Purchasing

Purchasing is the act of buying the goods and services that a company needs to operate and/or manufacture products. Given that the purchasing department of an average company spends an estimated 50 to 70 percent of every revenue dollar on items ranging from raw materials to services, there has been greater focus on purchasing in recent years as firms look at ways to lower their operating costs. Purchasing is now seen as more of a strategic function that can be used to control bottom-line costs. Companies are also seeking to improve purchasing processes as a means of improving customer satisfaction.

THE TRADITIONAL PURCHASING PROCESS

The traditional purchasing process involved several steps—requisition, soliciting bids, purchase order, shipping advice, invoice, and payment—that have come to be increasingly regarded as unacceptably slow, expensive, and labor intensive. Each transaction generated its own paper trail, and the same process had to be followed whether the item being purchased was a box of paper clips or a new bulldozer.

In this traditional model, purchasing was seen as essentially a clerical function. It was focused on getting the right quantity and quality of goods to the right place at the right time at a decent cost. The typical buyer was a shrewd negotiator whose primary responsibility was to obtain the best possible price from suppliers and ensure that minimum quality standards were met. Instead of using one supplier, the purchaser would usually take a divide-and-conquer approach to purchasing—buying small amounts from many suppliers and playing one against the other to gain price concessions. Purchasing simply was not considered to be a high-profile or career fast-track position—when surveys were taken of organizational stature, purchasing routinely rated in the lowest quartile.

That attitude has changed in recent years, in part because of highly publicized cases wherein companies have achieved stunning bottom-line gains through revamped purchasing processes. In addition, increased competition on both the domestic and global levels has led many companies to recognize that purchasing can actually have important strategic functions. As a result, new strategies are being used in purchasing departments at companies of all sizes.

Analysts observe that in this new purchasing environment, a guideline known as the total cost of ownership (TCO) has come to be a paramount concern in purchasing decisions. Instead of buying the good or service that has the lowest price, the buyer instead weighs a series of additional factors when determining what the true cost of the good or service is to his or her company. TCO calls for closer attention to what else should be counted in addition to price. Categories include freight, warranty requirements, financing costs, tooling requirements, storage/inventory costs, disposal costs, and the like—but netting out scrap values.

To lower TCO, companies are taking a number of steps to improve purchasing.

STRATEGIC SOURCING

Strategic sourcing is one of the key methods that purchasing departments are using to lower costs and improve quality. Strategic sourcing involves analyzing what products the company buys in the highest volume, reviewing the marketplace for those products, understanding the economics and usage of the supplier of those products, developing a procurement strategy, and establishing working relationships with the suppliers that are much more integrated than such relationships were in the past. During this process, the team conducting the analysis should ask these questions:

• Why do we buy this product or service?
• What do we use it for?
• What market conditions do suppliers operate under?
• What profit margin do suppliers seek to obtain?
• What is the total price of purchasing from a particular vendor (in other words, the cost of the item plus the costs associated with quality problems)?
• Where is the good or service produced?
• What does the production process look like?

The products that are purchased in the highest volume will be the best candidates for cost reductions. That is because once those products are identified, the company can then justify the time and expense needed to closely study the industry that supplies that product. It can look at the ways key suppliers operate, study their business practices to see where the most money is added to the final cost of the product, and then work with the supplier to redesign processes and lower production costs. This maximizes the contribution that suppliers make to the process.

By knowing the market and knowing how much it costs for a supplier to do business, the purchasing department can set "target prices" on goods. If the supplier protests that the price is far too low, the purchasing company can offer to visit the supplier's site and study the matter. Such visits can occasionally spot problems in the supplier's operation that can help the vendor shave costs and thus lower price. Such "supplier alliances" can result in improved buyer/seller communication, improved planning, reductions in lead time, concurrent engineering, decreased paperwork, and better customer service.

The alliances also can sometimes register significant improvements in product quality. Buyers can build clearly-defined quality targets into their target prices. It will then work with the supplier to improve the manufacturing process until that quality target is met. Such a process can yield enormous benefits for buyers, including reduced inventory levels, faster time to market, significant cost savings, and reduced development costs.

Not all suppliers can meet the high standards demanded in this purchasing environment. Some studies indicate that companies that adapt strategic sourcing have lowered the number of suppliers they use by an average of nearly 40 percent. What characteristics make a good supplier, then? If the supplier is willing to partner, then analysts have identified several traits that good suppliers share:

• Commitment to continuous improvement
• Cost-competitive
• Cost-conscious
• Customer-oriented
• Encourages employee involvement
• Flexible
• Financially stable
• Able to provide technical assistance

Analysts indicate that suppliers receive some benefits in the emerging purchasing dynamic as well. Reduced paperwork, lower overhead, faster payment, long-term agreements that lead to more accurate business forecasts, access to new designs, and input into future materials and product needs have all been cited as gains. Other observers, meanwhile, point out that some buyer-supplier relationships have become so close that suppliers have opened offices on the site of the buyer, an arrangement that can conceivably result in even greater improvements in productivity and savings. Of course, companies are not going to form such "partnerships" with all of their suppliers. Some form of the traditional purchasing process involving bidding and standard purchase orders and invoices will continue to exist at almost every company, and especially at smaller companies that do not have the financial weight to make large demands on their suppliers.

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