Chapter Two Procurement

By Brandon Henderson,2014-04-05 22:24
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Chapter Two Procurement

    Chapter Two


    Basic Requirements:


    Major Points:


    Difficult Points:


2.1 Definition

    Procurement is the process of obtaining all the goods and services required by an

    organization from external sources. The aim is to obtain the bought-in goods and service at the

    lowest possible total acquisition cost. This does not mean simply the lowest possible purchase

    price, though that is the starting point.

    In fact, the total acquisition cost involves a complex mix of factors such as the following 1) Best purchase price commercially available

    2) Hidden costs of stockholding and internal administration

    3) Cost of poor quality and late delivery

    4) Loss of interest on early payments

    5) Operational and maintenance cost

    6) Costs arising from a negligent or failed supplier

    7) Costs of disposal and/or recycling.

    At a more strategic level, it includes the following activities

    1) Analysis of conditions and opportunities in the supply market

    2) Evaluation of potential suppliers

    3) Calculation of total cost of acquisition

    4) Joint responsibility with users for agreeing specifications

5) Development of sourcing strategies.

    A table about the condition of the enterprise finance affair would illustrate the function of the lever theory. Suppose our aim is to double the profit. The enterprise’s total sale is a hundred

    million dollars, while the profit is five million dollars. 60% of the sale is for the bought-in goods and service, the rest cost includes labor services, salary and the general management cost. The problem is: how much should we increase or reduce on the sale amount, products prices, labor services, salary and the general management cost, or the procurement amount so as to improve the profit from the present five million dollars to ten million dollars?

    Table 2.1 lists the changing ranges of each item for the improvement of profit. We can see from it that except for price, all the rest items should experience a large range of changes in order to double the profit. Even for the single item of price, the severe market competition would make the rise impossible. When it comes to the cost, though it’s impossible for us to control the major part of the cost of the procurement, it’s usually possible to reduce the cost significantly through

    some simple devices. For instance, we can ask two suppliers to bid for the same products, cooperate closely with the suppliers to control the cost, take advantage of the quantity discount by the suppliers, or choose carefully the sources of products, transporting routs, transporting methods, etc.. An insignificant percentage of the reducing in those aspects would realize a significant drop in the absolute cost and increase in the profit.

    Labor General

     Sale Price Services and Management Procurement

    Salary Cost

    Present +17% +5% -50% -20% -8% Value

    Sale 100 117 105 100 100 100

    Bought-in Goods 60 70 60 60 60 55 and Service

    Labor Services 10 12 10 5 10 10 and Salary

    General 25 25 25 25 20 25 Management Cost

     Profit 5 10 L0 10 10 10

    Table 2.1: An example of improvement in profit by means of lever theory

    The importance of procurement not only lies in its function in the improvement of profit, but also the lowering in the base of an enterprise’s capital by a lower purchasing price, and thus allowing

    the improvement in an enterprise’s capital return percentage to overweight the lowering in the

    price. For instance, suppose the total sale in the above example is 100 million dollars, total

    cost is 95 million dollars, while capital of the enterprise is 50 million dollars, 20 million of which is inventory. The cost of bought-in material occupies 50% of the sale. According to the following Modal of Standard Capital Return Rate of Table 2.1(Unit: 10,000 dollars):

    Figure 2.1 A Model of Procurement Capital Return Rate

    How much would be the rise in capital return rate if purchasing price could drop by 5%? Due to the function of lever theory, such a small range of changes in price would increase the profit by 50%.On the other hand, the drop in price would make the inventory value drop to 95% of the original; when purchasing price drop by 5%, total capital would drop 5000×5%=2.5million dollars, profit would rise to 7.5 million dollars, total capital would thus change to 92.5million dollars, gross profit rate 7.5%, inventory 19million, total capital 49 million, capital base of the enterprise would be lowered, and the turnover speed would then rise from the original 2.00 to 2.04, capital return rate from 10% to 15.2% with a rise of 53%.

2.2 Application of Procurement Systems

    Procurement systems can enable the integration of procurement actions with those of the wider logistics functions .Computerized procurement systems have been developed and implemented using purchasing software, MRP and MRP II software, electronic data interchange (EDI), enterprise resource planning (ERP) software and supply chain management (JIT) software.

    Enterprise resource planning (ERP) automates the tasks involved in performing a business process and gives them transparency across the whole organization. For example order fulfillment involves taking an order from a customer, delivering it and invoicing for it. Modules within the ERP system can include customer-relationship management, supply-chain management; demand

    planning, component management, product data management, and transportation management

    Automatic planning and scheduling (APS) is generally a module of an ERP or MRP system, which gathers and analyses data on sales, purchases, production and inventory to ensure that the right materials required for the production process are always available at the right time.

    Just in time (JIT) is a philosophy which minimizes stockholding by matching deliveries to the point in time when they are required for consumption. It is most applicable to manufacturing where specific quantities and quality of parts are required for production lines. JIT relies on the co-ordination of production and purchasing to ensure synchronization of supplies and manufacture. Control right through the supply chain is key because the supplies must be of the right quality and quantity, as well as being delivered at precisely the right time. Electronic data interchange (EDI) enables direct electronic links with suppliers but this is now being superseded by Web-based e-procurement systems.

    Because there are many buyers and many suppliers, all in different supply chains and relationships, there are various options as to location for e-procurement systems. In the sell side model, the supplier mounts software that enables each buyer to browse and purchase. This could be a single supplier or consortia. In the buy side model, the suppliers have to bring their offerings to the buyer. Marketplaces are where third parties set up an electronic portal to connect buyers and sellers.

    This is called the marketplace mode or portal model or, when it serves a vertical market,

    the vortal model. All these e-procurement options rely on the creating and maintenance of electronic catalogues and an interface or integration with internal computer systems. The online auction allows suppliers to tender in a transparent process managed by the buyer or its agent, and buyers can use standardized criteria for making purchasing decisions in automated auctions. The move to trading networks and multiple supply chains, along with the transparency created by the instant exchange of information, will fundamentally alter buyer-seller relationships.

2.3 Procurement Planning and Specifications

    Procurement planning should generate the necessary information to formulate procurement plans. A procurement plan may include the following:

    1) Schedule of required goods and services with estimated quantities and required delivery dates (linked to supply lead times);

    2) Contracts requiring renewal with expiry dates and lead time for renegotiation.

    A contract plan for a specific contract must allow adequate time for pre-contract or upstream contract activities, such as: risk assessment, strategy development, identifying and evaluating

    potential suppliers, issuing and receiving tenders, evaluating tenders and drafting the contract.

    In formulating these plans, procurement must be mindful of the requirements placed on suppliers, such as time allowed for return of tenders. Once a contract has been placed, procurement must ensure that agreed contractual requirements are incorporated into the overall plan. Supplier performance can then be measured against this.

    Specification is a description of what a customer wants from a supplier. The purpose of a specification is to communicate to a supplier what is required, so that the product or service supplied meets the needs of the organization. Specifications can be: simple, for example if they relate to products in everyday use; complex, for example for services with performance standards and performance monitoring requirements; framed in such a way as to allow the supplier to provide innovative solutions rather than being expressed as a detailed design. Unclear or incorrect specifications can result in the following problems. Quality defects and Products not performing the required task. There are different types of specification.

    There are three main types of specification. Detailed or technical; Functional and Performance.

    A detailed specification confirms the limits of compatibility or describes an item which has already been designed or has been prescribed. It should be used where there are complex and critical interfaces or where internal functions of a machine must be defined in order to avoid misunderstanding.

    A functional specification describes the task or desired result by focusing on what is to be achieved, without describing the method of achieving the intended result. It is used where there is no special consideration or any particularly sensitive processes that may need careful control to achieve an end result. Its content may include the following: Product characteristics; Level of quality; Level of safety. If a functional specification is used it means that: suppliers can offer alternatives; suppliers can offer a range of coasted solutions;

    A performance specification describes the required performance parameters by setting out details of operating inputs and outputs, without stating how this performance is to be achieved. Its content may include the following: Minimum/maximum levels of performance; Quality levels; Safety levels; Criteria and rules for measuring performance. The benefits of using a performance specification are the latest technological advances can be implemented; the supplier’s expertise is

    maximized and the suppliers are encouraged to achieve higher levels of performance.

    Additional technical information can be defined by reference to standards. These standards define products by a combination of their dimensions, performance, and design or safety requirements. The advantages of standardization are as follows:

    1) Removal of uncertainty as to what is required

    2) Purchaser avoids need to produce company specifications and correspondence to clarify


    3) Common comparison of quotations

    4) Saving in inventory and cost through variety reduction

    5) Reduced investment in spares for capital equipment

    6) Reduced cost of material handling

    7) Elimination of the need to buy by brand name

2.4 Contracting

    The contractual arrangements must be structured to match the particular requirement. The examples of different types of arrangement must satisfacts the following elements: spot orders; one-off purchase order; supply agreement or framework agreement; fixed price contract; contract with rates. Procurement is responsible for ensuring that the best fit commercial conditions are applied to the particular purchase.

    In applying contracting, procurement must take account of any relevant legislative requirements; for example, chemicals are subject to the COSHH (Care of Substances Hazardous to Health) regulations, and the Health and Safety at Work Act applies to the majority of purchases. Low-value purchases can be satisfied by the invitation of bids from a small number of suppliers, without the formalities and costs of tendering. Competitive tendering is a formal process involving the drawing up of an invitation to tender document made up of the following elements.

    Instructions to tenderer

    1) Form of tender

    2) Contract award criteria

    3) Technical specification

    4) Drawings

    5) Health and safety plan

    6) Pricing schedules

    7) Terms and conditions of contract

    Market Analysis

    In order to obtain the right goods and services, purchasing must know the supply market thoroughly. Supply market analysis involves obtaining information about potential suppliers, the

    nature of products, prices and economic forecasts. The information can then be analyzed and incorporated in a market intelligence system to provide knowledge and understanding of the markets being used. Many sources of information are very important in the market analysis. The following are

     some examples:

    1) The Internet;

    2) Web-based marketplace portals;

    3) Company directories and buyers’ guides;

    4) On-line databases;

    5) Current and past supplier records;

    6) Exhibitions and conferences;

    7) Supplier catalogues/brochures.

    Local, national or international markets may be used for sourcing. Issues that need to be considered in deciding which is best, include the following: need for just-in-time delivery; transportation costs; any rules of origin which may require a high percentage of local content; criticality of delivery and response times; location of the best-quality suppliers; standard trading practice in the product; the lowest-cost supply source; difficulties arising from global sourcing.

    Supplier Appraisal

    Supplier appraisal is undertaken before a supplier is awarded business and is designed to establish if a potential supplier is capable of meeting the organization’s requirements. Suppliers may be local, national or international. This distinguishes supplier appraisal from possible later stages of vendor evaluation and vendor rating, which relate to supplier performance after contract award. Supplier appraisal is essentially the collection and analysis of data and information about potential suppliers. Different organizations use different systems such as the following: 1) Supplier registration

    2) Approved supplier list

    3) Preferred supplier list

    4) Pre-qualification

    5) Qualification

    A key factor in supplier appraisal is to ensure that information used is current and up to date, so information needs to be updated regularly and decisions reviewed. Client benefits of supplier appraisal include the following:

    1) confidence in supplier

    2) supplier oriented to client business objectives

    3) supplier clear as to required performance requirements

    Supplier Development

    Supplier development means the provision of advice, finance, technology or other forms of

    assistance by the buyer to a supplier to enable the supplier to offer a product or service which meets the buyer’s needs, or to interface with the buying organization in a mutually appropriate

    way. Where suppliers are strategically important to an organization, supplier development programmers may be used. Supplier development is a practical series of steps, based on developing more effective relationships, designed to get the best out of a supplier.

    Supplier development is normally undertaken with existing suppliers that can be, and agree to being, improved. Suppliers are often selected for development as a result of supplier assessment or vendor rating. The use of this tool is determined by supplier strategy and will generally be targeted at those suppliers categorized as strategic. The supplier’s performance against agreed criteria must

    be measured in order to identify the scope for development at the outset and, once the development process has started, to monitor and manage improvement.

    Supplier development depends on good communication. Suppliers will tend to view any client initiatives as just another means of exploitation driving down costs and profit. The key

    starting point, therefore, is to have a clear set of objectives, which are agreed internally. This should then form the basis of explaining and selling the concept to the supplier. Once communication channels have been established they need to be kept open, using supplier newsletters, supplier conferences, supplier open days etc. Sharing information is very important. Buyer and supplier need to understand each other’s strategy and objectives. So, as well as sharing procurement plans,

    overall business plans should also be shared. This fosters a sense of shared objectives. Information that could be shared includes the following: market prospects, customer requirements, procurement targets and new initiatives.

    Supplier development is a specific mechanism which can be used to improve a particular aspect of a supplier’s performance. Supplier development teams will generally be multi-functional,

    so that they can look at all aspects of any particular process or initiative. It is essential to have a method of monitoring progress and establishing targets and timescales. For each supplier there should be an agreed series of milestones based on the factors being measured. Progress against these milestones can then be reviewed on a regular basis and, if necessary, revised targets agreed.

    Words and special terms

1module n..模数?系数?组件?舱

    2synchronization n. 同步?一致

    3consortiumconsortiapl n. 合作?联合?国际财团

    4formulate vt.用公式表示?系统地阐述?制定配方?按配方制造 5innovative a. 革新的?创新的

    6compatibility n. 和谐共存?适合?一致?兼容制 7formalities n. 拘泥形式?拘谨?正式手续?礼节?俗套 8monopoly n.. 垄断?垄断者

    9cartel n. 卡特尔

    10questionnaire n. 调查表?用调查表进行的调查 11overhead n. 企业一般管理费?天花板

    12option n. 选择?选择权?;供?选择的事物?买卖的特权?在规定


    13.entrant n.进入者, 新到者, 新工作者, 新会员, 大学新生, 参加竞赛者 14.aggressive adj.好斗的, 敢作敢为的, 有闯劲的, 侵略性的; 劲的, 侵略性

    15.appraisal n.评价, 估价(尤指估价财产,以便征税), 鉴定 16.desktop n [] 桌面;桌上型电脑

    17.criteria n.标准 intervals. 每隔一段时间?每隔一段距离

    19.current adj.当前的, 通用的, 流通的, 现在的, 草写的, 最近的

    n.涌流, 趋势, 电流, 水流, 气流

    20.up to date 直到最近的, 新式的, 现代的

    21.update v.使现代化, 修正, 校正, 更新

    22.mutually adv.互相地, 互助;

    23.vendor n.卖主;

    24.initiatives n.发端; 首创(精神); 主动; 积极性 25.exploitation n.开发, 开采, 剥削, 自私的利用, 宣传, 广告; 26.foster vt.养育, 抚育, 培养, 鼓励, (希望) ;n.养育者, 鼓励者; 27.milestone n.里程碑, 里程标, 重要事件, 转折点; 28.ERP 企业资源计划

    29.JIT. 准时制

    30.APS 自动行程计划

    3128.MRP 物料需求计划

    32.COSHH 有害物质控制

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