Dr Rovel Shackleford Procurment Fundamentals june 2011

Objectives (1)1. Identify the impact purchasing has on the organisations balance sheet2. Identify an applicable code of ethics for buyers3. Compare the BoB’s purchasing system and procedures to those of industry and commerce.4. Explain the need for for accurate, detailed information.5. Identify the character of various supply markets.6. Plan an approach to suppliers.7. Plan and conduct a survey of potential suppliers.8. Analyse a suppliers capabilities and capacity9. Rate a suppliers performance

Objectives (2)10. Compare and contrast cost and price analysis11. Perform cost analysis12. Perform price analysis13. Select a supplier14. Communicate a supplier selection result15. Recognize how a contract is formed16. Describe the elements of a contract17. Define common trade terms18. Explain how to change a contract once it is made19. Identify when to seek advice and help in contract matters

The Five Rights of PurchasingThe specified equipment, material, supplies andservices must be obtained:In the...............................................Right QuantityWith the...........................................Right QualityAt the ..............................................Right TimeDelivered to the ..............................Right PlaceAll of which should be achieved atthe..................................................Right Price

Challenges in PurchasingUnderstanding End User RequirementCost ContainmentCost ReductionValue EnhancementService Delivery - Balance Cost Quality

Effect of Purchase Savings on ROI Sales $20 m Investment Turnover Divide d B y 2.1 Total Assets $9.1 m ROI M ultiplie d B y 10.5% $1.3 m Sales 13.6% $20 m or 29% Profit Other CostsImprovement $1 m M inus $8.4 m Profit Margin Divide d B y Total Costs 5.0% P lus $19 m (6.5%) Sales ($18.7 m) Purchases $20 m $10.6 m ($10.3 m)

Net Profit Versus Purchasing SavingsAt 5 % Net Profit Margin, an Organization needs :$20 of sales to generate$1 contribution to the balance sheetWhereasEvery $1 saved by purchasing is a$1 contribution to the balance sheet

Characteristics of a ProfessionA Body of knowledge and/or principlesResponsibility to clients or employerA code of ethicsExchange of information

Code of EthicsConsider the Organization’s Interests FirstBe Open to AdviceObtain Maximum ValueObtain Knowledge of all ProcessesBe Honest, Avoid Sharp PracticeBe Courteous and Professional in all DealingsRespect the Obligations of all PartiesAssist Other Commodity Officers and Organizations

Conflict of Interest Employees must be careful that their interests are not in conflict with their organizations interestsOutside Employment and Other Activities Keep all outside activity totally separate from your organizations work Not undertaking outside work without approval Ensure outside activity does not involve use of your organisations information, property, funds, materials, systems or time Avoid outside activity likely to affect your performance or conflict with your organisations interests

Conflict of InterestDealing with Suppliers Business is awarded strictly on suitability, quality and price Avoid relationships with current or potential suppliers that may be seen as influencing your judgement Be careful in accepting gifts - restrict to nominal value items only Do not solicit expensive hospitality, concessional travel, gifts or loans If you accept a meal or a few drinks in interests of normal business courtesy, return the compliment as soon as practical If in doubt on any matter seek advice from your manager or the organization’s Ethical Standards Committee

Stages of PurchasingRecognition of NeedProcurement/Requisition PlanningSupply Market AnalysisRequisitioning MethodOffer or Bid AnalysisOrder or ContractContract/Supply Management and review

Information to be Shown on RequisitionAdequate Description of Item Service to bePurchasedRequired Delivery DateDelivery PointSpecification - Minimum RequirementClear Statement of End UseEstimated Cost/Budget (Optional)Inspection RequirementsConfidentiality Requirements (Optional)

Supply Market DynamicsThree fundamental types of competitionPureMonopolyImperfect

Types of CompetitionPure CompetitionForces of supply and demand alone determine prices not the individual actions of buyers or sellersMonopolyOne seller or selling group controls the entire supply of a particular commodity and is free to maximise profits by regulating output

Types of competition (2) - Imperfect competitionEssentially two types: Markets characterised by few sellers producing relatively few different products. – Automobile, steel, cigarette industries are examples of this oligopoly situation. Market characterised by many sellers producing many products. – Sellers spend much money and effort to persuade buyers their products are different. – This is the market for the majority of products in developed contracts.

Locating a Supplier - SourcingExperience MemorySupplier FilesTrade MagazinesCataloguesDirectoriesSales RepresentativesPeersTrade Commissioners at Embassies and ConsulatesBanks International Trade DepartmentAdvertising - TenderingChambers of CommerceTrading Houses

Supplier AnalysisManagement CapabilitiesQuality Standards - PerformanceTechnologyPhysical FacilitiesFinancial Capacity

Supplier AnalysisCapacity Plant, Machine and or Service Capacity HR Manpower Capacity Order BookingsTechnical Capabilities Staff Machine Quality Standards Field Service Customer Reference

Supplier AnalysisSecurity Raw Materials Licences Against TakeoverSupplier Financial Strength Balance Sheet Review Mercantile Reports Customer References

Supplier AnalysisAdditional Checks Plant Visit and Audit Qualifications of Key Staff Validated Patents Licenses Held Insurances Held - ExpiryDate

Weighted Point Rating System1. Establish rating factors2. Determine relative importance3. Compute values Example : Quality = 40 Points Price = 35 Points Delivery = 25 Points

Relationship of Price to CostA Fair Price: Will the lowest price that ensure a continuous supply from a vendor who is making a reasonable profit The buyer must always try to ascertain what is a fair priceMeaning of Cost Price is one element of cost Cost includes transportation, handling, storage, and also quality, service and obsolescence

Cost and Price Issues for Consideration (1) Competitive Bid - v - Single Bid ? Is the Business Base Loaded for Supplier ? Should Full Cost Disclosure be Requested ? Should Supplier Help with Life Cycle Costing ? Can the Learning Curve be Applied ?

Cost and Price Issues for Considerations (2) Where Should Order be Placed in the Distribution Chain ? Is There an Imported Content that Lends Itself to Preferential Treatment ? Is There the Possibility of Further Orders ? Is the Organization to Finance Research, Tooling or Development ? Should Penalties for Non Performance be Considered ?

Cost BreakdownDirect Costs Are those which can be specifically and accurately assigned to a given unit of production/serviceIndirect Costs Are those incurred in the operation of a production plant or process but which normally cannot be related directly to any given unit of production For example, rent, property taxes, machine depreciation and so on

The Essential Elements of a Contract1. An intention by the parties to create a legal relationship2. An offer made by one party and accepted by the other party3. Valuable consideration4. Legal capacity of the parties to enter into a legal relationship5. Genuine agreement and consent by the parties6. Legality of the objects of the agreementAll of the above elements must be present for a contractto be valid

Rules of Acceptance1. Must be communicated to the offerer or the offerer must have dispensed with notification thereof2. Must be unconditional3. Must be made in the way specified/prescribed4. Can only be given by the party or parties to whom the offer was made5. Cannot be revoked without the consent of the offerer6. Must be made within the time prescribed, or if no time prescribed, then within a reasonable time

Consideration1. Is essential in every simple contract2. Must have some value, but courts are not concerned as to its adequacy3. Must not be illegal or unlawful4. Must be definite5. Should be present or future, but not past6. Must be possible of performance7. Must move from the promisee8. Must amount to something more than the party is obliged to already do

Additional Considerations for BuyersInadvertent formation of a verbal contract during negotiation.The relevant strength of contractual clauses.Conditional and warranty clauses and remedies for breach.Use of functional specifications to enhance protection underconcept of merchantability.If possible include functional specifications as an adjunct totechnical specifications.If progress payment are to be part of a contract ensure thepayment are linked to identifiable completed stages of aproject and that a suitable passing of title clause isincorporated into the order.

Supplier Performance AnalysisPurpose: Improve Performance of the Supplier.Benefits: Better Information for Decision Making. Fair Judgement on Competing Bids. Aid to Supplier in Improving Performance. Basis of Dropping Poor Suppliers.

The Three Basic Systems1. Categorical - Generally too basic.2. Cost Ratio - Data collecting too onerous for most organisations.3. Weighted Point - Most commonly used.

The Five Rights of Purchasing & the Weighted Point System 5 Rights Weighted Point Right Quality - Quality Right Price - Price Right Quantity - Delivery Right Time - Delivery Right Place - Delivery

Weighted Point Rating SystemThe Steps1. Establish rating factors2. Determine relative importance3. Compute values

Weighted Point System - ExampleQuality = 40 PointsPrice = 35 PointsDelivery = 25 Points 100 Points

Quality Lots Lots Lots Percentage Quality Received Accepted Rejected Accepted x Factor Control RatingSupplier A 60 54 6 90.0 40 36.0Supplier B 60 56 4 93.3 40 37.3Supplier C 20 16 4 80.0 40 32.0

Delivery Promises Kept Service Factor Service RatingSupplier A 90% 25 22.5Supplier B 95% 25 23.8Supplier C 100% 25 25.0 Service rating = Promises kept X Service factor

PricePart A Unit price discount Transportation Net price chargeSupplier A $1.00 10% $0.9 $0.03 $0.93Supplier B $1.25 15% $1.06 $0.06 $1.12Supplier C $1.50 20% $1.20 $0.03 $1.23Part B Lowest Net Percentage x Factor = Price price price ratingSupplier A $0.93 $0.93 93/93 100% 35 35.0Supplier B $0.93 $1.12 93/112 83% 35 29.1Supplier C $0.93 $1.23 93/123 75.6% 35 26.6

Composite Rating Rating Supplier A Supplier B Supplier C Quality 36.0 37.3 32.0 (40 Points) Price(35 Points) 35.0 29.1 26.6 Service 23.8 22.5 25.0(25Points) Total Rating 93.50 90.20 83.60

Factor Guidance Scale 100 94 - 99 87 - 94 Under 87 (Needs (Excellent) (Good) (Fair) investigation) Quality 40 38 - 39 36 - 37 Under 36(40 Points) Price(35 Points) 35 33 - 34 31 - 32 Under 31 Service 25 23 - 24 21 - 22 Under 21(25Points)

Purchaser - Supplier Satisfaction Model (0.10) (5, 10) (10,10) Satisfied Purchaser Dissatisfied Purchaser Satisfied Supplier Satisfied Supplier Satisfied C ASupplier Marginal (0,5) (10, 5) (5, 5) Purchaser Dissatisfied Purchaser Satisfied Supplier Dissatisfied Supplier Dissatisfied A C Dissatisfied Dissatisfied Marginal Satisfied Purchaser

Extended AnalysisManagementQualityPriceDeliveryTechnology

Elements of ManagementOrganisational StructureIndustrial StabilityResponsiveness

Elements of Quality1. Use of Statistical Process Control2. Quality Standards IS0 90023. Problem Responsiveness4. Utilisation Of Statistical Process Control.5. Problem Reporting And Resolution.6. Notification Of Changes.7. Record Retention And Control.

Elements of Price1. Globally Competitive2. ProductivityService Offsets3. Cost Reduction Program4. Price Control5. Long Term Contract Agreement6. Product Development Cost Disclosure7. Logistics

Elements of Delivery1. Supply Performance Against Schedule2. Notification Of Impending Problems3. Effective Contacts4. Valid Lead Times5. Invoice And Packing Accuracy6. Inventory Control7. Electronic Data Interchange8. Manufacturing Resources Planning

Elements of Technology Access to Technology Prototype Support Research and Development

Degrees of Importance to an Organisation (Example) Purchasing Technical AverageQuality 20 60 40Delivery 40 10 25 Price 50 20 35 110 90 100

Quality - Example Elements Weight Score Score1. Use of statistical process control 10 102. Problem responsiveness 10 53. Achieved ISO 9000 Standard 20 10 Total 40 25

Delivery - Example Elements Weight score Score1. Performance against schedule 15 152. Flexibility to schedule changes 5 43. Inventory control 5 5 Total 25 24

Price - Example Elements Weight score Score1. Competitive - Global 10 52. Price Cost - Disclosure 5 53. Absorption - zero economics 10 10 4. Productivity offsets. Minimum 2.5%/Yr 10 7 Total 35 27

Supplier Continuous Improvement Program (An example from a motor vehicle manufacturer) Process•The team will conduct a preliminary internal assessment of the suppliers performance, quality,cost, delivery and technology.•The team visit will consist of members from the company’s supply and quality assurance.•Where there is limited knowledge of an element, the team will rate the element as zero “with anasterisk”. This element will be reviewed during the arranged team visit.•Prior to the team visit, the preliminary assessment will be provided to the supplier for review anddevelopment of an action plan which will be focussed on continuous improvement.•The visit will include a tour of supplier’s facilities and the preliminary assessment will be used asthe basis of discussions with supplier senior management.•During the team visit the supplier will provide a timed action plan for continuous improvement andidentify any elements that require further clarification.•The team will reconvene at and any additional supplier information will be considered to finalisescores.•Revisions will be formally notified future assessments will be conducted as required.•The ratings achieved against the performance standards will predicate future business

Supplier Continuous Improvement Program Definition of Elements - Management1. Effectiveness The suppliers management team will demonstrate effective control of the key business elements of Management, Quality, Cost , Delivery and Technology.2. Viability The suppliers management team must ensure the companys viability is sustained to provide continuity of supply.3. Committed to the customer. The support and active participation in the supplier continuous improvement process will be the measure of the supplier management team commitment.4. Continuous improvement philosophy The suppliers management team will engender the philosophy of continuous improvement in the pursuit of excellence.5. Business plan The suppliers management team shall develop and provide a long term business plan and progress report which will embrace, but not be limited to the Supplier Continuous Improvement Programme elements.6. Communication The suppliers management team will have an effective communication system that implements two way communication between management and employees.7. Responsiveness The suppliers management team must be responsive to the customer’s requirements.

Supplier Continuous Improvement Program Definition of Elements - Quality8. Utilisation of Statistical Process Control :- The supplier assessment is based on the utilisation of S.P.C. techniques to control process outcomes.9. Process Control Plan (PCP): The supplier assessment is based on the establishment of approved P.C.P.s, conformance, and notification of pending changes.10. Material Identification And Control The supplier assessment is based on the identification and control of material during all stages of the process, indicating the quality status from receipt through to delivery.11. Problem Reporting And Resolution :- The supplier assessment is based on having in place a system to report and correct both internal and external quality problems.12. Drawing And Specification Control :- The supplier assessment is based on having an effective system for controlling the engineering drawings and specifications supplied to ensure only latest engineering data is being used.13. Sample Submission Process:- The supplier assessment is based on adherence to sample procedure and satisfactory conformance to the total submission.

Supplier Continuous Improvement Program Definition of Elements - Cost1. Competitive Global :- The suppliers assessment is based on being cost competitive in a global environment.2. Competitive Local :- The suppliers assessment is based on being cost competitive in a local environment.3. Piece Cost Disclosure The supplier will provide complete piece cost disclosure at the time of quotation and in subsequent price variations for all elements detailed in " Supplier Cost Analysis " format.4. Absorption (Zero Economics):. The supplier will have a control to eliminate the automatic flow on of cost increases.5. Productivity Offsets (2.5% PA.): The supplier will reduce the component selling price to by a minimum of 2.5% per annum.

Supplier Continuous Improvement ProgramDefinition of Elements – Cost (2)6. Reduction Program: - The supplier will have an active program to reduce product piece costs which will be shared equally between buyer and the supplier.7. Price Control :- The supplier will use effective systems to accurately monitor all cost elements.8. Long Term Contract Agreement: The supplier will have a proven record of Management, Quality, Cost, Delivery and Technology to be considered for a long term contract

Supplier Continuous Improvement Program Definition of Elements - Delivery1. Supply Performance Against Schedule :- The supplier will control resources in a manner that assures conformance to scheduled requirements.2. Flexibility To Schedule Changes :- The supplier will have the ability to accommodate positive/negative volume changes within the contractual lead time.3. Flexibility To Replace Material The supplier will have the ability to supply replacement material ensure production continuity.4. Notification of Impending Problems :- The supplier is responsible to contact Material Control in the likelihood of a delivery interruption.5. Flexibility Of Delivery Promises :- The supplier must provide timed and accurate information against critical shortages.

Supplier Continuous Improvement Program Definition of Elements - Delivery6. Responsive Recovery Programs :- The supplier will provide written recovery programs to cover behind schedule items and maintain production continuity.7. Effective Contacts :- The supplier must provide sufficient resources to return calls within a reasonable period from the initial contact with timely resolution of problems.8. Valid Lead Times :- The supplier will provide the necessary resources to achieve the contractual lead times.

Supplier Continuous Improvement Program Definition of Elements - Technology1. Product design and development A supplier is expected to have the resources to design and develop parts.2. Manufacture. design/.development A supplier is expected to have appropriate technical capabilities for the manufacturing design and development of parts and/or systems.3. Product testing facilities A supplier is expected to have the capabilities to perform all applicable performance tests on its parts or systems.4. Prototype support A supplier is expected to have the resources for prototype development.5. Research & development activities A supplier is expected to have the resources to undertake research and development activities.

Supplier Continuous Improvement Program Definition of Elements - Technology6. Manufacturing capability A supplier is expected to have the appropriate capabilities for the manufacture of parts and/or systems.7. Maintenance activities A supplier is expected to dedicate appropriate resources to maintenance.8. Tool design and fabrication A supplier is expected to provide appropriate resources and facilities for tool design and fabrication.

Inventories and the Flow of MaterialSupplier Purchased Work In Parts & Progress Material Customer Warehouse Demand Customer Warehouse Demand Customer Warehouse Demand

Objectives of Inventory ManagementA. Define and attain a desired customer service levelB. Keep inventory investment below a certain levelC. Support the achievement of specified workforce and equipment utilisation methodsD. Achieve a desired return on investment

Supply and Demand Considerations1. Demand pattern of item2. Production process at supplier3. Variability of supply and demand4. Marketing logistics5. Lead times6. Commonality of supply and demand sources

Functions of Inventory (1)Decouple demand and supply. Inventory is a buffer between:Customer demand and finished GoodsFinished goods and component availabilityMaterial required and the output of the precedingfor an operation operationMaterials required and the suppliers of materialsto begin productionThe user and variations in the cost of inventoryThe geographical and the geographical location of thelocation of the user supplier

Functions of Inventory (2)Fluctuation (Safety Stock)Anticipation (Seasonal)TransportationLot Size (Cycle Stock)DecouplingHedge

Logistics Chains Our Organization Purchasing Operations PlanningSupplier Supplier Supplier Supplier Distribution Transport

Impact of Inventory Investment Impact on Small Inventory Large InventoryCash investment Low HighCustomer service Low HighOrder costs High LowProduction set Low Highup costsTransport &handling costs High Low

Inventory Costs: OrderingRaising the RequisitionCompiling the OrderReceiving the GoodsPhysical InspectionProcessing the InvoiceRaising the Cheque

Example Inventory Costs: Carrying StockFinance 10 - 14% paOpportunity 3 - 10%Handling 1 - 2%Space 1 - 3%Damage 1 - 2%Shrinkage 0 - 2%Insurance 1 - 3%Physical Inventory 1 - 2%General Administration 1 - 2%Total 19 - 40% Per AnnumAverage Holding Time = 6 Weeks

Inventory Costs: Stock outExpediting CostsFreight PremiumsBack-Order ProcessingIntangible Costs such as LostOpportunity and End user Goodwill

Customer ServiceCustomer Service is HAVING ITEMS AVAILABLE WHEN NEEDEDThe customer is: User of a finished product/service Another warehouse The department performing the next operationObtain customer service target level for: The initial schedule Backorders (make to order only)

Inventory ManagementReduced Throughput Time Reduced Inventory Levels Frees up working capital Reduces Debt Reduces Interest Cost Improves Performance

Probability of On-Time DeliveryAssemble to order Lead Lead Time TimeOperation (Days) Probability (Days) ProbabilityOrder Entry 1 0.99 2 0.995Sub-assemblyavailable Item 1 0.99 0.99 Item 2 0.95 0.95 Item 3 0.98 0.98Picking 2 0.99 3 0.95Final Assembly 5 0.92 7 0.99Pack and Ship 2 0.96 3 0.99 10 days 80% 15 days 90%

Normal Probability Demand Distribution 34% 34% 14% 14% 2% 2% −3σ −2σ −1σ 0 +1σ +2σ +3σ

Levels of AggregationThe Three Levels of Aggregation Frequently Usedfor Classifying Inventory Management Decisions: A. The aggregate level B. The intermediate (group) level C. The individual item level

Aggregate Inventory ManagementFactors: A. Distribution plan B. Suppliers schedule C. Purchasing commitments D. Family/Item lot sizes E. Safety Stock levels F. Quantity discount/hedge purchase G. Transport modes

Principle of ABC Analysis: “Control the Vital Few”Establish levels of importance– 80/20 rule– other item characteristics Classify each itemApply the necessary amount of control

ABC Curve Percentage of Value -V- Percentage of Items100 90 80 70 60 50 40 30 20 A B C Items Items Items 10 0 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 10 0 Percentage of Items

Relative Measures of Inventory InvestmentA The Inventory Turnover Rate (ITR) 1. Historical (HITR) 2. Projected (PITR)B The Inventory to Cost of Sales RatioC Time Period Coverage

Essential Steps in Obtaining Accurate RecordsA. Demand accurate records. (Managements attitude determines how operating personnel view this objective).B Designate those responsible for each aspect of record accuracy.C Provide adequate tools.D Provide adequate training.E Establish accuracy goals and measure performance.

DemandDependent Subassemblies Calculated Components Requirements Raw MaterialsIndependent Finished Goods Forecasted Service Parts Requirements

Inventory Management ConceptsMatch Order Size Not matching Order Sizeand Timing to Use or Timing to UseTime Phased Non Time PhasedMRP DRP Periodic Constant Periodic Reorder point Review Two bin

The Periodic Review System ConditionsDemand is independentDifficult to record withdrawalsJoint ordersLimited shelf lifeFully utilising transport capacity

Periodic Review System Safety StockSS = SF * SD * (R + L) * FPWhere : Example :SS = Safety Stock Desired Customer Service = 0.95SF = Safety Factor SF (for 0.95) = 1.65SD = Standard Deviation S = 1.0 unit/day, thus FP = 1.0 dayR = Review Period R = 10 daysL = Lead Time L = 2 DaysSS = 1.65 1.0 (10 + 2)/1 = 5.71 = 6 Units

Order Point System Stock Versus TimeUnitsin Stock Independent DemandOP Q S L Time

Net RequirementsTotal Requirements Available InventoryGross Allocat- minus Scheduledrequire- + On Hand + ions Receiptsments equals Net Requirements

The MRP Process X 1 Product "X" 2 Master Schedule Lead Time = 4 Periods Periods 5 6 7 8 9 10 11 25 30 15Part "1" Inventory status Periods 0 1 2 3 4 5 6 7 8 On Hand 50 Gross Requirements 25 30 15 Allocated 10 Allocations 10 Part Master Data Scheduled Receipts Safety Stock 10 Safety Stock 0Lead Time 3 Periods Projected on Hand 50 40 15 15 85 85 85 70 70 Lot Size 100 Net Requirements 15 Planned Order Receipts 100 Planned Order Release 100

Pull & Push SystemsPull Systems Decentralised Warehouse submits order Stock is pulledPush Systems Centralised Warehouse requirements projected Available inventory allocated

Dr Rovel Shackleford Procurment Fundamentals june 2011

by Dr Rovel Shackleford

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