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Submitted By:Brij Mohan Gupta..…037Shweta Bhandari…....005Varsha Tushir………034Neha Singh…………004Anuj Sagar……….....014 Deepak Tyagi….…...028

PURCHASE MANAGEMENT

Purchase Management is a function of materials management in a company. Their basic

function is procuring the inputs for production function. This function encompasses suppliers

in the market external to the organization and several internal to the organization.

Till recently, the purchasing process simply involved placing an order with the supplier who

offered the lowest price. Nowadays, increase in competition and market demand and scarcity

of resources have forced organizations to reexamine their purchasing activities. The

purchasing department functions have expanded considerably and include activities such as

verifying the credentials of suppliers, inspecting the quality of the material to be purchased,

ensuring the timely delivery of the material, etc.

While the value of purchased items varies from industry to industry, it adds up to more than

fifty percent of sales in all industries. Purchase management is regarded as a significant

activity in many organizations because of the high cost involved in carrying out purchasing

activities, increasing quality benchmarks, and increasing global competition. Purchase

departments buy raw materials, parts, machinery, and services used by production systems.

The objective of purchase management is to procure the right equipment, materials, supplies

and services in the right quantity, of the right quality, from the right suppliers, at the right

time, at the lowest price.

IMPORTANCE OF PURCHASE MANAGEMENT

Purchase management is considered to be very important function of materials management

in a company. Its importance is felt even outside the formal scope of materials management.

As the purchase decisions commit a very large portion of financial resource of the company

purchase function is said to be highly important. Purchase personnel deal with large number

of external agencies while performing their functions. Hence they represent company’s

reputation in the outside world. As they negotiate and finalize deals worth lot of money for

the company their integrity is of utmost importance for the organization.

OBJECTIVES OR GOALS OF PURCHASING

Primary objective or goal of purchasing function is making inputs available to the conversion

process at minimum cost to the final output of the company. Thus focus is on system output

rather than on micro level objectives.

The inputs to be made available are raw materials, semi finished items, bought out items etc.

There are certain parameters to be monitored for fulfilling the system objectives. We can call

them goals of purchasing. These goals are popularly known as 5R’s of purchase namely, right

price, right quantity, right quality, right place and right time. In simple terms, if the above

5Rs are achieved primary objective is fulfilled:-

Right Price: Right price is determined by costing the production process of the supplier.

Right price is determined by allowing reasonable profit for the supplier and insisting and

helping to reduce cost. Tender system should be used to identify lowest responsible

bidder rather than lowest bidder. Principles normally used to ensure right price are cost

structure and learning curve.

Right Quantity: Right quantity of purchase is the one that ensures no excess and no

shortage. High priority items are subjected to EOQ analysis to determine the right

quantity for purchase. This ensures overall minimum cost for inventory.

Right Quality: In an item purchased should ensure adhering to mutually accepted

standard by supplier and customer at the time of finalizing the purchase order. The

accepted standard may be a drawing, a sample, a grade or a universal standard like DIN,

IS, BS etc.

Right Place: is the one where the item is going to enter the value stream. If the item is

not available here, when needed, it is in short supply for the process.

Right Time: is as decided by production schedule for meeting customer’s requirements.

ORGANISING PURCHASING

The effectiveness of purchasing activities can be enhanced by proper organization and

coordination of the activities. There are two types of purchasing system:-

Centralized purchasing system

Decentralized Purchasing system

i. Centralized purchasing system: In a centralized purchasing system, all purchasing

activities of an organization are carried out by a separate department. A centralized

system is effective when an organization has a number of production sites within the

same site which requires the material with same or similar specifications. In such cases,

a centralized system allows pooling of all the requirements so that benefit of bulk

purchasing can be realized. The centralization also leads to consistency in buying

policies and uniformity in maintaining purchasing records.

ii. Decentralized Purchasing System: In a decentralized purchasing system, the heads of

different departments purchase the needed materials according to their specific

requirements. This method gives each department the flexibility to alter its purchasing

policies on the basis of specific requirements.

However, most organizations do not totally depend on any one system: instead, they use a

combination of both the systems.

FUNCTIONS OF PURCHASING DEPARTMENT

The purchase department is one of the key players in achieving the strategic objectives of a

firm. Functions of purchasing department or often categorized as the responsibilities of

Purchasing Manager are:-

Vendor Development: The primary responsibility of a purchase manager is to search

for and identify a list of possible suppliers. He should ensure that sources of supplies

are reliable and stable.

Selection of Suppliers: The purchase manager should examine the cost of the material

and other aspects. And selection should be made after analyzing all the relevant

issues.

Contract Negotiations and Communication Interface: Once a vendor is selected, the

purchasing manager should negotiate and establishes the terms and conditions of

contract to be drawn between the two parties.

Value Analysis: The purchasing manager conducts value analysis that aims at

achieving cost effectiveness and maintaining the required level of quality.

PURCHASE SYSTEMS

In an organization all activities are carried out according to systems and procedures for

reducing variations and errors arising out of individuality. This makes performing the

function simple and less prone to errors. Purchase organization also consists of such systems

established for smooth running of purchasing function. These systems are pre purchase

system, ordering system, post purchase system.

1. Pre Purchase System : This system lays down how purchase activity is initiated. Various

activities controlled by this system are requisitioning, selection of suppliers and obtaining

& evaluating quotations.

Requisitions : Requisition for an item may be made by anyone in the organization.

Pre purchase system prescribes separate requisition form for capital equipment as

this purchase activity is controlled by a separate system. Requisition for an item

shall be made in a standard format. This format ensures that indenting person

furnishes all relevant information like quantity, specifications, etc. and gets the

purchase authorized by competent authority in the organization. Thereby making

purchase activity easier and less time consuming. This system shall identify the

hierarchical level competent to authorize the purchase depending on the nature

and value of the item.

Traveling requisitions: In an inventory system where an item is made a stock

item to be perpetually maintained at a minimum level, purchase activity is

triggered by stores function based on ROL. The requisition is a permanent

document with specification, authorization and quantity required permanently

marked on it. The traveling requisition returns to indenting department after

purchase is initiated.

Inquiries: Pre-purchasing system prescribes standard formats for making

inquiries in the market for supply of a particular product. These are standard forms

boldly declaring that they are not explicit or implicit purchase orders.

2. Ordering System: Purchase order is the most important element in ordering system.

Purchase manager releases the purchase order after selecting the supplier and finalizing

the price and other conditions of sale. Once the purchase order is raised and accepted it

becomes a legal document.

Contents of the purchase order are:-

Purchase order reference number

Description of materials and specifications

Quantity required and delivery schedule

Price and discounts

Shipping instructions

Location where the material is to be shipped

Signature of the authorized officer

Detailed terms and conditions:-

a) Several numbers of copies made to be forwarded to various recipients. Many

companies color code the copies making the color destination specific.

b) Original and a copy is sent to the supplier for acknowledgment of the original

order. This acknowledgment is acceptance of terms and conditions of purchase

order.

c) One copy is sent to the receiving department for making necessary receiving

arrangement

d) One copy is sent to the indenting department for information.

e) One copy is sent to finance department for organizing payment to the supplier.

3. Post Purchase System: This system includes follow up procedures, receipt and checking

invoices.

Follow up procedures: Follow up is an expensive activity for an organization.

Hence this should be minimized and made more effective. A sound procedure for

follow up is required to eliminate duplication and ineffectiveness. After conducting

FSN analysis follow up frequency should be fixed for follow up according to FSN

status so that follow up doesn’t become wasteful. Follow up responsibility is

assigned to buyers responsible for areas in which suppliers are situated.

Receipt: Receipt system should ensure that defects in receipt process are eliminated

proactively. A systematic record of all receipts, carrier details and descriptions is

maintained. This record is in chronological sequence of arrival of supplies. The

system ensures that inspection of consignments received is arranged in time and

payment to suppliers for accepted consignments is organized. In many organizations

a receipt section handles this activity centrally.

Invoice checking: supplier sends his invoice to customer’s finance department for

payment for the goods supplied. Invoice checking system ensures that the invoice is

checked against the PO terms, receipt details, quantity received, inspection reports

[accepted quantity and rejected quantity], losses, damages etc. this system helps

materials management to coordinate with finance department for payment to

suppliers.

IMPORTANCE OF SOURCE

Source is the place from where we procure our inputs. These inputs may be in the form of

raw materials, out sourced components or semi finished items. Manufacturing companies

outsource large number of items as they slim down processes.

Following reasons are considered to be making source an important element in materials

management:-

Source of market intelligence: source is a window through which the buyer

organization looks at the world outside. Source provides access to the real time

information about the phenomenon. Information about current trends and industrial

climate is obtained from the sources.

Crucial for product quality : buyer organizations depend on out sourced components

for producing the product which central to the objectives business. Reliance on

capabilities of supplier to meet tough quality standards is very high in current

business environment.

Member in the value chain : supply source is an important element in the value chain.

Any cost added to the value chain reaches the end user as price. Hence effectiveness

and efficiency of the source becomes vital to business.

Import substitution, cost reduction, value improvement : as indigenization of sub

assemblies, components and spare parts is necessary to reduce the cost of product in

competition, buyer organizations turn to supply sources to develop these items.

Several trials and corrections may be required to finalize the substitute. In house

capacity is generally not available for this kind of trials. A resourceful supplier is very

useful in this process. Same logic holds good in other exercises for cost reduction and

value improvement. It is quite logical that entire process is not outsourced but isolated

developmental activities are invariably done. It is common knowledge that many

small scale companies do not have full-fledged tool rooms but rely on sources for all

tool room activities.

PURCHASING POLICIES

The major principles on which purchasing policies should be based are a sound orientation,

reflect a cross –functional approach and be directed at improving the company’s bottom line.

i. Business orientation

Developing a purchasing and supply strategy requires a thorough understanding of the

company’s business policies. The following questions are important to determine how

purchasing and supply strategies will need to support the company in meeting its goals and

objectives:-

- What end-user market is the company targeting and what are the major developments

going on in those markets?

- What competition is the company suffering from and what leeway does the company

has in setting its own pricing policies?

- To what extent can material’s price increases can be passed onto the last customer or

is it impossible?

- What changes are happening in the company’s product, production and information

technologies?

- What investments will be made by the company in terms of new products and

technology?

- What products will be taken out of the market for the years to come?

ii. Integrated, cross-functional approach

Purchasing decisions cannot be made in isolation, and should not be aimed at optimization of

purchasing performance only. Purchasing decisions should be made taking into account the

effects of these decisions on other primary activities like:-

- Production planning

- Materials management

- Transportation

Therefore purchasing decisions need to be based on balancing total cost of ownership. When

buying for instance, a new packaging line it is important to consider not only the initial

investment, but also the costs which will be incurred in the future for buying accessories,

spare parts and services. This example itself illustrates the complexity of its type of purchases

and the different kind of decisions that need to be made.

Careful decision making in those circumstances, therefore requires a cross functional and

team based approach among all the business disciplines affected by it. This can only be done

when top managers are involved. The purchasing and supply manager will lead the

developing of such views and visions.

iii. Bottom-line orientation

The purchasing should provide a healthy commercial opposition vis-à-vis its internal

customers. Through their activities the buyers should make their company more and more

cost aware. They should consistently look for improving the price/value ratio of the goods

and services bought by the company. To accomplish this, purchasing should be able to

suggest alternatives to existing product designs, materials or components to be used and

alternative suppliers. Experience with companies in which purchasing is recognized as a

bottom-line driven activity shows this function contributes to a permanent reduction in cost

price of the end product, whilst stimulating innovation from the suppliers at the same time.

IMPLEMENTATION OF PURCHASE POLICY

Important areas to consider when implementing supply and purchase policy are supply,

product and supplier quality, materials costs and prices, supplier policy and communication

policy

i. Supply

Supply is aimed at the optimization of both the ordering process and the incoming materials

flow.

Purchasing order processing entails handling of:-

- Purchasing requisitions

- Order processing and expediting

- Development of efficient, computer –supported order routines

Materials and supply planning relates to:-

- Issuing materials delivery schedules to suppliers

- Reducing supplier lead times

- Troubleshooting in case of delivery problems

- Reducing (pipeline) inventories

- Monitoring supplier delivery performance

ii. Product and supplier quality

Central to this aspect are the materials specifications. Two important subjects of concern here

are purchasing early involvement in design and product development and improving product

and supply quality performance. Activities which may contribute to both areas are:-

Standardization of materials-by striving for standardisation or simplification of

product- specifications, the buyer may reduce product variety resulting in both cost

reduction and supplier dependence at the same time;

A purchasing policy focussed on the life cycle of the end products- there is not much

point in investigating material quality improvements used in products which will be

eliminated shortly;

Specific quality improvements- negotiating targets on improving reject rates, reducing

incoming inspection, and negotiating quality agreements;

Agreeing on and gradually extending permanent warranty conditions that are to be

provided by the supplier;

Initiating special programmes in the field of value analysis to simplify product design

and/or reduce product costs;

iii. Materials cost policy

The objective of cost policy is twofold:-

- First to obtain control of materials cost and prices in such a way that suppliers are

unable to pass on unjustified price increases to the company.

- Second, to systematically reduce the supplier’s materials cost through joint, well

prepared action plans.

In order to be successful in both aspects a thorough knowledge of the supplier’s pricing

policies and cost structure is required. Understanding and knowledge of the market structures

and of their susceptibility of the price paid to market and cost factors is necessary. It should

be decided for what products to build detailed cost models, for what models to monitor

underlying cost factors, and for what products to develop detailed materials budget estimates.

iv. Supplier policy

The supplier policy is focused on the systematic management of the company’s supplier base.

- Decisions need to be made for what commodities to pursue a multiple sourcing

strategy or to go for single sourcing or a partnership relationship.

- Suppliers who perform best should be rewarded with more business in the future.

- Targets and possible projects for future co-operation should be determined carefully.

- Relationships with suppliers who consistently fail to meet the company’s expectations

should be terminated.

However such decisions need to be made based on detailed data on how the supplier

performed in the past and be implemented carefully.

v. Communication policy

The company’s purchasing policies need to be communicated both internally and to

suppliers. Companies use the Intranet for the former and many employ their own Purchasing

Websites in order to communicate their future materials requirements and ways of working to

their suppliers.

The next step is that preferred suppliers have access to the customer’s Intranet through which

internal users can order directly from them through their electronic catalogues.

VALUE ANALYSIS

The purchasing manager conducts value analysis that aims mainly at achieving cost

effectiveness and maintaining the required level of quality. Value analysis is an organized

effort that studies in detail the ‘value’ of material. Value Analysis reviews the design changes

with the objective of eliminating high cost materials and the materials that are technically

obsolete and reducing the number of parts. After analyzing the functions and cost of material,

the purchasing manager evaluates the possibilities of using the material.

Value Analysis evaluates the materials by seeking answers to the following questions:-

- What is the function of the item?

- Is it possible to run the system without the item?

- Can the item be substituted with a standard part?

- How much does the item cost?

- How much does the substitute, if any, cost?

- Can the functions performed by two or three materials be clubbed together and be

replaced by any other material?

Value Analysis involves the coordinated efforts of the engineering, production and the

purchasing personnel and helps in reviewing purchase activities to ensure that expenditures

result in the receipt of appropriate value.

The step by step procedure of Value Analysis is given below:-

- Examine all the products/materials that are being reordered and identify each

product/material that needs an improvement.

- Gather all possible information about the designs, costs and so forth of the product.

- Form a team that includes experts from various functional areas that are related to the

functions performed by the material.

- Generate alternatives by generating new ides and evaluate different ways of

accomplishing the task.

- Evaluate the alternatives on criteria like cost and feasibility and eliminate the non

feasible alternatives.

- Refine the feasible alternatives and select the optimal one.

MAKE-OR-BUY DECISIONS

The make-or-buy decision is the act of making a strategic choice between producing an item

internally (in-house) or buying it externally (from an outside supplier). The buy side of the

decision also is referred to as outsourcing. Make-or-buy decisions usually arise when a firm

that has developed a product or part—or significantly modified a product or part—is having

trouble with current suppliers, or has diminishing capacity or changing demand.

Make-or-buy analysis is conducted at the strategic and operational level. Obviously, the

strategic level is the more long-range of the two. Variables considered at the strategic level

include analysis of the future, as well as the current environment. Issues like government

regulation, competing firms, and market trends all have a strategic impact on the make-or-

buy decision. Of course, firms should make items that reinforce or are in-line with their core

competencies. These are areas in which the firm is strongest and which give the firm a

competitive advantage.

Considerations that favor making a part in-house:-

Cost considerations (less expensive to make the part)

Desire to integrate plant operations

Productive use of excess plant capacity to help absorb fixed overhead (using existing

idle capacity)

Need to exert direct control over production and/or quality

Better quality control

Design secrecy is required to protect proprietary technology

Unreliable suppliers

No competent suppliers

Desire to maintain a stable workforce (in periods of declining sales)

Quantity too small to interest a supplier

Control of lead time, transportation, and warehousing costs

Greater assurance of continual supply

Provision of a second source

Political, social or environmental reasons (union pressure)

Emotion (e.g., pride)

Factors that may influence firms to buy a part externally include:-

Lack of expertise

Suppliers' research and specialized know-how exceeds that of the buyer

cost considerations (less expensive to buy the item)

Small-volume requirements

Limited production facilities or insufficient capacity

Desire to maintain a multiple-source policy

Indirect managerial control considerations

Procurement and inventory considerations

Brand preference

Item not essential to the firm's strategy

LEAN MANAGEMENT

It is a philosophy concerning how to run a manufacturing organization, which entails all

aspects of the business system in general, and design, manufacturing and supply management

in particular. Fundamental to lean management is that it transfers the maximum number of

tasks and responsibilities to those workers actually adding value to the product and it has in

place a system for detecting the defects that quickly traces every problem.

Important features of lean management are:-

Teamwork among line workers, who are trained in a variety of skills to conduct

different jobs within their working group. These not only relate to manufacturing

tasks; workers are also trained to do simple machine repairs, quality checks ,

housekeeping and material ordering.

Simple, but comprehensive information display systems that make it possible for

everyone in the plant to respond quickly to problems and understand the plant’s

overall situation.

Total commitment to quality improvement5 on the shop floor. Workers are

encouraged to think and act positively on how to improve the effectiveness of their

work, whereas their supervisors need to provide active support to bring these ideas to

fruition.

LEAN MANAGEMENT AND PURCHASE SYSTEM

The average supply base is much smaller in lean management system .Suppliers are usually

involved in new product development in a very early stage. Supplier along with engineers

from the manufacturer may work full time at each other premises when solving technical

problems and/or working out improvements .

Suppliers are confronted with well defined targets in terms of quality improvement, lead time

reduction and cost reduction and are, by means of a simple grading and performance system,

fully informed as to whether they meet contractual obligations.

JIT AND PURCHASING SYSTEM

The principle of just-in-time (JIT) means that all materials and products become available at

the very moment when they are needed in the production process, not sooner and not later,

but exactly on time and in exactly the right quantity .It implies that nothing is produced if

there is no demand. The production process is in fact ‘pulled’ by customer orders. When no

customer orders have been received, manufacturing activities will come to an end and the

spare time is used to do minor repairs/maintenance, housekeeping and/or prepare for

materials planning.

A second characteristic of JIT principle is related to quality awareness, smaller batch sizes

which make it necessary to detect quality defects at an early stage.

The JIT concept cannot be limited to production only. It must be supported and implemented

in every functional area in the organization .Applied to purchasing JIT is a philosophy that

aims to make the required materials and products available at exactly the time they are

needed, so that value is added only to the product which is to be manufactured , and indirect

costs are avoided . JIT has a major impact on both the quality and quantity of the materials to

be purchased.

The JIT approach is characterized by regular but flexible supply .ordered materials are

delivered frequently in different quantities. To facilitate this, the supplier is informed of the

production planning and the related purchasing requirements on a daily, weekly and monthly

basis through delivery schedules which are available on-line. In this way

Conditions are renegotiated with the supplier. Targets for productivity improvement and cost

reduction, as required by the producer, are also part of these negotiations.

As far as quality is concerned, the guiding principle is zero defects. Imposing quality targets

upon suppliers may represent large savings to the producer, both in terms of a reduction of

the numbers of incoming quality inspections and a reduction of buffer stock. In this way the

supplier is educated towards a better quality performance.

VENDOR MANAGEMENT

Vendor Management is the management and control, by an entity, of those third parties that

supply goods and/ or services to that entity. It is the discipline of establishing service, quality,

cost, and satisfaction goals and selecting and managing third party companies to consistently

meet these goals:-

Establishing Goals - Just as employees need clearly established goals, operations need

clearly defined performance parameters.  When selecting or managing vendors,

vendor managers must optimize their opportunity to achieve these goals by using third

parties companies.

Selecting Vendors - The fine art of vendor management is essential to optimizing

operational results.  Different vendors have different strengths and weaknesses, and it

is the vendor manager’s responsibility to match the right company with the desired

performance characteristics.  Failure to consider this comprehensively could lead to

complete failure.

Managing Vendors - On a daily basis, vendor managers must monitor performance,

provide feedback, champion new projects, define or approve/disapprove change

control processes, and develop vendors.  There’s a tremendous amount of detail to

this aspect of the discipline, and we’ve covered this in many posts here.

Consistently Meet Goals - Operations must perform within statistically acceptable

upper and lower control bounds.  Everything the vendor manager does should focus

on meeting goals, from providing forecasts to defining requirements, from ensuring

vendors have adequate staff to ensuring the staff have completed all required training.

VENDOR RELATIONS

An important objective in purchase management is that of maintaining good relations with

vendors. A good vendor is an asset of the company; and, therefore, just as customer goodwill

is considered important, a good relationship with the vendor should be treated likewise. A

vendor who supplies the proper quality material in proper amounts in proper time is not very

easy to find. Moreover, there are many situations where materials are required in hurry. There

are situations where materials are in shortage in the supply market. In all such situations,

good relationships with the vendors pay dividends. This may entail: personal relationship,

professional relationship:-

- By helping the vendor in times of stress and strain with financial aid, by providing

management skills if necessary, and,

- Maintaining a healthy professional relationship by fair negotiation, fair evaluation

and fair compensation.

The modern management theory and world class manufacturing call for a long-term, almost a

lifetime, association with the vendors. This also means that there will be fewer vendors but

these will be dedicated vendors- almost a part of organizational family.

Until the present and even now, the Indian industry has not given/is not giving much

importance to vendor relations. The emphasis, if any, has been on vendor selection and on

monitoring the performance of the vendor through a vendor rating system. Vendor is the

entity that is, generally, taken for granted. This attitude is: All said and done, the vendors for

the company may change over a period of time. They may change to another business; some

of them may not give the desired performance in quality, delivery and price, and therefore,

one should always expect a drop-out rate in the vendors list of the company.

SELECTION OF VENDORS

1. The production capabilities of the vendor

(a) Capacity to manufacture the required product in desired quantities.

(b) Possibility of future expansion in capacity.

(c) The understanding or the knowledge of the vendor regarding the buying company

and its need.

2. The financial soundness of the company

(a) The vendor company’s capital structure.

(b) Whether it belongs to a larger group of companies; whether it is a Private Limited

or a Public Limited company.

(c) The profitability record of the company in the past.

(d) Expansion plans of the company in the future.

3. Technical capabilities

(a) Whether the available machines are capable of the required quality of materials?

What are the future plans of the vendor?

(b) Whether there are enough technical skills available with the vendor?

(c) Whether there is proper research, design and development facility available with

the vendor?

(d) What is the record of the vendor in filling the orders of other buying companies in

the same business?

(e) What has been the consistency in the quality produced by the vendor?

(f) Whether the vendor has appropriate storage and warehouse facilities to retain the

quality of the product produced?

(g) Whether proper quality control procedures are being followed in the vendor

company?

4. Other considerations

(a) What are the working conditions in the vendor company?

(b) How are the industrial relations in the vendor company?

(c) Whether there is any possibility of disruption of the supply of materials in terms

of quantity and/or quality due to human relations problem in the vendor company?

VENDORS MANAGED INVENTORIES

Vendor Managed Inventory (VMI) is a supply chain practice where the inventory is

monitored, planned and managed by the vendor on behalf of the consuming organization,

based on the expected demand and on previously agreed minimum and maximum inventory

levels. In its simplest form, Vendor Managed Inventory is the process where the vendor

assumes the task of generating purchase orders to replenish a customer’s inventory. VMI is a

term that is used to describe many types of supply chain initiatives.

Traditionally, success in supply chain management derives from understanding and managing

the trade off between inventory cost and the service level.

The Vendor Managed Inventory Approach

VMI reduces stock-outs and reduces inventory in the supply chain. Some features of VMI

include:-

Shortening of the supply chain

Centralized forecasting

Frequent communication of inventory, stock-outs, and planned promotions. Electronic

Data Interchange (EDI) linkages facilitate this communication.

No manufacturer promotions

Trucks are filled in a prioritized order. For example, items that are expected to stock

out have top priority, then items that are furthest below targeted stock levels, then

advance shipments of promotional items (promotions allowed only in transition

phase), and finally, items that are least above targeted stock levels.

Relationship with downstream distribution channels

Result: Inventory reduction and stock-out reduction

VMI is based on the belief that supplying parties are in a better position to manage inventory

as they have better knowledge of the goods production capacities and lead times. Also it is

based on the belief that allowing vendors to manage inventory reduces the number of layers

in the supply chain, increasing stock visibility and reducing overall inventory levels. To

enable VMI, sales data must be provided to the vendor via Electronic Data Interchange

(EDI), other electronic means, or via traditional human agents at outlets.

Origin of Vendor Managed Inventory

VMI started in the retail business and grew out of Efficient Consumer Response (ECR),

where consumer satisfaction or rather consumer expectation of stock availability is an

important way to have a competitive edge over others. Wal-Mart is one of the successful

pioneers of this supply chain strategy.

VMI is now gradually progressing towards strategic-partnership based forms. These

influences the way companies plan their inventory, evolving to Collaborative Planning,

Forecasting and Replenishment (CPFR).

Usage of Vendor Managed Inventory

Error sensitive industries. Example: Pharmaceutical Sector.

Multiple outlets, fast-moving consumer goods. Example: Wal-Mart.

Perishable goods. Example: K Mart.

Valuable and unpredictable components. Example: PC manufacturing.

Strong competition (small margins). Example: Automotive.

Steps in Vendor Managed Inventory

VMI should be achieved in a number of phases:-

1. Communicate expectations of all parties.

2. Retailer/distributor must commit to sharing precise information.

3. Vendor must ensure reliable transmission, receipt, and use of information.

4. Agreement on ordering policy, risk and reward sharing.

5. Commit time and resources.

6. Extensive testing.

7. Implementation and evaluation. Adjust.

8. Appreciate vendors that manage the inventory well. Example: promotion to Category

Captain, profit sharing schemes, etc.

Strengths of Vendor Managed Inventory

Supply Chain level

o Lower inventory levels at total supply chain level.

o Less overhead.

o Increased sales.

o Reduces human data entry errors.

Vendors

o Better insight in customer demand (better resource usage, reduced raw and

finished goods inventories).

o Improved, more direct communication with customers.

o Improved market analysis.

o Increased sales via lower out of stock rates.

o Opportunity to provide category management and other value-added services.

Suppliers

o Reduced replenishment times and lower inventory costs.

o Increased sales through reduced stock outs.

o Less redundancy.

o Build strategic strengths through establishing strong supply chain

relationships.

o Vendor assistance with category management.

End-users

o Increased service level.

o Reduced stock outs

Limitations of Vendor Managed Inventory

Success of VMI initiative depends on the strength of relationship between the vendors

and retailers.

Increased dependency between the parties and increased switching costs.

Lack of trust to exchange data can result in the ineffective implementation in one or

more of the following forms:

o Inventory invisibility.

o Inventory imbalance.

Costs of technology and changing organization.

Extensive data- and EDI testing is needed.

Loss of necessary shelf space at the selling party may result in less attention by

buyers, compared to competitors that are not into VMI yet.

Special promotions or events need to be communicated beforehand to avoid

replenishment planning mistakes (loss of flexibility).

Increased vulnerability for non-foreseeable risks such as employee strikes, hurricanes,

etc. due to lower inventory levels.

Most of the benefits are for the end client and for the selling party, while the vendor

does much of the work.

Assumptions of Vendor Managed Inventory

VMI is usually successful for industries and organizations with the following characteristics:

Multiple outlets, because this increases the benefits compared to traditional inventory

management.

Severe consequences in case of human errors (Pharmaceutical).

Industries with steady and high volumes (Retail, Consumer Products).

Industries with high-value inventory and a high level of demand unpredictability

(High Tech).

Management with strong leadership capability to form strategic long term

partnerships (Automotive).

VMI Implementation Challenges

VMI can be made to work, but the problem is not just one of logistics. VMI often encounters

resistance from the sales force and distributors. At issue are roles and skills, trust, and power

shifts. Some of the sales force concerns are:

Loss of control

Effect on compensation - incentive bonuses may depend on how much is sold, but

sales force has less influence under VMI.

Possible loss of job

Scepticism that it will function well - technical problems

Concern that reduced inventory will result in less shelf space and therefore loss of

market share. This concern can be addressed by filling the shelf space with other

stock keeping units from the same vendor.

VENDOR RATING

Vendor rating is the result of a formal vendor evaluation system. Vendors or suppliers are

given standing, status, or title according to their attainment of some level of performance,

such as delivery, lead time, quality, price, or some combination of variables. The motivation

for the establishment of such a rating system is part of the effort of manufacturers and service

firms to ensure that the desired characteristics of a purchased product or service is built in and

not determined later by some after-the-fact indicator. The vendor rating may take the form of

a hierarchical ranking from poor to excellent and whatever rankings the firm chooses to insert

in between the two. For some firms, the vendor rating may come in the form of some sort of

award system or as some variation of certification. Much of this attention to vender rating is a

direct result of the widespread implementation of the just-in-time concept in the United States

and its focus

CRITERIA FOR EVALUATION

Vendor performance is usually evaluated in the areas of pricing, quality, delivery, and

service. Each area has a number of factors that some firms deem critical to successful vendor

performance.

Pricing factors include the following:-

Competitive pricing: The prices paid should be comparable to those of vendors

providing similar product and services. Quote requests should compare favorably to

other vendors.

Price stability- Prices should be reasonably stable over time.

Price accuracy: There should be a low number of variances from purchase-order prices

on invoiced received.

Advance notice of price changes : The vendor should provide adequate advance notice

of price changes.

Sensitive to costs: The vendor should demonstrate respect for the customer firm's

bottom line and show an understanding of its needs. Possible cost savings could be

suggested. The vendor should also exhibit knowledge of the market and share this

insight with the buying firm.

Billing: Are vendor invoices are accurate? The average length of time to receive credit

memos should be reasonable. Estimates should not vary significantly from the final

invoice. Effective vendor bills are timely and easy to read and understand.

Quality factors include:-

Compliance with purchase order: The vendor should comply with terms and

conditions as stated in the purchase order. Does the vendor show an understanding of

the customer firm's expectations?

Conformity to specifications: The product or service must conform to the specifications

identified in the request for proposal and purchase order. Does the product perform as

expected?

Reliability: Is the rate of product failure within reasonable limits?

Reliability of repairs: Is all repair and rework acceptable?

Durability: Is the time until replacement is necessary reasonable?

Support: Is quality support available from the vendor? Immediate response to and

resolution of the problem is desirable.

Warranty: The length and provisions of warranty protection offered should be

reasonable. Are warranty problems resolved in a timely manner?

State-of-the-art product/service: Does the vendor offer products and services that are

consistent with the industry state-of-the-art? The vendor should consistently refresh

product life by adding enhancements. It should also work with the buying firm in new

product development.

Delivery factors include the following:-

Time: Does the vendor deliver products and services on time; is the actual receipt date

on or close to the promised date? Does the promised date correspond to the vendor's

published lead times? Also, are requests for information, proposals, and quotes swiftly

answered?

Quantity: Does the vendor deliver the correct items or services in the contracted

quantity?

Lead time: Is the average time for delivery comparable to that of other vendors for

similar products and services?

Packaging: Packaging should be sturdy, suitable, properly marked, and undamaged.

Pallets should be the proper size with no overhang.

Documentation: Does the vendor furnish proper documents (packing slips, invoices,

technical manual, etc.) with correct material codes and proper purchase order

numbers?

Emergency delivery: Does the vendor demonstrate extra effort to meet requirements

when an emergency delivery is requested?

Finally, these are service factors to consider:-

Good vendor representatives have sincere desire to serve. Vendor reps display

courteous and professional approach, and handle complaints effectively. The vendor

should also provide up-to-date catalogs, price information, and technical information.

Does the vendor act as the buying firm's advocate within the supplying firm?

Inside sales. Inside sales should display knowledge of buying firms needs. It should

also be helpful with customer inquiries involving order confirmation, shipping

schedules, shipping discrepancies, and invoice errors.

Technical support. Does the vendor provide technical support for maintenance, repair,

and installation situations? Does it provide technical instructions, documentation,

general information? Are support personnel courteous, professional, and

knowledgeable? The vendor should provide training on the effective use of its

products or services.

Emergency support. Does the vendor provide emergency support for repair or

replacement of a failed product.

Problem resolution. The vendor should respond in a timely manner to resolve

problems. An excellent vendor provides follow-up on status of problem correction.

A more comprehensive approach is needed for suppliers that are critical to the success of the

firm's strategy or competitive advantage. For firms that fall into the latter category

performance may need to be measured by the following 7 C's.

1. Competency -managerial, technical, administrative, and professional competence of

the supplying firm.

2. Capacity- supplier's ability to meet physical, intellectual and financial requirements.

3. Commitment- supplier's willingness to commit physical, intellectual and financial

resources.

4. Control- effective management control and information systems.

5. Cash resources- financial resources and stability of the supplier. Profit, ROI, ROE,

asset-turnover ratio.

6. Cost -total acquisition cost, not just price.

7. Consistency- supplier's ability to exhibit quality and reliability over time.

BENEFITS

Benefits of vendor rating systems include:-

Helping minimize subjectivity in judgment and make it possible to consider all

relevant criteria in assessing suppliers.

Providing feedback from all areas in one package.

Facilitating better communication with vendors.

Providing overall control of the vendor base.

Requiring specific action to correct identified performance weaknesses.

Establishing continuous review standards for vendors, thus ensuring continuous

improvement of vendor performance.

Building vendor partnerships, especially with suppliers having strategic links.

Developing a performance-based culture.

Vendor ratings systems provide a process for measuring those factors that add value to the

buying firm through value addition or decreased cost. The process will continually evolve

and the criteria will change to meet current issues and concerns.

RECENT TRENDS AND DEVELOPMENT IN PURCHASING

Many companies are now confronted with diminishing growth opportunities, which results in

a situation where an increase in turnover can only be realized at the expense of the

competition and only with a great deal of effort. This leads to increased pressure on sales

prices and consequently on cost prices and margins, which causes two developments.

- On the one hand it has resulted in shifts of power between purchasing and selling

parties in many markets. Due to the fact that in many cases the market has changed

from seller’s market to buyer’s market, the role of the buyer is now more dominant

than a number of years ago.

- On the other hand the increasing pressure on sales prices and margins has resulted in

an increased pressure on direct materials-related costs. Because the purchasing prices

determine the sales prices in the industrial sector to a large extent, the company will

be constantly on the look-out for opportunities to keep these prices as low as possible.

As a result of both developments, the purchasing and supply strategies of industrial

companies have undergone major changes.

Several examples of these changes are presented below:-

i. Co-ordination of purchasing requirements: In companies with several manufacturing

plants, important purchasing advantages can be realized by combining policy is seen to

emerge in many European companies of this type, even across national borders.

Traditionally this was already common for raw materials; at present however, a similar

approach is used for the purchase of computer hardware and software, capital goods and

components. Good examples of companies with an active policy concerning purchasing

co-ordination are, apart from the automotive and computer industry, Shell, Philips

electronics and Alcatel.

ii. Integration of purchasing in logistics: Automation enables companies to improve

materials planning and supply systems. It furthermore may significantly improve the

productivity within the materials area. An integrated approach of materials management

requires close cooperation between the production planning, inventory control, quality

inspection and purchasing. To achieve succesful automation, system standardization is a

prerequisite. Purchasing cannot be allowed to follow its own course. To ensure effective

integration of the different materials related areas. Purchasing increasingly is integrated

into supply chain management.

iii. Integration of purchasing in engineering and production planning: In practice,

supplier selection is determined to a large degree by the technical specifications. Once

established, this specification is often very difficult to change. From a commercial point

of view it is undesirable that specifications are defined towards a particular supplier; in

that case purchasing often ends up with a monopolist, which seriously hampers

negotiating. To prevent this it is desirable to include purchasing in the development

process at an early stage. The goal is to make optimal use of purchasing knowledge of

products and markets for the benefit of the product design.

iv. Make or Buy : Practice shows that several production activities can be done cheaper and

faster by specialized suppliers. Moreover, companies may take greater demands in

terms of quality on external suppliers than on their own. This is why in some industrial

branches, the purchasing to sales ratio has been steadily rising. For some companies

these have resulted in detailed make or buy studies. Purchasing should always be

closely involved in this type of study, because they are the logical source of market

information.

v. Reciprocity agreements and compensation obligations: Companies operation on

international markets is often obliges to compensate their sales turnover by counter

purchase obligations. The recent opening up of the eastern European block has counter

trade an actual issue. Buying from these countries may even open up interesting sales

opportunities. Purchasing become involved in fulfilling such obligations

vi. Total quality control and just-in-time production : In several companies a growing

interest in quality improvement and increased productivity can be observed. The

activities of the European foundation for Quality Management, initiated by the

presidents of 14 European industries on 5 September 1988, illustrate the first; several

EEC programmes, aimed at logistics, the second. There is a growing awareness in the

international business scene that, if Europe wishes to remain competitive on a world

scale in several sectors, Improvements must be made in both the level of costs and the

level of quality of the end products.

E-PURCHASING AND E-PROCUREMENT

The Internet and e-commerce is drastically changing the way purchasing is done. Internet use

in buying has led to the terms "e-purchasing" or "e-procurement." Certainly, communication

needed in competitive bidding, purchase order placement, order tracking, and follow-up are

enhanced by the speed and ease afforded by establishing online systems. In addition,

negotiation may be enhanced and reverse auctions facilitated. Reverse auctions allow buying

firms to specify a requirement and receive bids from suppliers, with the lowest bid winning.

E-procurement is considered one of the characteristics of a world-class purchasing

organization. The use of e-procurement technologies in some firms has resulted in reduced

prices for goods and services, shortened order-processing and fulfillment cycles, reduced

administrative burdens and costs, improved control over off-contract spending, and better

inventory control. It allows firms to expand into trading networks and virtual corporations.

Criteria for e-purchasing include:

Supporting complete requirements of production (direct) and non-production

(indirect) purchasing through a single, internet-based, self-service system.

Delivering a flexible catalog strategy.

Providing tools for extensive reporting and analysis.

Supporting strategic sourcing.

Enhancing supply-chain collaboration and coordination with partners.

ETHICS IN BUYING

Since the purchasing department deals with large sums of money purchasing personnel may

in some cases may take part in unethical and illegal activities such as manipulating

quotations, fixing prices, favoring up specific supplier and so on.

Most organisations develop a set of rules and guidelines to ensure that their purchasing

manager conduct business in ethical manner. Some of these rules are:-

- The organization’s interest should be kept in mind while purchasing.

- No undue favor should be taken from or given to suppliers.

- All purchasing activities should be conducted honestly and truthfully.

- All purchasing commitments should be completed on time.

Organisation can reduce the temptation to adopt unethical practices by compensating

employees suitably.

Bibliography

Operations Management By S.N. Charry

Purchase and Supply Management by Arjan J Van Welee

Operation Management by ICFAI Business School

Operation Management by K. Ashwathapa

Purchase Management by L.C. Jhamb

Wikipedia