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PURCHASING METHODOLOGIES

2 purchasing methodologies

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Page 1: 2 purchasing methodologies

PURCHASING

METHODOLOGIES

Page 2: 2 purchasing methodologies

PURCHASING METHODOLOGIES

• Centralized vs decentralized purchasing.• Purchasing from single source.• Purchasing from multi-source.• Purchasing from subsidiary.• Reciprocal purchasing.• Contract purchasing.• Credit purchasing.• Cash purchasing.

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CENTRALISED PURCHASING• Purchasing activities are carried out from one point

usually from head office.• Requirements are consolidated from different units

and procurement actions are taken for the total requirements together.

• Raw materials, items involving high value, items of critical nature like items related to nuclear energy, explosives are purchased through centralized purchasing system.

• Imports are usually done through centralized system.

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ADVANTAGES OF CENTRALIZED PURCHASING - 1

• It is easy to obtain very attractive discounts in view of large volume of purchases involved.

• Transportation costs can be substantially reduced by combining supplies under various orders and taking advantage of full container load.

• It is easy to standardize the requirements of various units, which helps in optimizing inventory levels.

• Supplies can be made easily to any unit at the time of emergency by diverting the materials being procured for one unit to other unit, or even by arranging supplies from other units.

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ADVANTAGES OF CENTRALIZED PURCHASING - 2

• Every unit is not required to exercise to establish the quality of new products. The same can easily be done from a centralized place.

• In view of the large volume , it is easy to develop new vendors.

• Best managerial inputs are available in purchasing, as top management is interested in such purchases to get the best results.

• Imports are easily and economically handled under centralized purchasing.

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DECENTRALIZED PURCHASING

• In multi-units organization, not possible to meet the requirements from one place.

• Material requirements differs from one unit to another unit due to technological differences.

• Consolidation of requirements of different units is often time consuming and results in delays and frequent stock outs.

• Small value purchases are more suited to decentralized purchasing.

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ADVANTAGES OF DECENTRALIZED PURCHASING - 1

• Easy to meet the requirements of each unit from local markets.

• Shorter deliveries of materials are possible.• Chances of stock outs are less as it is easy to

have direct control on the vendors

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ADVANTAGES OF DECENTRALIZED PURCHASING - 2

• Less communication and therefore purchasing activities become efficient.

• Top management need not spend its time on small value items which can be better managed under decentralized system.

• Inventory levels can be reduced in view of easy availability of materials from local sources.

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PURCHASING FROM SINGLE SOURCE

Purchasing from single source is resorted to in the following situations:

• When the item is manufactured by only one source.• To procure items from main machinery supplier, where

complete design details, material specifications etc. are commensurate to the machine supplied by the main machinery supplier and detailed drawings are not available.

• In procurement of certain professional or technical services, where competence are known and competition would not result in any price or performance advantage.

• In case of emergencies to meet the requirement of urgent repairs or to fulfill the company’s contractual commitments to its customers.

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DEMERITS OF PURCHASING FROM SINGLE SOURCE

• Purchasing from single source is not in the interest of an organization, as it has to pay prices as demanded by the supplier.

• Buyer is always dependent on the single source, if other sources are not available.

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NEED FOR PURCHASING FROM MULTI-SOURCES

• It is the responsibility of the purchasing department to assure uninterrupted supply of the materials if one source fails to deliver the goods.

• Supply of coal (fuel) for power houses, bauxite (raw material for cement) are examples, which are purchased from more than one source.

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PRACTICE USED IN PURCHASES FROM MANY SOURCES

• It is attempted that prices of all the suppliers are same• If not possible to achieve, the major quantity of the total

requirements are received from the lowest supplier and proportionately smaller quantities are received from other suppliers.

• For example, 70 percent of the total order may be awarded to the lowest evaluated bidder, 20 percent of the order to the next lowest evaluated bidder, and the remaining 10 percent to the third lowest evaluated bidder.

• Such a decision is taken keeping all aspects into consideration such as location of the suppliers, political situation in the country of the supplier, and currency fluctuations of various countries etc.

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SUBSIDIARY COMPANY

• Some of the big organizations create subsidiary companies for producing goods which are consumed by them.

• For example, a large cement company may establish a refractory manufacturing company or a paper bag factory.

• Refractory is regularly used in repair and maintenance work where as paper bags are used for packing cement.

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MERITS & DEMERITS OF PURCHASING FROM SUBSIDIARY

Merits: • To have an assured source of supply.• Efficient and trouble free operations.

Demerits:• They often become burden on purchasing department:

– Firstly, at times their quality of the product is to be tolerated even though this may not pass all the tests.

– Secondly, their prices may not be competitive– Thirdly, service may not be as efficient as if these were obtained from

competitive market.

• Number of organizations have realized that purchasing from subsidiary may be beneficial only for some period but on long run, and the subsidiary should be left to open market competition.

• This way, the subsidiaries will be under pressure to perform and give professional services at competitive prices or else face closure.

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RECIPROCAL PURCHASINGA SIMPLE TWO WAY RECIPROCITY

Organization A Organization B

Org. A buys the product of Org. B

Org. B buys the product of Org. A

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THREE WAY RECIPROCAL PURCHASING

Cement PlantSteel Manufacturing

Company

Switchgear Manufacturer

Cement

Steel

Switchgear

Cement plant induces switchgear manufacturer to buy steel items from the particular steel mill.

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ADVANTAGES OF RECIPROCAL PURCHASING

• Real advantage comes to sales. • Greater volume of sales under buyer’s market

conditions.• Reciprocity of purchasing helps to the high-

cost-producer, inefficient or incompetent distributor, weak sales plans and organization.

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DISADVANTAGES OF RECIPROCAL PURCHASING

• Purchasing becomes less selective by loosing the freedom of choice among suppliers.

• It is against the principles of scientific purchasing by not purchasing from the most favorable supplier.

• It looses the benefit of competition among the suppliers, who become aware of the negligible opportunities to share the market.

• Purchasing looses the negotiation power due to little competition prevailing.

• This is not a healthy way of purchasing as it is done by attempting coercive tactics on suppliers, to buy their products or of their subsidiaries, under the threat of withdrawing their business from the suppliers.

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SUGGESTED POLICY FOR RECIPROCAL PURCHASING

• Reciprocal purchasing should not be adopted blindly ignoring the inherent disadvantages in this policy.

• Reciprocal purchasing should be resorted after all the aspects are evaluated judiciously and analytically, with an assurance that its advantages are real rather than apparent.

• In some cases, reciprocal purchasing has been found counter productive and therefore should be avoided to the extent possible.

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CREDIT PURCHASING

• To have better liquidity, companies prefer deferred payment e.g. 75 days after receipt of material at site.

• Success of any purchasing manager lies in obtaining credit payment terms, as much as possible, which depends largely upon the dealings of the company with the supplier.

• In some cases, suppliers may insist on other terms of payments such as Cash against documents (CAD), Letter of Credit etc..

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CASH PURCHASING

• Small value items should be purchased without following the long purchase process.

• There may be special circumstances, when the stock items may be required at short notice. It is preferable to buy such items of small value through cash.

• Non-stock items of small values are normally purchased when required and therefore should be purchased through cash.

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CONTRACT PURCHASING

Under a contract, the seller promises to sell goods or provide services under certain agreed-upon terms and conditions, and the buyer promises to pay the agreed-upon price for those goods and services.

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ADVANTAGES OF CONTRACT PURCHASING - 1

• The vendors are more interested in a long term arrangement or for a large work.

• Due to large volume of work involved, the buyer is able to get very competitive and attractive prices and good services.

• The buyer is forced to plan extensively in consolidation of work, which ultimately helps in better performance.

• Better control over deliveries of materials / services.• Vendors with better resources are involved, who

provide better services.

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ADVANTAGES OF CONTRACT PURCHASING - 2

• Better control over quality of goods/services.• No need to pay day to day attention in procurement

of materials/services. The buyer can devote his attention on other issues.

• Contract finalization normally involve all relevant departments and top management. Better decisions are made with the involvement of various experts.

• Contract develops a strong relationship between buyer and seller and both the parties work as partners.