Materials Management

Lecture 4: Purchase Practices

Udit Chaudhuri

Purchase - Practices

1. Budgeting & Control – purchase cycle2. Price Forecasting 3. Hedging & Forward Buying4. Vendor Evaluation & Rating 5. Negotiation6. Buyer-Seller Relationship7. Supplier Quality Assurance Programme

Purchase Budget & Control

To plan & control cost and cash outgoings

1. Annual Sanction – Expected Material Receipt

2. Auto Limit - % of previous period

3. Special sanction – new product, project

4. Posting of P.O. against Limit

5. Cost Control & Sanction Control

Price Forecasting

Multiple approaches, top management decides1. External: Market trends, Logistics, Data availability2. Internal: Variety, facilities, skills, systems available

Techniques, based on materials research3. Extrapolation of time-series / trends – Moving

averages4. Relationship with another price - Correlation

Moving Averages

• Seasonal buying• Commodity-based business • Sensitive raw materialsSimple Moving Average E.g. 200 Day SMA, 5-month mean, 5 Qtrs trailing

Moving Averages

Exponential Moving Average• To accommodate wider variations – volatile markets• To remove the error in previous forecasts

EMAt = EMAt-1 + (k * (Pt - EMAt-1))

EMAt is the exponential moving average for the current period. EMAt-1 is the exponential moving average for the previous period. Pt is the price for the current period. k is the exponential smoothing constant.

Moving Averages

Price Forecast for Month ‘m’ with Interval of ‘D.’ • Where D=1, (m-D) is previous monthHence, forecast price for the month m= 1/n [Actual price for month (m-D) + (1-1/n) Forecast price for month (m-D)]

Example: EMA for Steel and Steel products

Correlation

E.g. Oil prices and Dollar

Correlation

E.g. Combined trend of oil price (Brent Crude at Dubai), refining margin, AG Crude production, shipment over 2 years

Other Techniques

• Regression Analysis• Linear programming• Delphi Techniques

• Reliability and consistency governs the choice of method used.

Hedging

• To go against the trend of prices or demand

• Buy in slump – buy larger quantities as demand

falls

• Buffer Stocks - Counter the rising demand by

deferring purchases

• Hedge against crash by buying before free-fall

Forward Buying

• To go with the trend of prices or demand

• Anticipate rising price and buy in advance,

keeping higher inventory – e.g. retail

• Anticipate falling prices and buy frequently

Vendor Evaluation & Rating

1. Static aspectsa. Facilities – factory, store, office, display… b. Staff – strength, qualifications, awareness…c. Service – Efficiency, response, courtesy…

2. Dynamic aspectsa. Frequency of ‘right delivery’ b. Slippage – quality, price, terms, replacement…

3. Ratinga. Ranking of vendorsb. By industry standards

Negotiation Practices

• Price Vs Quantity – slab discounts

• Price Vs Cash – advance payment

• Price Vs Trend – added quantity or frequent orders

• Price to stock – spl. price to ensure minimal stocks

• Material & labour component – full or part

• Tax – Transfer of liability, exemption, etc

• Transport & Insurance

• Technical support – esp. to sub-contractors – training, testing, tools

Buyer-Seller Relations

• Effectiveness – results with ethics

• Cordial relations – free and frank communication

• Reciprocity – buying from customers

• Access by salesmen – importance, control

• Public relations – internal and external

• Training to vendors

Supplier QA Programme

• QA evaluation at vendor location

• Issue of instruments & tools

• Control of drawings & critical documents

• QC - at vendor or at buyer’s plant?

• Testing facility – access to vendor

• Rejection – replace or debit?

• Training

• Tech upgrades

Value Analysis

• What is the item?• What does it do?• What does it cost?• What else would do the same job?• What would the alternative cost be?

Cases

• Copper-aluminium replacements – electricals• Al castings replacing steel – auto• Brass fins in condensor • Zinc replaces/reduces Lead content – paints• Plastic pouches replace Tin/Al cans – FMCG • Tetrapack – replaces bottles• Laminated tubes for collapsible Al – pastes &

ointments

Materials Management

Lecture 4: Purchase Practices

Thank you