10.

PURCHASING PRINCIPLES
The objectives and functions of the purchase department to fulfill responsibility of procurement in an orderly and efficient manner has been explained earlier. The effectiveness of the purchase department will be judged from how well these objectives have been fulfilled. To fulfill the objectives laid down the purchase department has to take right decisions about what, when, how, how much, from whom and at what price to buy or in other words decide about Right Right Right Right Right quality quantity price source time

The above factors are interdependent, and as such for right decision about the procurement of materials characteristics of each factor has to be considered and then advantages and disadvantages of each factor has to be weighed against the other. These decisions about procurement will not come automatically, but would upon certain underlying principles which are to be followed. 1. RIGHT QUALITY 1.1 Specifications of right quality losses its sense unless specified items are available at economical prices. Buying the specified items at higher prices may prove to be uneconomical. As such, in such circumstances efforts should be made to modify the quality specification. 1.2 For assurance of supply of right quality materials, supply sources should be developed; preferably nearly to reduce the transportation cost, quality control cost etc. Reasonably long term contracts also assures supply of right quality material. 1.3 Right quality definition deciding about the material ultimate cost of production machine hours should also be includes cost consideration. As such in being bought at a particular cost, the profitability, savings in man-hours or considered.

1.4 Purchasing by brand name (when specification is given in that fashion) reduces the problem of selection of right quality, but sets in rigidity of selection and price. This also at times, encourages

malpractices and gives the supplier an upper hand for delivery date and price. To bring in flexibility of selection and also development of sources, it is always a good practice to specify or equal in all specifications given by the brand name. 1.5 When the specification is too rigid or giving correct specification is rather difficult. Selection of sources of supply by sample method is good. This sample method also helps to compare quality of actual deliveries against the sample. 1.6 The selection of right quality material is simplified when specification are given in terms of market grades (e.g. Cotton) or formalized specifications (ISI, BSS etc.). 1.7 The selection of right quality material will be guided to a very great extent on close coordination with the quality control department carrying out incoming materials control. This department develops measures to test the quality and reports back to the purchasing department about rejections and deviation from the set specifications. 1.8 Value Analysis helps in attaining the right quality. Similarly through Standardisation of materials to be procured, much can be contributed towards procurement of materials of Right Quality (These two aspects are dealt separately). 1.9 The procurement of right quality material depends to a very great extent on the specification. From the purchasers stand point, a satisfactory specification should have the following : Specification should state exactly, what is wanted clearly, definitely and completely. This is absolutely necessary for buying, as well as informing the supplier correctly. Wherever possible specification should be linked with established standards. It should provide details or basic for testing deliveries for conformance with specification. It should avoid nonessential quality restrictions and rigidity. Flexibility is preferred so that it is open to competition and gets suppliers cooperation. It should be complete and specific in all respects and without loopholes which will permit evasions of its conditions. 1.10 We should remember that best quality need not be the right quality. Extra quality adds nothing but costs to the product. Purchase department should always scrutinize and compare the quality being bought by the competitors and bring it to the notice of the user

department. The purchase department being in touch with the market should also inform the user department A(design dept. etc.) about alternative materials that can meet quality requirements or about other difficulties in procurement in time, so that unnecessary time is not lost in design of product or development to f specifications.

2. RIGHT QUANTITY 2.1 The second decision a buyer must make, after determining the right quality to buy is how much to buy. In general the materials requisitions not only specifies the item but also specifies the quantity required. For project work or other non-repetitive item purchasing can be done on the basis of immediate need but for the great bulk of industrial purchase this is a cumbersome and uneconomical policy. 2.2 Buying quantities of material as per forecasted demands at time would relieve the buyer of botheration, but would definitely prove to be uneconomical considering the money locked up, inventory carrying cost, storage cost etc. Purchasing quantities therefore must maintain a balance with the operating needs and with the advantages of volume buying aided by the cushioning effect of an inventory reservoir of materials to which current purchases are added and from which currently needed quantities are withdrawn. So, as in the case of right quality, right quantity has the special meaning of quantity ot be purchased at a time keeping in view the economical gains and weighing it against the operating gains. 2.3 For buying the right quantity the following factors should be considered : 2.3.1 Use of Formula :- A number of practical working formula have been developed, to find out the most economical ordering quantity, considering the annual consumption, unit cost of item, inventory carrying cost, ordering cost, quantity discount, stock out cost etc. One such formula that has gained wide acceptance and has proved its effectiveness as a purchasing guide is

Q =

2AS ------- ; where I

Q = Economical Order Quality A = Annual Usage S = Cost of Ordering I = Cost of carrying inventory as a

Decimal percentage of inventory value The formula does not give effect to changes in the unit price of the materials or reflect the price advantage in of volume buying. This also does not take care of commercial practice in respect to unit packages, economical manufacturing quantities, full car load or truck load quantities, storage facilities, deterioration factors etc. However, the use of the formula acts as a guideline for deciding purchasing policy and substitutes factors for intuitive judgment. It establishes a definite relationship between the significant variable in the situation and eliminates the variables of personal judgment, so that quantity decisions are consistent and in accord with policy. For the great majority of stores and supply items the mathematical approach (with suitable modification to suit the need) can be relied upon. The use of formula shows the within reasonable variations of order size the total cost varies very little; beyond these limits the total coast goes up rapidly. This formula also shows ordering too little usually costs much more than ordering too much. To make the use of formula simple, help of monographs and ordering quantity table should betaken. 2.3.2 Effect of quantity discounts :- When quantity discounts are offered by athe suppliers for purchases in bulk quantities, the unit price of a material is reduced in successive stages as larger quantities are purchased. If the use of formula shows that E.O.Q. is close to the quantity at which supplier would give quantity discount common sense would dictate adjusting the quantity purchased so as to take advantage of this extra saving. But in other cases the lower unit cost extra investment and extra cost of carrying inventory over a longer period, to determine whether, the quantity discount offered really earns savings to the purchaser (vide appendix-II for example). 2.3.3 Apart from the above two factors the right quantity decisions will make use of : Rate contract, running contract, etc. where the buyer gets certain advantage of assured delivery, fixed price, less inventory at a time, greater flexibility of adjusting quantity ordered etc. Group purchase of items, so that total clerical cost is less and there is savings in transportation cost, package cost and handling cost. Open market purchases for those items which are readily available in the market so that total money locked up in inventory is less.

 Lead time of supply. Market fluctuations in prices, so that during periods of advancing prices purchased quantity is increased, while in periods of declining prices the quantity to be purchased is reduced. Storage facilities available. 3. RIGHT PRICE 3.1 The management judges the efficiency of the purchasing department on the basic of price paid for materials. Price no doubt is an important factor, but the price becomes meaningless unless it is predicted on adequate quantity assured delivery, reliability and continuity of supply and satisfactory commercial relations. So that right price of the material should be based on the ultimate cost of operation, not the invoice price. It should be one which bring the best ultimate value or return for the investment. 3.2 The factors which affect the prices are quality and quantity required; urgency of requirements; demand and supply of the material in the market; whether there is competition in the market or not; whether the requirements are standard or non-standard; whether the requirements are repetitive or not; whether the past business relationship was strained or not etc. 3.3 For arriving at the right price of materials, the following factors should be considered and analysed. 3.3.1 The purchaser should be familiar with the prevailing market price and market conditions. 3.3.2 Calling tenders to explore prices offered by different suppliers. Excessively high bid may clearly be out of line, but the lowest bid need not always be the right price. Other factors concerning price, quality and ultimate return for investment should also be considered. For calling tenders, specifications should be properly made and should not be so conclusive that only one supplier can supply the item. In deciding about the supplier to be selected, due weightage should also be given to the past performance. It should be remembered that calling tenders increases the price of the product and as such should be done only when necessary. 3.3.3 Price negotiation with the supplier, detailing every aspects of manufacturing cost, overhead material etc., helps in arriving at the correct price of the item. The supplier should be assured of a reasonable profit.

3.3.4 Right Price of the material should include the ordering cost, packing cost, handling and transportation cost, cost of damage, forwarding and clearing costs, interest in anticipation of delayed payments etc. and as such these should be analysed and added to the cost of the item. Local purchases, in general, reduces the above costs. Correct interpretation of supply and demand influence on price should also be made, to buy at right price. 3.3.5 Chances of increase in the manufacturing cost due to inferior workability should also be analysed. 3.3.6 Quantity discounts and other facilities offered by the supplier. 3.3.7 Trade relationship with the suppliers. Delayed payment to suppliers at times forces the suppliers to increase the prices.

4. RIGHT SOURCE Steps :- Selecting the right source of supply involves the following four stages 4.1 Survey Inquiry Negotiation and Selection Experience and Review

Survey :- This phase of the process collects the data about the various suppliers and the list of materials they will be able to supply. The probable source of this data may be (a) Trade Directories; (b) Regional Directories (Chamber of Commerce); (c) Telephone Directories; (d) Purchasing Agents and (e) Salesmen. Inquiry :- In this stage from the possible sources obtained by the previous stage, a list of acceptable sources are prepared. This is determined by examining vendors (a) production facility; (b) capacity; (c) financial stability; (d) product quality; (e) technical competence and analysing them whether the quality, quantity and reliability required can be attainable. The process of examining might be done by one or more of the following ways. Interview with Technical personnel of the suppliers. Examination and trial of samples. Personal inspection of the modernization

4.2

 4.3

Efficiency of the suppliers machinery.

Negotiation & Selection :- In this stage a decision is arrived at regarding the quality, service and price of the materials to be supplied from different suppliers. May systematic methods have been developed to aid these negotiations and a review of them in worthwhile in this context. Purchasing Cost Analysis : Purchasing is obligated to buy at the best price, so it has to find out for itself what the price is. Obviously the best price is the cost of best manufacturing method and best materials plus a fair profit for the supplier. Pre-pricing the many hundreds of parts that go into companys end product is exorbitantly costly and time consuming. Purchase analysis should operate selectively. For the most of the parts it simply calculates the difference in the cost of materials, labour, etc., between a new component and its former version. The cost difference is called variance. A variance between a current and previous parts is arrived at by costing out the differences in design, material content and any other element that affects the price. An absolute target price does not involve the previous part as a cost reference point. The purchase analyst should prepare a full cost breakdown for a part including cost of materials, direct labour, factory overhead, general and administrative expenses and profit. The overhead is precisely figured to reflect not only the size of suppliers plant but also the value of his capital equipment. The rate of vendors profit and general and administrative expenses are based on industry averages. From the various quotations most favorable ones are picked after evaluating the bids. Next the winning quotes are matched against target prices. If they do not agree buyers must negotiate with vendors either to reach the target price or to get from suppliers hand statistical proof that target prices are unrealistic. The final order prices are entered in the purchase analysis parts form and sent to Purchase Analysis for review.

4.3.1

 When a buyer meets or betters a target price, he is credited with a favourable negotiation; but if the exceeds the target price he is debited with unfavourable negotiation. 4.3.2 Target Pricing This is similar to the Purchasing Cost Analysis; only difference being the value engineering and cost reduction techniques are mingled to arrive at a target price. Also, how much it would cost if it is made is also estimated to help make or buy decisions. Value analyse each part giving consideration to design, and process alternatives which might reduce costs without compromising function. Cost analysis of each part and selection of vendor whose machine capability meets the demands of a particular job. The number of components often dictate the kind of equipment that is economical. For e.g. Take Screw Machine Parts Quantity 200 200 2000 2000 Get quotations. Compare with target and send a feedback form if all quotations are over target. Get suppliers cost breakdown. Negotiate on those breakdown costs. 4.4 Experience and Review :- This is a stage where the information about the suppliers supplying the materials are fed back to review the list of suppliers and the materials they supply. One of the practices is to prepare an approved list of suppliers from this data which will be reviewed periodically. This review of approved list is being done new-ddays by some scientific methods viz. (a) Vendor Rating; (b) Incoming Material Rating. Economical Machines Hand Screw Machine Single station automatic screw machine Multiple station automatic screw machine

5. RIGHT TIME 5.1 For regularly used or recurring items, the right time for purchase would be when the stock reaches the minimum level. In other type of requirement right time of purchase should the time at which the material is required. But in both the above assumption, type of market, price fluctuations, cost of transportation, advantages of bulk purchase, probability of increase of consumption rate etc., has not be given considerations. In actual practice, selection of right time must analyse the advantages derived out of these factors and weigh it against buying only when stock is minimum or just when material is required. 5.2 Prevailing market conditions may lead to one of the following basic timing policies : 5.2.1 Hand to mouth buying :- This practice of buying is adopted to satisfy current operating requirement in quantities smaller than those normally considered economical. 5.2.2 Forward buying :- The practice of buying materials in a quantity exceeding current requirements, but not beyond actual foreseeable requirement. 5.2.3 Speculative buying :- It refers to the buying of materials in excess of foreseeable requirement in anticipation that a need will arise for the material and the firm will profit by making a purchase at the current price. Opportunities for purchases arise when the market drops temporarily and the buying firm has sufficient working capital to finance in speculative investment. There is always a certain amount of risk involved in speculative buying and the ethics of this involved in buying are controversial. 5.3 The buying time is referred to as Lead Time and consist of 3 components, viz: 5.3.1 Internal processing time :- The period from the time of indenting to the time when a purchase order is placed. 5.3.2 Delivery time :- The period from the time the purchase order is placed to the time the materials are received in the Goods receiving stores.

5.3.3 Internal clearing time :- The time taken for the packages to be cleared, opened, inspected and moved on to the stores to be ready for use by the consumer departments. Of the above 5.3.1 and 5.3.3 are within the control of the management and efforts should be made to reduce it. 5.3.2 would be assured by proper selection of sources advance planning and better follow up procedures.