readings & References ne en kee ereSE eS oea NOES oes on PRUNE RODUCTORY 1 AY BOOSTING A COMPETITIVE EDGE THROUGH IMPROVEMENT IN PROCUREMENT MANAGEMENT ~ CASE OF BRAMMER, UK SI as Hickman ‘Source: Evolution Power Tools Brammer and Buck & Hickman is Europe's leading distrib quality industrial maintenance, repair and overhaul ucts and services. It is one of the single-source sup ‘world’s leading brands across 22 countries. It ff orders every year. department to influence profitability ply. As Brammer distributed pi pliers and had a customer b imperative for it to streamline its procur practices to achieve the competitive edge. Inallianee with the Cha uute of Procurement and Sup- ply (CIPS), Brammer re-engineering its procure- ment processes and procedures. It adopted the industry's best dures and benchmarked them with industry standards. It sue- cessfully increased its competitive edge by establishing itself as ‘an organisation that adhered to rigorous and consistently high standards in fulfilling customer orders. As part of procurement process re-engineering, the entire team of, procurement professionals at Brammer was educated and trained ‘on best practices in procurement management. Its purchasing managers acquired Masters in Procurement Management from CIPS while its employees, on the whole, increased their procure- ‘ment management skills with the implementation of a new set of procurement processes that were certified by CIPS as best-in- class. ‘The re-engineering of the procurement process was hugely suc- cessful with cost savings in the first three years amounting to GBP ‘59 million per year. The procurement and supply department be~Pee eer Nee came a professional department that could set and achieve tangi- ble results. The department provided the company with a clear competitive advantage arising out of efficient processes based on the best practices. It also embedded sustainability and ethi- cal practices into its procurement processes. Accreditation with CIPS through CIPS corporate certification ensured that the pro- ‘urement management processes allowed the company to source: products under most advantageous terms for customers. It also greatly enhanced its corporate reputation as a leading interna- tional quality MRO distributor ‘The adoption of best practices streamlined procurement ma 's one of the biggest jes in the UK.SEE ese NOES eee on EUS NOTES After studying this chapter, you will be able to: > Discuss the scope and objectives of the procurement man- ‘agement function fferentiate between procurement management, purchas- ing and supply chain management Discuss the concept of negotiation in procurement Explain the importance of various interfaces of purchasing with stakeholders Discuss the roles and responsibilities of the purchase List various types of purchases made by the ‘department Explain the various types of requisitions Explain the concept of RFx _ TRODUCTI Y ' For a company like Brammer, discussed inl the caselet above, apply- ing the best practices in procurement management is too important when it comes to acquiring a competitive edge in the market as the company is a distributor that sources products from several thousand manufacturers for fulfilling customer orders. However, even for a typ= ical manufacturing or service organisation like the one in the automo- bile industry or in the hospitality industry, procurement management turns out to be a critical areaiwhere maximum cost savings and in- creased profitability can be achieved. This is because of the very na- ture of the procurement funetion. For most of the organisations, 60% of their sales revenue goes to buy raw materials and components. This automatically makes the procurement management function an ideal area through which organisations can do maximum cost savings. For a leading organisation, every dollar saved while sourcing raw material will directly go towards improving its bottomline. Also, as we learn from the caselet, implementing the best practices in procurement management not only results in major cost savings and efficiencies but can also provide a significant competitive advantage to the organisations. Given this strategic importance associated with the procurement function, it is necessary that we study the subject in detail and understand various concepts related to it, This chapter begins by explaining the concept of procurement man- agement in detail. The chapter also covers the purchase procedure and the roles and responsibilities of a purchasing manager. Next, the chapter explains different types of purchases, and purchasing and supply procedures. The chapter also explains different types of req-CER Teeter oy NOTES uisitions. Finally, the chapter discusses the role of RFx in the supplier selection process. MEANING OF PROCUREMENT MANAGEMENT Earlier, procurement was considered to be a service function meant for supporting the manufacturing function of organisations. Thus, it was not given much importance in either organisational structure or strategies. The basic objective of procurement was to do the bidding for mainstream departments. Hence, the procurement manager's role was only to fulfil the purchase requisitions raised by other de- partments. With an increased level of competition in the market, the role of procurement evolved from being transaction based to strategic based. ‘Today, procurement management is considered to be a vital part of operations management. Though purchase continues to be one of the major activities under the function of procurement management, it is no longer the only focal theme. As a function, procurement man- agement focusses on sourcing the right material, in the right quan- tity, of the right specifications and quality, at the right time, from the right souree and at the right price. To ensure that all these objectives are met, procurement managers need to play a larger role, which re- quires them to work closely with both internal and external custom- es, This is because factors like the right time, the right quantity and the right quality depend on several internal factors, which cannot be taken care of if the procurement function just aims to fulfil purchase requirements. To achieve the procurement management objectives, the procurement department needs to work in collaboration with all the departments of the organisation, including the produet design and quality department, the shop floor and the materials planning depart- ment, the finance department, the production department, and so on. In addition, the procurement manager needs to manage the external environment to meet the objectives of procurement management. This involves developing long-term relationships with suppliers and vendors. Procurement plays an important role in service organisations also. Each service has a tangible aspect. The quality of the service and customer satisfaction from it depends on the tangible aspects of the service. Service organisations need to procure these tangible goods from vendors. For example, a restaurant requires food products or a hospital requires varieties of medicines and other supplies. These ser- vice providers need to conduct the procurement process effectively to ensure than their service delivery process is not interrupted. ‘Some major objectives of procurement management are to: facilitate an efficient flow of materials and services as required for manufacturing end-productsPEELE C SS oe OER NOTES establish processes and procedures that allow continuity of supply and effective procurement of raw materials leading to the best val- vue for money 2. build and maintain long-term relationships with suppliers 2. develop alternate sources of supply for meeting future and planned needs collaborate with internal customers for meeting their present and future requirements @ provide market intelligence and product information to other de- partments and advise them on efficient procurement practices 2 manage procurement activities by creating proper policies, proce- dures and organisational structure for meeting procurement man- agement objectives. @ address procurement issues strategically by implementing the procurement management plan and collaborating with other com- ponents of the supply chain for meeting the overall supply chain management objectives. ‘The procurement management function requires proactive purchas- ing with emphasis on the total cost of ownership (TCO). The TCO con- cept embraces the notion of Total Acquisition Cost that goes beyond the objective of sourcing from a low-cost supplier, It considers costs associated with waste, inspection costs, costs associated with delays, inventory-carrying costs, handling and delivery costs and other costs related to procuring raw material, Procurement management has also become a value adding the centre instead of being a service or cost centre, Instead of reporting to production, it has now become an im- portant and independent management function. With reference to the wider Supply Chain Management (SCM) con- cept, procurement management is a subset function owing to the sim- ilarity of their core objectives. Supply chain management involves other functions like category management, inventory management, logistics and warehouse management, designing a sourcing strategy, materials planning, demand planning, supply chain planning and ca- pacity planning, ete. 1. Procurement managers need to work closely with both internal and external customers. (True/False) The function involves sub-functions like category management, inventory management, logistics and warehouse management, and so on,PURSES Ce roy NOTES Using the Internet, find the role of procurement management in an automobile company. Write a short note on it. EE] rurcnase procepure Business processes carried out in any organisation can be classified into several business process eycles, which are performed repetitively, pertaining to different functional areas. The business process cycle that starts from identification of material requirements (based on pro- duction planning schedules) to procuring materials to final payment to vendors is termed as ‘Procure To Pay (P2P) Cycle’. It is the procure- ment process cycle that involves purchase processes from several de- partments, such as material, purchase, stores and accounts payables. Let us discuss all the steps involved in the P2P eycle or procurement process cycle. 1. Identify material requirements: The P2P cycle starts with the identification of materials to be purchased. The whole exercise of demand planning, and MRP is generally done through computerised MRP applications which are now the essential modules of any ERP package. The MRP software automatically derives the quantity of various raw material and component parts required for each product to be manufactured based on the production schedule and Bill of Materials (BOMs). The purchasing module of the ERP package can then automatically generate purchase requisitions/purchase orders without any manual intervention. 2. Issue purchase requisition and review requirements: Once the need for procurement of material from external suppliers/ vendors is identified, the purchase requisition form is created, indicating the detailed specifications of material to be procured. ‘The form may be created manually in the ERP purchase module by those internal departments which require the material. Tt may also be auto-generated based on the inputs from the MRP module, ‘The purchase requisition is then forwarded to the procurement department. The purchase manager reviews the purchase requisition for completeness, budgetary allocation and purchase policy requirements before starting the supplier selection process or generation of PO, Based on the purchase requisition, the purchase order requirements are determined. Figure 1.1 shows a sample format of the purchase requisition form. Note the important fields in the form, like PR requisition number, requesting department, delivery location, delivery date required, item details, suggested suppliers, etc.SE esos NOES oe Ion EU) NOTES |ABC Manufacturers Ltd, [PR Nember Figure 1.1: A Sample Purchase Requisition Form, 8, Identify potential suppliers and float RFx: The procurement manager is now required to identify potential suppliers who can manufacture and/or supply the requited raw material or component parts. For standard routine items required for every product manufactured, the company usually has a supplier base with long-term commitment. However, for new items or when a new long-term contract is envisaged, the elaborate supplier identification, the selection and evaluation process is required. For new products, the procurement manager may float a Request for Information (RFI) to gather market intelligence data. Based on the data, the procurement manager shortlists suppliers for obtaining proposals, 4. Evaluate and select suppliers: Evaluation of potential suppliers is normally carried out through the pre-set evaluation criteria which reduce the subjectivity involved in the selection of suppliers, as there are several factors involved. Each supplier is scored on various parameters, like cost, capability, past experience, reputation, management quality, etc. Companies develop their own supplier evaluation framework based on their purehasing policy. ‘The Chartered Institute of Procurement and Supply recommends the supplier evaluation framework proposed by Tan, Lyman and Wisner (2002), which involves product and delivery assessment, capacity assessment and information assessment. 5. Negotiate with suppliers for the best terms: For purchase requisition for one-off items or when new vendors are being identified for routine items, it is necessary to negotiate with suppliers for the best terms and conditions. Since price is just one of the parameters when considering the need for buildingURS ere NGI NOTES a long-term supplier partnership, it is important that both the parties discuss various factors involved and arrive at mutually beneficial order terms. Other than price, delivery, quality, etc. are some important factors to be considered while negotiating with suppliers for the best terms. 6. Establish contract with selected suppliersigenerate purchase order: After receiving the purchase requisition (PR), the purchasing department will review it and generate the purchase order (PO) to be sent to the supplier (already selected and empanelled for the organisation) for the material procurement. Usually, a blanket purchase order (BPO) is generated for standard items, based on the long-term purchase agreement with the selected supplier. BPO is a shortcut method for ordering items that a supplier delivers to a buyer over a period of time. It is usually an open order, covering repeated purchase of an item or family of items. This removes the necessity of sending purchase orders every week or month for the same set of items to the same supplier The BPO does not provide any single quantity or delivery date but is applicable for a particular period of time duxing which the supplier releases the order, based on. the production schedule. Thus, with a BPO, the release of order becomes a routine matter between the buyer and supplier. A release order states the quantity of material to be shipped at a particular point of time, based on the BPO specification. ‘The PO js @ legal document with terms binding on both the parties, A sample PO format is shown in Figure 1.2: | Peo sancicmen ie Rainn ) tence See cme free batt fst [ies Name [fom Doms Figure 1.2: A Sample Purchase OrderTerese BU a ee a Rea 7. Receive materials and perform related procedures like the issue of goods receipt notes, ete.: Based on the PO received, the supplier may confirm the sale by sending a sales order to the manufacturer. On the delivery date, the supplier ships the materials to the shipping address. He/she also sends the invoice document which specifies the billing amount. The received materials are then verified with the purchase order number (or release order). This is done to compare the packing list and the actual goods received. The packing list is a document that states the quantity of goods being shipped. The procurement department then generates a Goods Received Note (GRN) to confirm the receipt of the material from the supplier. The accounts payables department is given the original invoice; which specifies the amount being billed against the PO issued. 8, Match the PO and make payment to the supplier: The accounts payables department ensures that the payment is made to the supplier only for the goods received against a valid PO. This is done by matching the invoice with both the GRN copy reesived and the PO copy. This is called 3-Way Matching which ensures that the payment is only made for the goods ordered as per the PO and GRN. Goods that fail inspection and quality control procedures are returned and the department passes on the information to the payables department, Tf the invoice is already raised and reg- istered by the payables department, it sends a debit note to the supplier for the rejected quantity. 9, Manage the contract over its lifetime: This step ensures that the performance of the supplier is as per the purchase agreement. The supplier's performance is evaluated for long- term relationship. A supplier who constantly fails to meet the supply schedule requirement is replaced with a new supplier with better capabilities. 1.3 UNDERSTANDING NEGOTIATION Negotiation in procurement management can be defined as a process that involves a formal discussion between the buyer and the supplier towards reaching the desired outcome based on a mutual agreement. ‘The Chartered Institute of Purchasing and Supply defines negotia- tion as the ability to reach the desired outcome through discussion and compromise. ‘Thus, negotiation is a process by which two or more parties, with con- flicting requirements, interact to reach consensus or agreement. The objective of negotiation process is to ensure the supply of right prod- uct/service at the right price, right time, right location and the right NOTES ncr FS eet NERNEY NOTES quantity. Negotiation can be done offline like face-to-face interaction; or online like via social media, email, video conferencing, etc. According to Baily (2008), there are three phases critical to the suecess of a negotiated procurement relationship. These phases are pre-nego- tiation phase, meeting phase and post-negotiation phase. Let us dis- cuss these phases. PRE-NEGOTIATION PHASE The pre-negotiation phase involves preparatory work before the start of the negotiation. The preparatory work aims to answer questions like what are the objectives of the Hegotiation exercise, what is the priority of each of our objectives, what results we want to achieve and what are the entry and exit points? Here, it is important to understand thé Goncept of entry point and exit point in negotiations. The entry point is the opening bid and exit point is the wall-away position. The entry point is important as once the opening bid is disclosed, it is unlikely that it can be bettered during discussions. Itis also important to know the exit point beyond which the negotiated agreement will not benefit the procurement manager. For example, he might conclude negotiation at such a price which he might regret later when alternative options came to be known. Hence, it is important that proper homework in consultation with internal users is done before starting negotiation with prospective suppliers. Zero-based Costing (ZBC) is one concept that plays an important role in the pre-negotiation phase. ZBC is a method of budgeting where all expenses must be justified for each function. The costing method starts from a ‘zero base’, and every function within an organisation is analysed for its needs and costs. After analysing the need, budgets are decided for upcoming period regardless of whatever the budget was for the previous year. Thus, in ZBC, costs are built around regardless of whether total cost is higher or lower than the previous one. This helps the organisation in getting more current knowledge on costing, This can further help a buyer in having a strong position while nego- tinting with a supplier. Apart from ZBC, ‘Best Alternative to a Negotiated Agreement (BAT. AJ’ is another important concept in negotiation. The term ‘BATNA’ was coined by Roger Fisher and William Ury in their 1981 book, ‘Get- ting to Yes: Negotiating Without Giving In. BATNA presents the most attractive course of action that an organisation could take if negoti- ation fails and an agreement cannot be made. This ensures that the negotiator does not lose a possible negotiated deal or gets involved in a deal which he might regret later.Terese BU a ee a Rea MEETING PHASE, ‘The meeting phase of negotiation involves three stages: introductory stage, discussion stage and agreement stage. The introductory stage involves creating an atmosphere for negotiation, validating each oth: er’s assumptions, testing the other party’s position and clarifying sues. The discussion stage of the meeting phase involves actual bar- gaining and negotiation. In this stage, the actual terms and conditions of the respective parties are revealed and discussed. It is important not to use manipulation or ploys while negotiating for long-term sup- plier partnerships which could be countersproductive in the long term. Once a negotiated deal is achieved, parties can have an agreement on terms and conditions. ‘The agreement stage involves concluding the deal by recording the full details of the various points agreed and for- mally finalising the agreement, POST-NEGOTIATION PHASE ‘The post-negotiation phase involves confirming each other's respon- sibilities and implementing the agreement and monitoring the same. ‘This phase is meant to drive home the point that no negotiation ex- ereise can be considered successful until what has been agreed gets implemented as per the decisions, reached during the negotiation process. 1.32 INTERFACE WITH STAKEHOLDER: As discussed in an earlier section, procurement management requires proactive purchasing and embracement of the TCO concept. This re- quires the procurement department to build strong co-ordination with other departments in the organisation. The interfaces applicable to various internal and external stakeholders are discussed as follows: 2 Purchasing and engineering: Interfacing with the engineer- ing department is required during the selection of suppliers for identifying sources of technology and for clarification on material specifications. Technical inputs from the engineering department could be crucial in identifying right suppliers. Similarly, inputs from the purchasing manager are required during early product development initiatives. Proactive procurement planning requires early identification of material requirements for new products. Tt could be done by using scientific techniques for determining the requirements of raw materials, ancillary parts and components and spares in advance. The engineering department helps the pro- curement department in the preparation of a plan for procuring, storing and handling materials required for producing products. 2 Purchasing and production operations: The purchasing manag- er always needs to interact with production and operations peo- ple who are the originators of material requirements. Though the generation of a bill of material is not the job of the purchasing NOTESUBS ele NOTES department, it needs to work with the production department to understand material requirements to facilitate proper purchase order specifications and selection of suppliers. The procurement manager should have good knowledge of production and material requirements plans. In addition, he/she must understand the pro- ‘cess of generating material requirements through these plans. Purchasing and suppliers: The purchasing department should closely monitor suppliers with whom it has a long-term pariner- ship. The suppliers are often provided with material requirement plans and forecasts so that they could manage the supply of ma- terials accordingly. This helps in a smooth supply chain process and ensures continuous production flow. In addition, suppliers are involved in the purchasing department in the early phases of re- search and development activities to provide inputs for improving, the production process, Purchasing and finance: Interaction with finance and account- ing is required for capital budgeting and make/buy decisions. In- puts from purchase managers are required for capital equipment selection while evaluating capital budgeting projects. Apart from this, the purchasing department always interacts with the finance department with regard to the accounts payables function which ensures matching of goods procured before making payments to suppliers. Though these routine interfaces with other depart- ments are processed through electronic systems, it is necessary for the purchase manager to understand the nature of interaction required as part of various business processes. Purehasing and quality: Involvement of quality and inspection personnel is required in supplier selection, supplier quality per- formance evaluation, supplier development for future projects and for understanding material requirement specifications. The purchasing department can provide the quality function visibility to the supplier quality processes for arriving at process capability indexes. The interface between the two departments is required for establishing check procedures and handling defective supplies. SMENT QUESTIONS 3. The P2P eycle starts with the. of materials to be purchased. 4, For new products, @ procurement manager may float a Request for Information (RFI) to gather market intelligence data. (True/False) 5. Which of the following parameters is used to evaluate and select suppliers? a. Cost b. Capability c. Past experience d. Allof theseTerese BU a ee a Rea 6. The procurement department generates a to confirm the receipt of material from the supplier. The ability to reach the desired outcome through discussion and compromise is called 8. The term ‘BATNA stands for: a. Best Alternative to a New Agreement b. Best Alternative to a Negotiated Arrangement ©. Best Alternative to a Negotiated Agreement d. Best Alternative to a Negotiated Assignment Visit the Oracle's E-business suite documentation website. Down- load the purchasing module user guide and study the forms used for purchase requisition and purchase order. Write a report based ) on your study. PURCHASING MANAGER - ROLES AND RESPONSIBILITIES We have already discussed the objéetives of the procurement manage- ment function. The roles and responsibilities of a purchasing manager are based on these objectives. Let us discuss major roles and responsi- bilities of a purchasing manager: 2 Maintaining supply continuity: Ensuring uninterrupted, high-quality and cost-effective supply of materials is the primary responsibility of any procurement manager. As mentioned earlier, the procurement manager should be able to purchase materials at the right price, from the right source, of the required specification, in the right quality, and at the right quantity, and arrange for deliv- ery at the right time. 2 Establish, implement, manage and control purchasing policies, processes and procedures: The procurement manager is expected to establish purchasing policies, procedures and processes; set up proper organisational structure and approval mechanism within the purchasing department; determine and recruit staff in associ- ation with the human resource department; set up procurement procedures and processes that are benchmarked with industry standards; manage procurement budgets; train and evaluate staff; implement electronic systems to handle the P2P cycle that has an interface with the other departments; and continually improve the procurement processes forming part of the P2P cycle. NOTES 1SERBS ele nN NOTES Vendor Management: Creating, developing and maintaining « reliable supplier base that can effectively serve the objectives of procurement management is one of the primary responsibilities of the purchasing manager. He needs to be actively involved in selecting the right suppliers, helping the existing suppliers to grow and improve their quality systems, scouting for new opportunities towards better sourcing strategy and evaluating the existing sup- plier base for monitoring their performance. Proactively manage the procurement management function: ‘The purchasing manager is required to go beyond the responsibili- ty of just fulfilling the purchase requisition needs. We have already discussed how the function of the purchasing manager interfaces with other stakeholders of the organisation. He/she should, there- fore, take an active interest in each of these interfaces towards aligning the procurement management goals with organisational goals and supply chain management strategies. Design and implement procurement management strategies: ‘The purchasing manager is required to develop the procurement management strategy to decide how the entire procurement pro- cess should be managed. It is thus the responsibility of the pur- chasing manager to develop an action plan that details how or- ganisational resources will be organised and utilised within the organisation to meet the desired goals and objectives of procure- ment management. The procurement management plan and strategy should be designed in accordance with the overall supply chain management objectives. The procurement manager should proactively participate in corporate strategie planning meetings pertaining to the designing and implementation of organisational goals and supply chain management objectives. 9. Which of the following is not a part of the roles and responsibilities of a procurement manager? a. Maintain continuity of supply b, Manage and control pr processes surement policies, procedures and ¢. Develop and maintain long-term supplier relationship dl. Inspection of the quality of the material received ‘Suppose you run a food retail store and want to hire a purchase manager for managing the procurement function for the store. ‘Write a job description for the desired candidate.Terese BU a ee a Rea Ea TYPES OF PURCHASES A finished product manufactured by an organisation is the result of many inputs, some of which are manufactured within the organisation and the rest are purchased from outside. No organisation can manu- facture all inputs required to manufacture a product in-house. Some major categories of purchases, which are handled by the procurement department, are as follows: Q Raw materials: Raw materials refer to basie items, such as steel, coal, petroleum, cotton, wheat, ete., used for manufacturing fin- ished goods. The term ‘raw material’ is used as these products are generally mined (or grown) and are not manufactured by any sup= pliers, Different organisations require different types of raw mate= rials based on the finished goods they manufacture. 2. Semi-finished products: Apart from raw materials, there are sev- eral other components that are required for the manufaeture of, finished goods. Though theoretically all these components can be manufactured in-house by purchasing relevant raw materials and capital equipment, it could be highly unprofitable due toa lack of the economy of scale and specialisation involved. Hence, compa- nies procure these components from external specialised suppli- ers. These could include component like carburettors, assemblies like steering systems, sub-systems like gear boxes, etc. Semi-finished products are normally manufactired according to the specification given by the buying organisation and, therefore, are not sold as finished products to the outside market. Some of these products may come under the wider ‘sub-contraeting’ con- cept where a long-term association with a supplier is envisaged with the supplier possibly dedicating plants and production sys- tems to the purchasing organisation. Finished products: These products include the actual finished products meant for resale under the brand name of the buying organisation, When the final finished produets are sourced from external vendors, these are termed as ‘outsoureing contracts’. This requires the procurement department to give entire specifications and technology to the vendor for manufacturing finished prod: ucts. For example purchase of Heating, Ventilation and Air Con tioning (HVAC) equipment to perform heating and/or cooling for residential, commercial or industrial buildings, come under the finished product purchase category. 2 Maintenance, Repair and Operating (MRO) items: These in- clude items that do not become part of the finished product but are nevertheless required by the organisation. These could be spare machine parts related to capital equipment, office supplies, etc. There could be several types of MRO items which the organisation might require. Considering that these are low-cost items that are NOTES ryTRB Sele NOTES required in volumes across the organisation, managing procure- ment of these items in a cost-effective manner could be challeng- ing for the procurement department. 2. Production support items: Like MRO items, production support items also do not form part of the final product but they are re- ‘quired for the production process. Electrodes, lubricants, packing material, shipping material, etc. are a few examples of production support items that are outsourced from external vendors to sup- port and run the production process smoothly. 2. Capital equipment: This is entirely a different category compared toall the previous items. These actually constitute production ma- chinery, which is used to manufacture products. These tend to be ones that require huge capital expenditure and are supposed to be used for many years into the future, The purchase of capital ‘equipment is closely related with the concept of Return on Invest- ment (ROD. ROI is 4 ratio, which is used to describe the amount of money eamed/saved, when comparing to the amount of money originally invested. ROTis also known as the payback period and is often expressed in a period of time, such as weeks, months or years. It is calculated on the basis of how long it will take to earn back or return the cost of investment, made in purchasing a piece of equipment. Let us understand the concept of ROI in relation to the purchase of eapital equipment. Suppose a buyer purchases a piece of equipment for $5,000. Also assume that this equipment will save $1000 per year for the buyer for a five year period. Then, the ROI for the purchased equipment can be calculated as: ‘Money earned on (funds invested)/ (funds invested) = ROL (85,000 earned) ($5,000 invested) = 1.00 or 100% over five years Evaluation and decision of capital expenditure is part of the finan- cial decision and taken by the finance department in collaboration with the production and purchase department. Once the items are decided, the purchase is routed through the procurement depart- ment but in a different set of procurement processes. For example, some items may be leased out instead of being purchased outright. The purchase of capital equipment is generally a one-off event un- like routine and regular purchases done in the case of previous categories. 1. Services: Organisations also sub-contract services to other organ isations. These might be ordinary support services like manage- ment of cafeteria, maintenance of cooling and electric systems, machine repair services, transportation, security, housekeeping, ‘engineering services, catering services, etc., or more specialised services like design contracts, software testing, implementation of software packages, data entry, ete. 2. Transportation and logisties: This is a specislised service that is usually outsourced to external vendors. This involves the manage-Terese BU a ee a Rea ment of inbound and outbound material flows. Several transpor= tation and logistics providers are available who can provide these services based on long-term contracts with the organisation. 10, Semi-finished produets are normally manufactured according to the specification given by the buying organisation and, therefore, are not sold as finished products to the outside market. (True/False) Select a standard engineering product, like cars, two-wheelersy computers, audio systems, etc. List the various types of materials and components, which are procured from external suppliers to produce the select product, Prepare a list of such materials and components, i PURCHASING AND SUPPL’ PROCEDURES The purchasing policy refers to rules, regulations and guidance that apply to all purchasing activities, like purchase requisitions and ap- proval, purchase specifications and review, supplier selection, suppli- er negotiation, ete, carried out by the employees of the procurement department. The policy is meant to provide a set of guiding rules and principles with regard to managing procurement within the orga sation. The purchasing policy may elaborate the following policy ele~ ments: Roles and responsibilities of the purchasing department Operational issues and authority Supplier qualification and selection Buyer-seller relationship Conduct of purchase personnel Ethical and sustainable purchasing The purchasing procedure manual details operating instructions per- taining to purchasing, It is largely a how-to-do manual in contrast to the policy document that provides principle-based guidance. The pur- chasing procedure describes the following aspects of procurement: High-level business process map of the P2P Cycle Business process map of procurement activities NOTES rt)EUR Sere AL LY NOTES 2. Detailed information on individual business processes with inputs, outputs and tasks involved in each of these processes 2 Steps involved in major tasks and processes within procurement Operational procedures Instructions regarding usage of various forms, documents and electronic modules 2. Procedures for entering into legal contracts, The purchasing and supply procedure usually involves a number of steps which are discussed as follows: 1. Identifying a suitable supplier 2. Involving in different supply contracts 3. Analysing supply cost 4, Evaluating supplier performance: Controlling materials provided by suppliers Handling defective parts and over-shipments Authorising supply procedures ‘Managing purchase documents During the purchase process, the purchasing manager must consider the authority matrix, which shows the authorities of different levels of decision-makers. In addition, he/she needs to ensure that the pur- chase procedure abides by the ethical purchasing codes of the organ- isation. SUMS Loa ES 11. The purchasing procedure manual is basically a how-to- do manual in contrast to the policy document that provides principle-based guidance. (True/False) Reh ‘Using the Internet, find out the purchasing policies of a leading manufacturing organisation, Prepare a report based on your find- ings. Ea TYPES OF REQUISITIONS The material purchase requisitions could be generated through any of the following means: Standard purchase requisition form from internal users,Terese BU a ee a Rea Q Auto-generated requests from Material Requirement Planning (MRP) 2 Forecasts and customer orders of supply chain management and demand planning systems 2. Re-order systems of inventory management 2 Inventory planning systems 2 Material requirements based on new product initiatives Let us now discuss major types of requisitions that are raised in any manufacturing organisation. 1.71 STANDARD REQUISITIONS Purchase requisitions can be raised by the user department for the respective material as specified in the purchasing manual. Onee pur chase requisitions are received, the procurement department should verify the same for budgetary allocation, completeness, eligibility and for other purchasing policy guidelines. In most of the large organisa- tions, purchase management software is used to manage the purchase demands of various internal users. All the validations and verifica- tions may be built into the software during implementation as per the purchase procedure manuals and business processes. In organisations, where ERP software is implemented or where the supply chain management applications are installed, purchase requi- sitions/orders are automatically generated into the purchasing module for standard and routine items. For blanket purchase orders, release orders may directly be sent'to vendors with whom the procurement team has a long-term contract. In the éase of service contracts, it is termed as the ‘Statement of Work (SoW)’ which will provide the na- ture of work to be performed by the vendor along with various mile- stones and related payment mechanisms. 1.72. TRAVELLING PURCHASE REQUISITION Though, not frequently used, travelling purchase requisition is a purchase requisition mechanism designed for a repetitive use. Trav- elling purchase requisitions are used in small companies where the P2P eycle is not automated. These are meant for repetitive purchases of standard items ordered by stores. To avoid issuing a detailed pur- chase requisition every time (when stores need to be replenished), standard card containing details of the request, either in the form of codes or bar codes, is used. This eard contains details like description of the item, vendor code, price, etc. Once the card is received by the purchase department and a PO is created, the card is sent back to the store for later reuse. As the name suggests, in travelling purchase req- uisition, the card travels between originating and purchasing depart- ments. In the case of bar code-based travelling requisitions, electronic NOTES eyFS eet NERNEY NOTES scanning by the stores personnel can create a standard purchase req- uisition in the PO module to be processed further by the procurement department. 1.7.3. BILL OF MATERIALS (BOMS) BOM is a hierarchical listing of sub-assemblies, intermediates, parts and raw materials required to produce one unit of the final product. Itis used to determine the items for which purchase requisitions and production orders should be made. The BOM can be of various types and used for different purposes. For example, an engineering BOM includes details related to the materials required for product design, whereas a sales order BOM specifies the materials required by cus- tomers. Therefore, the BOM is classified) based on its usage and the business needs of the organisation. The BOM not only lists all the required parts but also outlines the se- quence of steps required to produce the end-product. The BOM has a series of levels, and éach level represents a stage in the manufacturing of the end-product. The first level may represent sub-assemblies that are combined to make the final assembly. The next lower level that comes below to this one might represent the parts needed to make sub-assemblies, and the bottom-most level might represent the raw materials from which the parts are made, SSS OMI RTOS .. A hierarchical listing of sub-assemblies, intermediates, parts and raw materials required to produce one unit of the final product is called 13. A travelling purchase requisition is meant for repetitive use, (TrueFalse) 2c Visit a bakery shop in your vicinity and observe its re-order system, for raw materials. Prepare a report based on your observation. ISSUING RFX RFx is a term, used to refer to a family of ‘Request For...’ documents, RFx is used to collect different types of responses from suppliers. The three most commonly used documents in this family include Request for Quotation (RFQ), Request for Proposal (RFP) and Request for Bid Terms. Let us discuss in detail these RFx documents and how they are used in the supplier selection process.Spe tee en MU eect ona Rr Cero NOTES 1.81 REQUEST FOR QUOTATION (RFQ) Request for Quotation (RFQ) is prepared by the buyer and sent to a number of prospective suppliers inviting them to submit commercial offers with regard to the product being sourced. RFQs are generally used in the case of competitive bidding (though they might also be used for non-competitive basis). Note that unlike a purchase requisi- tion, an RFQ may not be a single-page document form but could con- sist of a document consisting of a number of pages elaborating various requirements, Based on the responses, the purchase manager may award the contract to the most qualified bidder. In competitive bid- ding, bids are selected based on the price quoted. If the purchasing organisation decides not to award the contract to the lowest price bid= der, it needs to inform the bidder why he did not receive the contraet. Competitive bidding involving RFQs is the best method of seleeting suppliers in the following situations: 2 Procurement pertains to a standard produet or product require- ments are clear, Price is the dominant criterion owing to the nature of the product and there are no major non-price variables. Market is competitive and several qualified sellers exist. There is no preferred supplier for the item. Volume is high. ooog Government regulations require competitive bidding. 1.82 REQUEST FOR PROPOSAL (RFP) RFPs are used when suppliersivendors are selected on the basis of negotiation rather than through aformal competitive bidding process. RFPs require suppliers to submit a detailed proposal on how they propose to achieve the objectives stated in the document. Apart from price, there are several other criteria that play an important role in se- lecting the best supplier for the contract. These criteria may relate to the supplier's manufacturing ability, quality services, speedy delivery, risk sharing and product support. REP process can take one of two forms, ‘open’ or ‘closed’. In an open RFP. any potential supplier can view the RFP documents and sub- mit a response. Open RFPs are used more commonly in government environment to ensure that purchases decisions remain unbiased. Aclosed REP (also knownas closed envelop RFP) is issued to specific, invited respondents only. Closed RFPs are usually issued by organi- sations that have ample knowledge about the product/service being purchased, and have already shortlisted potential suppliers for the purchase.PR Sele ONSITE NOTES As against RFQs, RFPs do not seek a price quote that conforms to the given material specifications but invites bidders to propose potential solutions to the problem stated. RFPs facilitate competition, allow in- formation gathering about potential suppliers and acquire market in- telligence. Purchasers may also float a Request for Information (RFD) beforehand which is basically a market inquiry issued to prospective suppliers. Based on the RFPs received, interested suppliers may submit their proposals detailing how they propose to meet the requirements of RFP along with their pricing, lead time, service support and other as- pects of their value proposition. Note that unlike a response to RFQ, the response to RFP is not about conformance to given specifications but a detailed response on how the vendor proposes to meet the ob- jectives stated in the RFP Once proposals are received, the buyer will evaluate various proposals and compare alternative approaches proposed by various suppliers The buyer will then negotiate with the selected suppliers on differ- ent terms and conditions of the supply contract. In the case of soft- ware packages, the buyer may require the vendor to provide a product walk-through, Proof of Concept (POC) or Prototype to be delivered as, part of the selection process. 1.8.3 REQUEST FOR BID TERMS Request for bid terms is also called Request for Tenders (RFT), which is used in place of RFQs in specific cases. As against RFQs, which are normally for low-priced or standard items, Request for Tenders (RFT) (though similar to RFQs in respect of clearly defined confor- mance specifications) are used for more complex solutions where se~ lection involves factors beyond price, for example, qualitative factors. ‘A RFT is a formal, structured invitation to suppliers to submit a bid to supply products or services. In the public sector to fortify and se- cure the tender bid engagement, an official fee is needed to ensure that such competition for the use of public fund is open, fair and free from corruption. Government tenders are the most common example of RFTs, where a government may publish an invitation for suppliers to make a proposal for a contract. An evaluation team goes through the tenders and decides who will get the contract. SELF ASSESSMENT QUESTIONS 14. Which of the following is a wrong statement? a. RFis used for gathering information. b, RFQ is used for competitive bidding. c. RFT always involves negotiation. 4d. RFP is meant for inviting proposals for complex items.INTRODUCTION TO PROCUREMENT MANAGEMENT 25 NOTES [a Ene Using the Internet, identify how RFx are used in the supplier selec- tion process for a consumer durable manufacturing organisation. Write a short note on it. E rE SUMMARY Q Procurement management is one of the critical management func- tions in any organisation considering that 60% of sales revenue goes towards procurement of materials. Q The procurement management function has gained wider role, not just confined to fulfilment of purchase requisitions. 2. The entire eycle starting from identification of materials to pay- ment to the supplier after procurement is termed as the Procure to Pay (P2P) cycle. Procurement management plays the most sig- nificant part in the P2P eycle, 2. The various typical activities carried out by a purchase manager range from receiving and reviewing purchase requisitions to iden- tifying suppliers to ordering items and ensuring receipt and pay- ment. 2. Supplier negotiation is an important function of the procurement manager. It is a three-phase proeass involving pre-negotiation phase, meeting phase, and post-negotiation phase. Q. The primary responsibility ofaiprocurément manager is to ensure continuity of supply of materials and services to production opera. tions. In this regard, he/she needs to devise, implement and moni- tor procurement policies, procedures and processes. He/she needs to proactively manage the procurement function and develop a long-term supplier base. Q. The procurement department has the responsibility of purchasing different categories of material. 2 Procurement policies provide guiding principles regarding the procurement function. Procurement procedures detail various op= erating procedures involved in the procurement function. Apart from standard purchase requisitions, there are also other types like travelling purchase requisitions and requisitions based on BOM. The supplier selection process can involve competitive bidding or negotiation. RFQs are used for competitive bidding while RFPs are meant for detailed proposals where price is not the only crite- rion for the award of contracts.POR Sele ONGC NOTES Allocation: Process of distribution of resources for a particular activity or task. Capacity: Ability to produce a particular number of units at @ given time. 2 Controlling: Activities ensuring that the actual performance is in accordance with the planned one. Enterprise Resource Planning (ERP): A software package that helps in the optimum utilisation of resources of an enterprise in a planned manner. 2 Material Requirements Planning (MRP): A process of identi- fying the requirements of materials used for producing finished products. Q Operations management: A system in which inputs are trans- formed into tangible and intangible goods. Operations: A combination of a series of activities responsible for the conversion of an input into the finished product. @ Production: Conversion of raw materials into finished goods and services by using human effort and other equipment. @ Purchase Order (PO): A commercial document issued by buyer to a seller, specifying type, quantity, and agreed price for ‘a product/service to be purchased. 2 Purchase Requisition (PR): A document generated by a user department to notify the purchasing department of items it needs to order along with the quantity and the timeframe. Quality Control (QC): A process that ensures quality in a prod- uct or service, G RFx: A term, used to refer to @ family of ‘Request For..." doc- uments, such as Request for Information (RFD, Request for Proposal (RFP), Request for Quote (RFQ), and Request for Bid (REB). | 1.10 y DESCRIPTIVE QUESTIONS 1. What do you understand by procurement management? List the major objectives of the procurement management function. 2. Discuss the P2P Cycle. Explain the various activities involved in the procurement funetion. 3. What are the roles and responsibilities of a procurement manager? 4. Discuss major categories of purchases handled by the procurement department.Terese BU a ee a Rea 5. Write a short note on different types of requisitions. 6. Explain the purpose and contents of an RFR Ey ANSWERS AND HINTS ANSWERS FOR SELF ASSESSMENT QUESTIONS Top nswers ‘Meaning of Procurement Lo Tre Management 2 Supply chain managonent Saas 3 iaenscnien xz © Tue 5d Allettiess QB 6 Goods Received Note (GRN) tic Vv Neston, & Bost Akemative toa Nesotit ed Agreement ‘Purchasing Manager — a a of the Roles and Responsibilities ~ ‘Types of Purchases 10, True ‘Purchasing and Supply ome amt TypescfRequsiions 912. BillofMternl BOM) Teeing an Uke. RFT always involves negota tion. HINTS FOR DESCRIPTIVE QUESTIONS 1. Procurement management refers to the function of managing the procurement of materials and services from external suppliers for ensuring a smooth production process. Procurement management aims at ensuring the efficient flow of materials for production, establishing purchase processes and procedures, maintaining long-term relationship with suppliers, etc. Refer to Section 1.2 Meaning of Procurement Management. The P2P cycle depicts all processes involved in meeting the procurement needs of any organisation. It starts with material identification and ends with payment to vendors. A routine procurement function usually includes activities like selection of suppliers and supplier performance evaluation. Refer to Section 1.3 Purchase Procedure. NOTESEERE Sele ONSITE NOTES 3. A procurement manager is basically responsible for maintaining the continuous supply of materials for production, Refer to Section 1.4 Purchasing Manager - Roles and Responsibilities. 4. The procurement department is basically responsible for different types of purchases, like buying raw materials, semi- finished products, MRO items ete. Refer to Section 1.5 Types of Purchases. 5. The major types of requisitions that may take place in any manufacturing organisation include standard requisitions, travelling purchase requisitions and bill of materials. Refer to Section 1.7 Types of Requisitions. 6. The Request for Proposal (RFP) is used when suppliers/vendors are selected on the basis of negotiation rather than through a formal competitive bidding process. Refer to Section 1.8 Issuing an RFx. Ba SUGGESTED READINGS & REFERENCES SUGGESTED READINGS Q. Baily, P; Farmer, D., Crocker, B., Jessop, D., & Jones, D. (2008). Pro curement Principles and Management. Pearson Education. O_-Monczka, R. M., Hondfield, R. B., Giunipero, L. C., & Patterson, J. L. (2015). Purchasing and Supply Chain Management. Cengage Learning. >) Bower D. (2010). Management of Procurement (1st ed.). London: ‘Thomas Telford. E-REFERENCES 1D APICS - The Premier Association for Supply Chain Management. (2017). Apics.org. Retrieved 27 April 2017, from http:/;wwwaapies.org/ 2. CIPS - Leading global excellence in procurement and supply - The Chartored Institute of Procurement and Supply. (2011). Cips.org. Re= trieved 27 April 2017, from hitps:/www.eips.org/en-SG/ 2 ISM- Institute for Supply Management. (2017). Instituteforsupplym- anagement.org. Retrieved 27 April 2017, from https:/hvww.insti- tuteforsupplymanagement.org/index.cfm?SSO=1 2. Supplier Evaluation - The Chartered Institute of Procurement and ‘Supply. (2017). Cips.org. Retrieved 27 April 2017, from httpsi//www. cips.org/en-SG/knowledge/procurement-topics-and-skills/suppli- jc---tender-evaluation/supplier-evaluation-and-appraisall/ supplier-evaluation/ 2 Supply Chain Management Publications | American Purchasing Society. (2017). American-purchasing.com. Retrieved 27 April 2017, from https:/iwww.american-purchasing.com/propurchPURCHASING OPERATION AND ITS STRUCTURE CONTENTS Introduction Purchase Orders and Payiment Purchase Agreentent for Standard Purchase Orders Blanket Order@ Open-end Orders Self Assessment Questions Activity, Vendor Managed Inventory (VMI) Self Assessment Questions Activity, Stockless Buying and MRO Purchase ‘Self Assessment Questions Activity, Open and Closed Tendering Self Assessment Questions Activity, Internal Confliets during Purchasing Operation Self Assessment Questions Activity, Summary Descriptive Questions Answers and Hints ‘Suggested Readings & ReferencesRODUCTO! UE \VENDOR-MANAGED INVENTORY AT ROBERT BOSCH NORTH AMERICA Source: hip:/autecconemictimes indiatimes com ‘The quality movement\ and technology breakthroughs of the 1980s and 1990s made ERP systems a de facto requirement for most manufacturing companies. As competition increased with globalisation, these companies moved to Just-In-Time (JIT) man- tufacturing along with supply chain optimisation. The supply chain management concept required a close co-ordination and synchronisation eo, with suppliers. In this regard, the concept of Vendor-Managed Inventory (VMI) serves as a great tool thai facilitates efficient collaboration between manufacturers and suppliers. This case study looks at how Robert Bosch North America effectively used the VMI concept in combination with JIT manufacturing. Robert Bosch North America’s (RBNA) automotive division is one of the leading Tier-1 automotive suppliers, which supplies fin- jished goods to several original equipment manufacturers (OEMs) in North America, Europe and Asia. Its Charleston plant is one of the largest manufacturing plants with complex manufactur- ing processes. It manages more than 2,000 production parts with 175 suppliers. RBNA products include fuel injectors and antilock braking systems. RBNA’s Charleston plant implemented the VMI concept after which suppliers were required to replenish inventory at Charles- ton, based on consumption. At the same time, Charleston was also moving towards JIT-based manufacturing targeting at zero inventory levels. To implement the JIT strategy, Charleston want- ed its suppliers to move from weekly shipments of inventory to daily shipments in smaller lot sizes. The requirements for daily shipments were determined based on planned daily production schedule (which takes into account the finished goods require- ‘ments), inventory transit times and suppliers’ manufacturing ca- pability. er ey er ey aSra er nOT eo soiree eter ETT INTRODUCTORY ‘This requirement, while forcing suppliers to be efficient, also re~ ‘quired them to maintain at least 1-3 days of finished goods’ inven- tory at their location. At least, this level of inventory was required to ensure smooth replenishment of the required goods at Charles- ton, It was a challenging task for the suppliers to move to the VMI system that also followed JIT-based manufacturing owing to very close collaboration it required with the BPS, ‘To determine the daily requirements of shipments, which vary depending on production schedules, several factors were to be considered. On the Bosch side, it depended on customer order forecast, stock-in-hand and work-in-progress, goods received a daily basis, production completed, shipments to customers, Suppliers were expected to adjust their production schedules ‘was based on & pull signsl that provided the required dail quantity. Suppliers required up-to-date informatio While the implementation of VMI itself tion and real-time information-sharing, i ‘manufacturing became more challe1 to manage inventory at the manufa tive is to keep zero-level invent or when suppliers are expe manufacturing plant, it non suppliers. s case at least 2-3 days of the implementation of VMI, even suppliers are relieved of main- tory. Thus, it was a huge challenge for RBNA to ensure that suppliers are able to scale up to BPS and reap all benefits of VMI-based JT. ‘The challenge was successfully met with the implementation of a new online VMI collaborative tool. Charleston purchased and im- plemented an online VMI system called “SupplyOn” (along with WebEDD that allowed it to communicate delivery schedules, ac- tual stock-on-hand quantities and goods receipt information, etc. online to suppliers. tain large amounts inventory, at their Suppliers could access SupplyOn on a daily basis to determine the shipment required for the next day. This greatly helped them to more efficiently plan their production schedules and manage inventory requirements, The online VMI system helped Charles ton to reduce daily inventory levels by 30% and achieve signifi- cant cost savings. Satisfied with these results, RBNA decided to roll out the VMT system at all its plants.Ey FS eet NERNEY NOTES Sal After studying this chapter, you will be able to: Explain the steps involved in the purchasing eycle Explain the concept of blanket purchase orders and their ‘purpose Discuss the concept of vendor-managed inventory Explain the role of stockless purchasing Differentiate between open and closed tendering Discuss various internal conflicts that affect the purchasing operation YY rrry E@gbinrropucrion In the previous chapter, you studied the fundamental concepts re- garding procurement management. The chapter explained the pro- curement management funetion and discussed the roles and respon- sibilities of the procurement manager. In this chapter, let us discuss in detail the purchasing operation and its various components. In simple termis, purchasing refers to an act of procuring a product at a specific price. In a broader sense, purchasing is a managerial acti ity that aims at getting the different departments of an organisation the right materials at the right time in the right quantity from the right souree as and when required. In small organisations, the purchasing operation is performed by the production manager, whereas in large organisations, there is a sepa- rate department for the same. The basic objective of the purchasing operation is to ensure a continuous supply of raw materials, sub-con- tracted items and spare parts as well as to reduce the final production cost of finished goods. In other words, the objective is not only to pro- cure raw materials at the lowest price possible but also to reduce the cost of the final product. In recent decades, the objective of zero inventory or stockless pur- chasing has become crucial in inventory and supply chain manage- ment. With this objective in mind, organisations have devised sev- eral methods to reduce inventory through collaboration with their suppliers. This chapter begins with a detailed explanation of the purchase cycle and different types of purchase orders. Next, the concept of VMI and stockless buying are discussed. The chapter also differentiates between open tendering and closed tendering. Lastly, the chapter dis- cusses various internal conflicts that affect the purchasing operation of an organisation.Pre eof so OCP Miser ra eres) NOTES PURCHASE ORDERS AND PAYMEN’ Purchasing is the formal process of buying products and services. ‘The process of purchasing can vary from one organisation to another. However, there are some common key steps that are followed by all or- ganisations. To make purchasing effective, most organisations follow a purchasing cyele or process. The purchasing cycle is a step-by-step approach to an effective purchasing function. Figure 2.1 shows steps involved in the purchasing cycle: Hdentifying the Need} —>| Specifying the Need as Following up and ee et Aporoing Figure 2.1; PutehasingCyele Let us now discuss the steps involved in the purchasing eycle. 1. Identifying the need: It refers to the first step of the purchasing cycle in which the requirements of materials are determined by the user department. These requirements are determined by taking into consideration the purchase requisitions and BOM, which were discussed in the previous chapter. 2. Specifying the need: It involves determining the exact quantity of materials to be purchased for production. Different departments of an organisation need to define their requirements in the purchase requisition form. The approved PR reaches to the purchase department for making the purchase. If there is any error or unclear description in a requisition form, the purchase department does not make any changes in it, rather the department sends the form back to the respective department for clarification. 8 Selecting a source: It refers to one of the most important steps of the purchasing cycle, The quality of materials depends on the source from where they are procured. Therefore, the purchase department is responsible for selecting the right source for procuring materials. To do so, the department maintains a list of reputed suppliers. The purchase department also selects a ing tenders through advertisements. supplier by invitErMBS Wlaucta toe eran y NOTES 4, Determining the price: As discussed earlier, the purchase department is responsible for procuring the optimum-quality materials at the lowest price. Therefore, it is important for the purchase department to analyse its budget, perform market, research and determine the best price for procuring materials. The purchase department generally uses three ways for determining the best price of materials, which a 4 Vendor catalogue: It is list of different materials along with their prices and quantity, available from different vendors. ‘The department only needs to check the current list to deter- mine the best price of materials. 4 Negotiation: It involves bargaining with the supplier to reach the best price of materials. Tendering: It refers to a method mostly used by government organisations in which the buyer sets a price for materials and the supplier needs to bid for receiving the purchase or der from the buyer 5, Placing a purchase order: A purchase order is a legal contract that specifies the entire agreement between the purchase department and the supplier. It defines the agreed price, terms and conditions and specifications of materials to be purchased, ‘The purchase order helps in preventing any misunderstanding between the two parties. 6. Acknowledging the order: After the order placement, it has to be acknowledged by the supplier. Acknowledgement is all about getting confirmation from the supplier about the timely delivery of materials. Without acknowledgement, the order will remain only “an offer to purchase” with no legal standing. Once the supplier issues acknowledgment, it becomes a purchase contract, and the same needs to be noted in the purchasing system. 7. Following up and expediting: It ensures that the items are delivered by the supplier on time. No special expediting procedure is required in the following conditions: Good production planning Less engineering alterations Efficient inventory control Proper purchase order Appropriate supplier 8 Checking the invoice and approving the payment: This is the last step of the purchasing cycle wherein the invoice is verified by matching it with the purchase order and GRN. This, is called three-way matching. If there is no mismatch between the materials ordered and received, payment is made to the supplier. In certain cases, the invoice needs to be matched onlya esol aCe Maeno RET NOTES with the purchase order: This is called 2-way matching, and it is applicable in eases where GRN is not raised. For example, in the case of blanket purchase orders, GRN is not raised. As discussed, the purchasing eycle is applicable for any standard. purchase order, However, all purchases do not go through such elaborated stages. Owing to the nature of repetitive purchases of the same materials, organisations have invented new methods that simplify the purchasing cycle and integrate it with the inventory management process. In this chapter, you will study some important purchasing methods in detail. 2.21 PURCHASE AGREEMENT FOR STANDARD PURCHASE ORDERS ‘The Chartered Institute of Procurement and Supply (CIPS) defines purchase order (PO) as a document isoued by a buyer to his/her suppli- er that defines what is needed, in what quantity, when performance is required, and on what terms, including price and payment terms. The issue of a purchase order is a prerequisite in many payment systems for the payment of invoices. A sample format of the purchase order was shown in the previous chapter. It is important to understand that manufaetuting organisations pro- ducing the same set of finished products require similar sets of mate~ rials and components for each and every production schedule. Given that the manufacturing plant and the nature of production methods do not change, the required raw materials and component parts for manufacturing any particular finished product would not vary with every production plan. Only the quantity of raw materials and compo- nents may change depending on the customer demand forecasts and production plans. Similarly, procurement of standard inventory items that are required on a day-to-day basis usually involves the same set of suppliers who have already been approved (through a supplier selection process) by the organisation for sourcing its inventory requirements from them. ‘Therefore, organisations are not required to identify a new supplier every time an inventory procurement requirement is raised, owing to the repetitive nature of the requirement. ‘To fulfil their standard, repetitive purchase requirements, organisa- tions enter into long-term purchase agreements with suppliers. These purchase agreements envisage a long-term partnership with suppliers in terms of procurement commitment from the buyer organisation. Different types of organisations like manufacturing, service, software, etc. use different types of purchase agreements depending on the na- ture of their procurement needs.EB Were e Cera ny NOTES oe ‘Types of purchase agreements CIPS classifies purchase agreements into the following two catego- Framework contracts: Framework contracts are legal con- tracts where the buyer commits upfront that it will purchase a specified quantity of items in a given period. For example, a manufacturing organisation may enter into a framework con- tract with an electric utility for the off-take of a specified amount of electricity during a given period. Similarly, a pharmaceutical company might forecast that it requires a particular amount of chemicals to be used as raw materials in its batch production processes at any given period. Though the company might be certain of its requirements, it may not need to purchase the en- tire quantity at once. Instead, it ean enter into a contract where- in it commits to purchase the entire quantity from the same supplier over a specified period. This helps fix both the price and the supplier at-the best possible terms for the entire pro- duction period. Such a contract is called a framework contract. Q Framework agreements: A framework agreement is not a legal contract but only an agreement to buy an unspecified quantity over a particular period of time, For example, an automobile major like General Motors knows that it would require sourcing ofanti-braking systems from a supplier like Robert Bosch, over a period of time. But General Motors does not want to enter into a framework contract that specifies that it will purchase a specific quantity from Robert Bosch during a particular peri- od. In that case, it can enter into a framework agreement with Robert Bosch wherein it only commits (or firm up its intention) to purchase anti-braking systems over a period at given terms and conditions including the price. So, a framework agreement need not specify any quantity nor carry a legal commitment to purchase a fixed quantity. It may not even specify delivery dates or the shipment location. Most manufacturing organisations en- ter into framework agreements due to its flexible nature. Standard purchase orders are similar to framework agreements as they do not have a legal contraet but only an offer to purchase. A pur- chase order becomes a contract only after the supplier accepts it by acknowledging the same and committing to supply products/services as per the terms mentioned in the purchase order. 2.2.2 BLANKET ORDERS ‘The term ‘blanket purchase order’ is used differently in the context of different organisations and ERP modules. The APICS (AssociationSees sO G eM eae ET NOTES for Purchasing and Inventory Control Specialists) dictionary de- fines a blanket purchase order as a long-term commitment to a supplier for material against which shori-term releases will be generated to satis- ‘fu requirements. The CIPS definition says blanket purchase orders are ‘purchase orders placed on suppliers that cover a range of products or a time period that commits to a volume of one product. In the CIPS terminology, a blanket purchase order is a form of frame- work agreement. CIPS defines a blanket purchase order as an agree- ment between buyer and seller whereby certain goods will be purchased at prices established or agreed to by way of a formula over a period of time. In other words, it is an agreement with the supplier where the buyer commits to purchase the items over a specified period. It may or may not specify an indicative quantity. Blanket purchase order is generally meant for a particular item or a group of items required to be ordered repetitively from a single sup- plier. It is basically an open order effective for a specified period, say, for one year. It eliminates the need for issuing a separate purchase order whenever there is a need for materials. ‘The buyer will enter into a blanket purchase order through due nego- tiations after which ordering of any item covered by the blanket pur- chase order only requires a release order. Through this mechanism, the order and receipt of materials as per the production schedule be~ comes a routine matter between the buyer and the supplier. Most pur- chases in the organisation covering routine standard items happen only through blanket purchase orders. Standard purchase orders are used only for one-off purchases from new suppliers. When a blanket purchage orde¥ for an item is negotiated, the buyer and the supplier evaluate the anticipated demand for the item over a period of time. The two parties then agree to the terms and conditions including price, quantity, discounts, specifications, quality and deliv- ery lead times. For a purchase to be made by the blanket purchase or- der, individual purchase orders and GRNs are not raised. The blanket purchase order reduces transaction processing costs which can have a significant positive impact on the total acquisition costs of materials. ‘The salient features of a blanket purchase order are summarised as below: QA blanket purchase order is a type of long-term purchase orders and is the most preferred and widely adopted method for all repet- itive and standard purchases. A blanket purchase order covers a procurement commitment to a supplier for specific produets at an agreed-upon price for a speci- fied period. @ A blanket purchase order eliminates the need of issuing a pur- chase order every time there is a requirement for a material.ErMBS Wena Cera NOTES Q. Tomanage routine and standard inventory items, buyers enter into blanket agreements which enable the shipment of items through release orders obviating the need to go through an elaborate pur- chasing cycle. 2A blanket purchase order is based on negotiated terms and con- ditions including price, quantity, discounts and projected demand over a period. It leaves the delivery date and the ship-to location open. 1. Release orders are issued against blanket purchase orders as and when material requirements are identified in the MRP system. 2. On shipment, the supplier raises the invoice for payment. No GRNis raised for shipments based on blanket purchase orders. 2 ‘Two-way matching is done while making payment for shipments done on the basis of blanket purchase orders. 2. Total invoices raised against a blanket purchase order cannot go beyond the limit set for blanket purchase orders. RELEASE ORDERS AND SYSTEM-GENERATED PURCHASE ORDERS. Release’ orders (also called material purchase releases) are authori sation issued to suppliers to make shipments as and when required as per the blanket purchase order agreement. A copy of material purchase releases is also sent to purchasing, accounts payables and stores departments. Release orders specify the current quantity to be shipped, delivery date and ship-to location. These orders are based on material requirements identified by the MRP system. These orders raised by the MRP system are based on the BOM associated with the finished product. For example, for a desktop PC, there is a demand for 1,000 finished products, that is 1,000 PCs. To cater to this demand, release orders derived from BOM, for components or parts to be re- plenished will require shipment of 1,000 monitors, 1000 keyboards, 1000 mouses, 1,000 hard disks, etc. (assuming these are externally soured from suppliers). In an ERP system, automatic release orders for each of these components will be directly issued to the suppliers as per the respective blanket purchase order details. Such release or- ders are called system-generated purchase orders/release orders, In the real world, most purchases happen only through such automatic system-generated release orders. In such release orders, in the first few weeks (or days depending on lead time), the material requirement indicated will be the actual ship- ments required as per the delivery date specified, while the require- ment stated for the subsequent period will be the quantity forecast for the period. It is also practised by many supply chain-driven man- ufacturing organisations to share material requirement forecasts with their suppliers. This would help the supplier plan supply require- ments in advance.pre eso eLe so UG PMS e rt ru Lente) NOTES 2.23 OPEN-END ORDERS Opencend orders are similar to blanket purchase orders. However, they allow for inclusion/deletion of additional items over a period of time. Such orders are useful for procuring MRO and production sup- port items discussed in the previous chapter. Usually, these items are of low cost, high volume and large in number. The required items can also change and ean be unpredictable, Open-end orders allow the con- venience of modifying standard blanket purchase orders. The period of the order could be up to one year or till renewal. 1. Astandard purchase order isa legal purchase contract issied by a buyer organisation and received by the supplier. (True/ False) 2. The process of ensuring that the payables department pays‘! an invoice for actual goods received in accordance with,| a purchase order issted to the supplier is termed as , 3. A blanket purchase order can be defined as: a. A single purchase order that allows for the purchase of dif- ferent items pertaining to a single produet from different vendors. b. A single-purchase order meant for ordering the entire quantity of an item required during a specified period. ©. An umbrella purchase order against which further release orders for the shipment of quantities as and when required can be issued. d. Asystem-generated PO. 4. Arelease order is: a. A type of material purchase requisition received by the purchase department. b, Issued directly to the supplier against a blanket purchase order without going through the purchase department. ©. Meant for release of shipments to shop floor from stores. d. Allof the above. ‘As an owner of a retail chain, which purchase ordering format would you choose to maintain an appropriate level of inventory? Write @ short note on it.